EXECUTIVE SUMMARY

Health care is a vital service thatdaily touches the lives of millions ofAmericans at significant and vulnerabletimes: birth, illness, and death. In recentdecades, technology, pharmaceuticals, andknow-how have substantially improved howcare is delivered and the prospects forrecovery. American markets for innovationin pharmaceuticals and medical devices aresecond to none. The miracles of modernmedicine have become almostcommonplace. At its best, American healthcare is the best in the world.

Notwithstanding these extraordinaryachievements, the cost, quality, andaccessibility of American health care havebecome major legislative and policy issues. Substantial increases in the cost of healthcare have placed considerable stress onfederal, state, and household budgets, aswell as the employment-based healthinsurance system. Health care quality varieswidely, even after controlling for cost,source of payment, and patient preferences. Many Americans lack health insurancecoverage at some point during any givenyear. The costs of providing uncompensatedcare are a substantial burden for many healthcare providers, other consumers, and taxpayers.

This Report examines the role ofcompetition in addressing these challenges. The proper role of competition in health caremarkets has long been debated. For much ofour history, federal and state regulators,judges, and academic commentators sawhealth care as a “special” good to whichnormal economic forces did not apply. Skepticism about the role of competition inhealth care continues.

This Report by the Federal TradeCommission (Commission) and the AntitrustDivision of the Department of Justice(Division) (together, the Agencies)represents our response to such skepticism. In the past few decades, competition hasprofoundly altered the institutional andstructural arrangements through whichhealth care is financed and delivered. Competition law and policy have played animportant and beneficial role in thistransformation. Imperfections in the healthcare system have impeded competition fromreaching its full potential. Theseimperfections are discussed in this Report.

The Agencies based this Report on27 days of Joint Hearings from Februarythrough October, 2003; a Commission-sponsored workshop in September, 2002;and independent research. The Hearingsbroadly examined the state of the health caremarketplace and the role of competition,antitrust, and consumer protection insatisfying the preferences of Americans forhigh-quality, cost-effective health care. TheHearings gathered testimony fromapproximately 250 panelists, includingrepresentatives of various provider groups,insurers, employers, lawyers, patientadvocates, and leading scholars on subjectsranging from antitrust and economics tohealth care quality and informed consent. The Hearings and Workshop elicited 62written submissions from interested parties. Almost 6,000 pages of transcripts of theHearings and Workshop and all writtensubmissions are available on theCommission website.

The Report addresses two basicquestions. First, what is the current role ofcompetition in health care, and how can it be

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enhanced to increase consumerwelfare? Second, how has, andhow should, antitrustenforcement work to protectexisting and potentialcompetition in health care?

This Executive Summaryoutlines the Agencies’ research,findings, conclusions,recommendations, andobservations. Subsequentchapters provide in-depthdiscussion and analyses. Chapter 1 provides an overviewand introduction. Chapter 2focuses on physicians. Chapters3 and 4 address hospitals. Chapters 5 and 6 considerinsurance. Chapter 7 focuses onpharmaceuticals. Chapter 8 addresses arange of issues, including certificate of need,state action, long-term care, internationalperspectives, and remedies. We begin witha review of why health care issues are soimportant.

I. CURRENT HEALTH CARECHALLENGES

A. Health Care Expenditures AreOnce Again Rising Dramatically

Health care spending in the UnitedStates far exceeds that of other countries. Approximately 14% of gross domesticproduct, or $1.6 trillion in 2002, is spent onhealth care services in the United States. Federal, state, and local governments pay forapproximately 45 percent of total U.S.expenditures on health care; privateinsurance and other private spendingaccount for 40 percent; and consumer out-of

pocket spending accounts for the remaining15 percent.

As Figure 1 reflects, in 2002, 31percent of the $1.6 trillion spent byAmericans on health care went to inpatienthospital care; that percentage has declinedsubstantially over the past twenty years, ashospitalization rates and lengths of stay havedeclined. Physician and clinical servicesaccount for 22 percent, but physicians’decisions and recommendations affect a farlarger percentage of total expenditures onhealth care. Prescription drugs account forabout 11 percent; that percentage hasincreased substantially over the past decade. The remaining 36 percent is split amonglong-term care, administrative, and otherexpenditures.

