The purpose of the coursework is to undertake a critical analysis and an assessment of the level of competition in the insurance industry of the country of our choice. In my case, I have decided to explore the health insurance industry of the United States. One of our aims is to determine and discuss the market structure and the change in the level of competition in the sub-sector. We are expected to discuss different strategies, such as first-mover advantage, punishment and collusion, companies use in order to be successful in the industry for maximizing their profits and earning desirable market share. In addition to this, we need to analyze pricing strategy the insurers use and give relevant suggestions considering the nature of the market.
Competition in the US health insurance industry
Insurance markets are considered as sufficiently competitive in the US, especially in healthcare. However, it does not mean that the industry is perfectly competitive. Compared to production of the other types of insurers, health insurance sub-industry products are less homogeneous, which derives our attention to its unusual market structure. Even though there is an intense competition in the sub-industry, barriers to entry are still high with soaring market concentration year by year as has been examined by many.
In fact, we can even observe an existence of market dominants in certain geographic areas. These factors, to some extent, place us in a very interesting position, and therefore we rely on a critical analysis, of which I will try to conduct in a more detailed way in this section of my paper. First of all, I have to mention the fact that the US insurance industry is regulated at the state level, and regulation across the states varies significantly. This is one of the main reasons which contradict an existence of an intense competition, which exists within the country, but definitely not statewide.
In other words, highly regulated state insurance markets make competition less intense and therefore, highly concentrated. This can be observed on the first Appendix table, “Insurance Market Concentration: Ranked List (2007)”, provided by American Medical Association (AMA) and below given chart, by the Universities of Georgia and Connecticut professors, which shows Hirschman-Herfindahl index (HHI) estimated nationwide and statewide. Below chart demonstrates that interesting position we are in, where we have to HH indices (Hillard et al. 2008). But from this, we can derive a very clear, and accurate I believe, assumption that the US health insurers strive to take over statewide markets rather than dominating nationwide.
Based on the revenues of all operating insurers, the chart shows the range of approximately 250 – 550, where HHI indicates that unconcentrated nationwide health insurance market was increased over the given years. Nevertheless, average state HHI shows the market has extensively driven into highly concentrated zone over the years.
From this we can obtain a premise for previously given fact that rigorous regulations make insurers to pull out from the market. According to a nationwide survey by the Government Accountability Office, the median statewide market share of the largest insurer selling coverage to small business groups, which are small employer groups, increased from 33 percent in 2002 to 47 percent in 2008. It means that some small firms have been driven out of the market thus leading market share of largest firms to increase. It is worthy to mention that this is not only happening in few states but in the majority.
AMA reports that 94% of insurance markets in the US are now highly concentrated because of more than 400 corporate mergers, which happened in the past 13 years in the US health insurance sector. Some of them were acquisitions whereas others were mergers of firms in order to earn market share and power to be able to set prices and quantities they sold which maximized their profits. As a consequence, this led to more than 100% increase in premiums consumers had to incur, whereas average income of the US population had only increased by 29% over eight years, AMA stated.
High concentration in the market, as we all know, leads to market inefficiency, where insurers are able to set inadequate or unfairly discriminatory premium rates. Few oligopoly firms operating in the statewide markets are definitely to use market power for their advantages. These can be tightening barriers to entry what some of the US health insurers have been doing. For instance, large insurance companies like UnitedHealth Group, WellPoint and Aetna have been acquiring existing smaller health insurers without developing their own networks and products.
These acquisitions tend to decrease competition and thus making insurance market more concentrated. On the other hand, there are more of the few ways of getting rid of competitors, one of them being through cost-efficiency. As far as Choi and Weiss (2005) concerned, cost-efficient firms are able to minimize cost and thus charge lower prices than competitors, which enables them to capture larger market shares. This strategy tends smaller firms and those that are not cost-efficient to be driven out of the market and consequently increasing concentration in there.
As a result of consolidated oligopoly, a price leader is free to set prices which are not competitive enough if there was moderate concentration in the market or the unconcentrated one. According to the US Census Bureau, 16. 3% of the American population was uninsured in 2010. This number has risen from 13. 1%, which was accounted for 2000. This is more appalling in numbers, where there were only about 37 mln uninsured people in 2000 compared to approximately 50 mln in 2010. To see why there is a huge difference in these numbers we need to scrutinize the issue taking into consideration price effects.