The percentage of gross domesticproduct spent on health care rosesubstantially during the 1970s and 1980s,

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but stabilized during most of the 1990s ataround 13.5 percent. In the last few years,however, dramatic cost increases havereturned, attributable to both increased useof and increased prices for health careservices. Inpatient hospital care andpharmaceuticals are the key drivers of recentincreases in expenditures. These trends arelikely to continue – and even accelerate – asnew technologies are developed and thepercentage of the population that is elderlyincreases.

B. Health Care Quality Varies

Quality has multiple attributes. Many health services researchers andproviders focus on whether the care that isprovided is based on empirical evidence ofefficacy. The Institute of Medicine definesquality as “the degree to which healthservices for individuals and populationsincrease the likelihood of desired healthoutcomes and are consistent with currentprofessional knowledge.” The Agency forHealthcare Research and Quality definesquality health care as “doing the right thingat the right time in the right way for the rightperson and having the best results possible.” Some consumers may focus on how longthey must wait for an appointment, and howthey are treated at the provider’s office. Many health care providers and healthservices researchers treat the cost of care(and the resources of consumers) asimmaterial; for them, you either providehigh quality care to a particular patient ordisease set, or you do not.

From a consumer perspective, healthcare quality encompasses several distinct

factors, and the delivery system mustperform well on each if it is to provide highquality care. These factors include whetherthe diagnosis is correct, whether the “right”treatment is selected (with the “right”treatment varying, depending on theunderlying diagnosis and patientpreferences), whether the treatment isperformed in a technically competentmanner, whether service quality is adequate,and whether consumers can access the carethey desire. Information is necessary forconsumers to make decisions regarding theircare, and determine how well the health caresystem is meeting their needs.

If we focus strictly on technicalmeasures, what is known about the qualityof health care in the United States? Commentators and panelists agree that thevast majority of patients receive the carethey need, but there is still significant roomfor improvement. Commentators andpanelists note that treatment patterns varysignificantly; procedures of known value areomitted, and treatments that are unnecessaryand inefficacious are performed and tens ofbillions of dollars are spent annually onservices whose value is questionable ornon-existent. As one commentator stated,“quality problems . . . abound in Americanmedicine. The majority of these problemsare not rare, unpredictable, or inevitableconcomitants of the delivery of complex,modern health care. Rather, they arefrighteningly common, often predictable,and frequently preventable.”1

1 Mark R. Chassin, Is Health Care Ready

for Six Sigma Quality?, 76 MILBANK Q. 565, 566

(1998).

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C. The U.S. Economy Typically Relieson Market Competition

In the overwhelming majority ofmarkets, the government does not decide theprices and quality at which sellers offergoods and services. Rather, rivals competeto satisfy consumer demand, and consumersmake decisions about the price and qualityof goods or services they will purchase. Awell-functioning market maximizesconsumer welfare when consumers maketheir own consumption decisions based ongood information, clear preferences, andappropriate incentives.

Vigorous competition, both price andnon-price, can have important benefits inhealth care as well. Price competitiongenerally results in lower prices and, thus,broader access to health care products andservices. Non-price competition canpromote higher quality and encourageinnovation. More concretely, competitioncan result in new and improved drugs,cheaper generic alternatives to brandeddrugs, treatments with less pain and fewerside effects, and treatments offered in amanner and location consumers desire. Vigorous competition can be quiteunpleasant for competitors, however. Indeed, competition can be ruthless – acircumstance that can create cognitivedissonance for providers who prefer to focuson the necessity for trust and the importanceof compassion in the delivery of health careservices. Yet, the fact that competitioncreates winners and losers can inspire healthcare providers to do a better job forconsumers. Vigorous competition promotesthe delivery of high quality, cost-effectivehealth care, and vigorous antitrustenforcement helps protect competition.

At the same time, competition is nota panacea for all of the problems withAmerican health care. Competition cannotprovide its full benefits to consumerswithout good information and properlyaligned incentives. Moreover, competitioncannot eliminate the inherent uncertainties inhealth care, or the informationalasymmetries among consumers, providers,and payors. Competition also will not shiftresources to those who do not have them. The next section identifies some of thefeatures of health care markets that can limitthe effectiveness of competition.