Price is the main driver of consumer demand. Alongside, the US government has often been providing subsidies for health insurance coverage and this is another driver of demand, which is correlated with price elasticity. According to Congressional Research Service (CRS) 2009 report, older studies which were carried out before 1995 estimated price elasticity for the industry to be fairly large, ranging from 1 – 2. That would mean 1% increase in price would lead to a 1% to 2% reduction in the number of health insurance buyers, and vice versa.
With improved data and empirical methods, more recent studies find elasticity in the range of 0. 0 to 0. 4. What is the reason for demand to change gradually from elastic to inelastic over this time? In my opinion, the main reason for this is the importance of having the health insurance for Americans. At the current times when health care expenses are skyrocketing in the US, it is crucial for people to have health insurance because it would not be affordable for majority of population to cover all the expenses on their own. Secondly, the country’s health insurance market is highly concentrated.
Last but not the least reason as was mentioned before is the government subsidizes the health insurance through the tax system. Subsidies result in more purchase of health coverage but they should be in large amount in order to attract more potential policyholders. CRS reports according to the Joint Committee on Taxation (JCT) estimates, the federal government forgoes about $230 billion annually in tax revenue because of the exclusion of income tax for the portion of salary paid for health insurance. Analysis of the US health insurance market structure
Both N-concentration ratio and HHI has proven that the US health insurance market is highly concentrated. Statewide concentration index, compared to nationwide, is the main indicator because consumers would definitely go with local insurers as they are only ones to provide local health care networks. So that means highly concentrated state insurance markets, where the largest firms have captured median of approximately 50% market share, would formulate oligopolies. Market gives oligopoly firms opportunity to act as price makers rather than price takers.
This is observed from premium hikes over the years we have examined so far. Relying on AMA’s 2007 market share ranking, we can observe an existence of dominant health insurers in states like Hawaii, Rhode Island, Alaska, Vermont, Alabama, Iowa, Michigan and more others. Dominant firms set prices where their profits are maximized at MC equal to MR point, deducting smaller firm supply curves from industry demand curve. On the contrary, smaller firms just act as price takers or followers and try to maximize profits at price equals their MC.
However, the US health insurance sector is mostly based on competition on price rather than on the number of coverage insurers provide to policyholders. Kinked demand curve model, one of the models which describe the operation of an oligopolistic market, suggests that if one insurer raises its premium prices above the competitors’ price, then it ends up losing its market share while the other insurer(s) gains by deciding not to follow. Nonetheless, US health insurance industry is stringently regulated by the states, so insurers would have to get legal confirmation in order to raise premium rates.
According to OLR Research report, only Anthem BCBS, the largest insurer of Connecticut, has been requesting premium hikes within the state for the last five years and has been succeeding so far. On the other hand, Blue Cross/Blue Shield of Maine, insurer with almost 80% market share in the state, has been requesting rate hike for the past few years, of which the recent one of 18% increase request resulted in denial, HealthReform. gov reports. This is because regulatory bodies of the state of Maine considered the requested rates as “excessive and unfairly discriminatory” by regulations.
The existing regulations are one of the entry barriers for new firms to enter the market in many states, seen as in the previous example. Other than these, oligopolies can retain long-run supernormal profits. According to US Securities and Exchange Commission filings, profits of the country’s 10 largest health insurers in 2007 rose 428% from 2000 to 2007, from $2. 4 billion to $12. 9 billion. It is also worth mentioning that oligopoly is the market where there is high interdependence of firms competing in it. Thus any action undertaken by any of the insurers affect the market.
Obviously, largest firms with the most market shares have more influence on the market. Pricing insurance packages trigger the most competition, however. Larger firms gain advantage in this case, too. They are the ones who are more cost-efficient compared to other small firms. Therefore, they can easily play with the prices, in the short-run, in order to gain market share either by weakening smaller insurers or even making them dropped out of the market. Previous mergers, of which I mentioned earlier, can be perfect examples for this and I will examine them more in detail in the following section.
Strategies oligopoly firms use
Collusions, mergers and acquisitions
Oligopoly firms usually use different strategies in order to maximize profits. According to Britannica Encyclopedia, collusion is prohibited under US Sherman Antitrust Act. But it does not mean insurers do not engage in cartels and tacit collusions, though we do not have any reliable information about cases. One of the main reasons for the US health insurance market to become highly concentrated is the mergers and acquisitions which have been going on for the past couple decades.
Insurers engaged in mergers and acquisitions because they strived to enhance their market power, thus affecting the market to be more concentrated. According to CRS report 2009, at the end of the last century traditional insurers had difficulty of implementing managed care techniques, on which the modern US health insurance industry is built now, being unable to maintain consumer satisfaction and thus leading those insurers who managed to respond to changing market conditions to acquire them or merge as a way to gain the management capability to run managed health care plans more efficiently (Ginsburg, 2005).
This, as a consequence, led health insurance market concentration to increase gradually over the past years beyond US Department of Justice (DOJ)’s highly concentrated level of HHI=1800 and to reach maximum levels as was discussed in previous sections of the paper. AMA report by a senior attorney Henry Allen (Allen, 2010) shows the merger of United Group and Health Net brought together two of the five largest health insurers in Connecticut, with each having 12% market share or greater giving them more market power over their 3 main competitors.
The merger might lead to an arrangement of tacit collusion among other undermined insurers in Connecticut. This example is one of the smallest mergers which have happened. Another report by CRS shows, one of the largest insurers until 2004, Anthem acquired BCBS affiliates located in more than 10 states and ended up merging with Wellpoint, which had also acquired BCBS plans in many states. These kinds of mergers threaten anticompetitive harm to both consumers and health care providers, and are more damaging rather than just forming a cartel.
That is why the Federal Government alongside with state supervisory bodies tries to regulate mergers that are likely to harm consumer welfare. For instance, Blue Care Network and Health Plan of Michigan announced a merger, which would give them 81% share of the local health insurance market, and was immediately stopped by the Antitrust Division of the DOJ, reports AMA (Allen, 2010). Given the possible gain of large proportion of the market, the merger would injure competition significantly.
This would have resulted in higher premiums, a decrease in bargaining power of consumers, a reduction in the quality of health plans and even health care as a result of a high bargaining power of insurers with hospitals and physicians. By not allowing mergers, the Federal government and states regulate premium rates to be more competitive and the health care system to be more efficient and qualitative.
First-mover advantage in changing price plans in health insurance market depend on different factors such as, if the firm is price maker, dominant, market degree of interdependence, perfect knowledge and product differentiation. According to “Reference for Business”, first-mover advantage has three benefits, which are technology leadership, control of resources, and buyer switching costs (Lieberman & Montgomery, 1988). Combining benefits and those stated factors we can make a brief analysis of the first-mover advantage, though we lack credible information and data.
Each state has its few own price maker insurers and some even has even dominant insurers. Definitely, those are considered as first movers in changing prices of premiums. Nonetheless, those firms have to rely on efficiency of the strategy they are choosing, in order to make the most of the above stated benefits. One way to benefit moving first is through cost efficiency and this is the ability of an insurer to control its resources better than its competitors.
Relying on perfect knowledge, that is to say knowing the cost and demand functions, cost efficient insurers can offer better premium rates than those of competitors. But how does a healthcare consumer differentiate among several competing health insurers when their products, benefits and costs might be very similar? This is where consumers are “influenced by the perception of the company”, says Debra Richman, Vice President, Healthcare Strategy at Harris Interactive.
Insurers’ brand values, and customer orientation and loyalty play a key role in making purchasing decision for customers. So that means, as long as the first mover insurer sets premium rates at MR=MC and its demand is relatively less elastic than those of competitors because of brand and high market share, then the firms payoff will be higher than any other firm whether they follow the set price or not. This gives the insurer a dominant strategy. Technological advancement can also be first-mover advantage in changing price plans.
For instance, according to Healthcare IT News, WellPoint was the first to develop and implement e-prescribing program, which allowed physicians to forward patient drug prescriptions through the special created network (Enrado, 2004). Consequently, it helped to reduce the error rate physicians and pharmacist could make before. Through the technology, the insurer benefits reducing costs, and most importantly, improving patient safety. Adding this service to its coverage plans, Wellpoint has got a first-mover and competitive advantage over its competitors and thus it would earn more of the market share because of this.
Given this development to spread the market in a matter of couple years, Wellpoint would still have ability to maintain its leadership in pricing its products through cost-efficiency because of technology leadership it has over its competitors and would be able to have dominant strategy. However, there is a possibility that high costs incurred by developing the system might end up being first-mover disadvantage for WellPoint as well.
Punishment strategy usually observed and studied on duopoly markets, where two identical firms operate and collusions are observed. The strategy is used in a collusive game, where players, those are insurers, illegally collude setting quantity and price in a monopoly and/or cartel level maximizing their total profits. But there is always a room for any firm to cheat by producing more than the quota and having a considerable one time greater payoff than its competitor. If this is to happen, the cheater is punished by the other insurer by producing the initial cournot level of output, where both firms earn relatively smaller payoff than they did in cartel.
But it is worthy to mention that punishment is imposed at a personal cost for the punisher, and depends on the harshness and duration of the punishment. Since we do not possess credible information on collusions among the US health insurers, we will not be able to rely on real life examples. The only thing we can assume is that health insurers are able to provide as much insurance plan coverage as demanded as long as they do not exceed their reserves which are usually huge under state regulations; therefore, the only way tacit collusion may happen is maintaining price fixing among insurers.
Besides having punishment strategies firms use against their competitors, now the Federal government is developing its own “punishment strategy” against the health insurers, reports Business Insurance (Bloomberg, 2010). The White House announced $250 million grant program which helps the states to “expand their ability to punish health insurers for unreasonable premium rate increases”, report says. It is meant to make premiums more affordable and the market competitive for new entrants, even though the barriers to entry are still extremely high. Pricing strategy and recommendations
Pricing is a significant subject in product development and the key component in marketing mix. With sensible pricing strategy, insurers determine the optimal level at which their customers value the proposed benefit. Nevertheless, the White House does not believe that the current premium rates are “reasonable” enough, according to above proposed grant program. There are a range of pricing strategies for services. Quirk’s Marketing Research Review reports that traditionally, the health insurance industry has priced its services on a cost-plus basis (Coriell, 2007).
It is the simplest method of pricing which involves calculating costs of producing one product and adding a percentage profit in order to get a selling price. However, it has not been optimal using this approach because it does not cover a key feature of any market: market sensitivity to price changes, the paper reports. For instance, when an insurer raises premium rates considerably, the “healthier” clients have a tendency to look for another cheaper plan in the market, knowing that s/he will generate lower costs. As a result, the insurer is left with those who use more services generating more costs.
Coriell was sure that the method was definitely hurting the bottom-line population, and using the right drivers insurers could capture market sensitivity and adjust pricing strategies relying on those. One of them was to determine optimal combinations of price and advertisement in order to stimulate sales growth. With that, insurers would be able to attract customers charging lower rates by spending less on advertising while doing it efficiently. Otherwise, high rates would require more spending on promotion to compensate sales growth.
The first strategy would be useful for young insurers and those with lower market share, such as CareSource and Premera, and with little experience in the health insurance industry while the latter would benefit those insurers with higher share in the market and reputable ones like Wellpoint, Aetna and United. Moreover, insurers use premium pricing for their health plans which offer more valuable benefits than the majority others. By doing this, insurers with good experience tend to create positive perceptions among potential policyholders, artificially keeping the prices for special health plans high.
Price discrimination is typical in the health insurance industry because of the assumption that health of a person gets inferior as s/he gets older. The insurers are still implementing more and more optimal pricing strategies based on that. For example, BCBS of North Carolina has been partnering with Duke University in providing special insurance plan with discount for the university students, according to the university website. Duke Student Medical Insurance Plan (SMIP) premiums have been relatively cheap compared to the market rates, and the younger is the student group, the lower is the rate, the university health insurance blog reports.
This type of strategy targeting specific age groups in particular bands would benefit both insurers and policyholders. I would suggest that insurers coordinated more targeting, partnering with particular organizations, where probability of community members to become sick was lower, and thus offering them discounted rates. This would definitely give insurers opportunity to expand their share of the market. Other than that, lower rates would tend to increase number of enrollments attracting more potential policyholders. Given the nature of the market, it would have a tendency to affect other insurers in the market and thus making them offer more competitive premium rates to consumers.
To conclude, I have made a critical analysis and an assessment of the level of competition in the health insurance industry of the US, both nationwide and statewide. I carried out a research and discussed the market structure and the change in the level of competition in the sector. I have also included different strategies, such as first-mover advantage, punishment and collusion, companies use in order to maximize their profits with relevant examples. In addition, I mentioned about the possible pricing strategies insurers use and gave relevant suggestions considering the nature of the market.
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- Heckathorne, W. (2010) Data Blue Cross/Blue Shield Highest Ranked Health Insurance Company Among Consumers [Internet], Harris Interactive. Available from: [Accessed 8 December 2011]
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- Healthreform. gov (2010) Insurance Companies Prosper, Families Suffer: Our Broken Health Insurance System [Internet],