II. FEATURES OF HEALTH CAREMARKETS THAT CAN LIMITCOMPETITION

A. The Health Care Marketplace isExtensively Regulated

An extensive regulatory framework,developed over decades, at both the federaland state levels of government affects whereand how competition takes place in healthcare markets. Much of the regulatoryframework arose haphazardly, with littleconsideration of how the pieces fit together,or how the pieces could exacerbateanticompetitive tendencies of the overallstructure. Proposals for new regulatoryinterventions have often focused solely ontheir claimed benefits, instead of consideringtheir likely costs, where proposals fit intothe larger regulatory framework, andwhether proposals frustrate competitionunnecessarily. Failure to consider suchmatters can reinforce existing regulatoryimperfections and reward incumbentinterests. Indeed, in health care, somecommentators see competition as a problemto be tamed with top-down prescriptive

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regulations, instead of an opportunity toimprove quality, efficiency, and enhanceconsumer welfare.

As a significant purchaser in mosthealth care markets, the government usesregulations to influence the price and qualityof the services for which it pays. Thegovernment’s actions as both purchaser andregulator have profound effects on the restof the health care financing and deliverymarkets as well. Price regulation, even ifindirect, can distort provider responses toconsumer demand and restrict consumeraccess to health care services. Regulatoryrules also can reduce the rewards frominnovation and sometimes create perverseincentives, rewarding inefficient conductand poor results. Restrictions on entry andextensive regulation of other aspects ofprovider behavior and organizational formcan bar new entrants and hinder thedevelopment of new forms of competition. The scope and depth of regulation is also notuniversal; providers offering competingservices are routinely subject to widelyvarying regulatory regimes and paymentschedules.

B. Third-Party Payment Can DistortIncentives

Health insurance shifts and pools therisks associated with ill health. Byproviding greater predictability, healthinsurance protects the ill and their familiesfrom financial catastrophe. Nonetheless,third-party payment of health-relatedexpenses can distort incentives and haveunintended consequences.

Consumer Incentives. Insuredconsumers are insulated from most of thecosts of their decisions on health caretreatments. The result is that insuredconsumers have limited incentive to balancecosts and benefits and search for lower costhealth care with the level of quality that theyprefer. A lack of good information alsohampers consumers’ ability to evaluate thequality of the health care they receive.

Provider Incentives. Panelists andcommentators agreed that providers have astrong ethical obligation to deliver highquality care. The health care financingsystem, however, generally does not directlyreward or punish health care providers basedon their performance. When this fact iscoupled with the consumer incentivesoutlined above, the result is that providerswho deliver higher quality care are generallynot directly rewarded for their superiorperformance; providers who deliver lowerquality care are generally not directlypunished for their poorer performance and,worse still, may even be rewarded withhigher payments than providers who deliverhigher quality care.

Payor Incentives. Insurers generallyoffer coverage terms tied to professionallydictated standards of care, restricting therange of choices and trade-offs thatconsumers may desire. Insurers aggregateconsumer preferences, but there can beincentive mismatches because insurersgenerally bear the costs but do not capturethe full benefits of coverage decisions andbecause insurance contracts have a definedterm (usually annually) that is generallyshorter than the period of interest to theconsumer.

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C. Information Problems Can Limitthe Effectiveness of Competition

The Lack of Reliable and AccurateInformation about Price and Quality. Thepublic has access to better information aboutthe price and quality of automobiles than itdoes about most health care services. It isdifficult to get good information about theprice and quality of health care goods andservices, although numerous states andprivate entities are experimenting with arange of “report cards” and other strategiesfor disseminating information to consumers. Without good information, consumers havemore difficulty identifying and obtaining thegoods and services they desire.

The Asymmetry of Informationbetween Providers and Consumers. Mostconsumers have limited information abouttheir illness and their treatment options. Consumers with chronic illnesses have moreopportunity and incentive to gather suchinformation, but there is still a fundamentalinformational asymmetry between providersand patients. There is also considerableuncertainty about the optimal course oftreatment for many illnesses, given diversepatient preferences and the state of scientificknowledge.

Consumer Uncertainty aboutReliability of Health Care Information. Uncertainty increases transaction costs,fraud, and deception dramatically. Althoughthe Internet can provide access toinformation about health care, it alsoenhances the risks of fraud and deceptionregarding “snake oil” and miracle cures.

Information Technology. Health caredoes not employ information technology

extensively or effectively. Prescriptions andphysician orders are frequently hand-written. Records are often maintained in hard copyand scattered among multiple locations. Few providers use e-mail to communicatewith consumers. Public and private entitieshave worked to develop and introduceelectronic medical records and computerizedphysician order entry, but commentators andpanelists agreed that much remains to bedone.

D. Cost, Quality, and Access: TheIron Triangle of Trade-offs

Health policy analysts commonlyrefer to an “iron triangle” of health care.2 The three vertices of the triangle are thecost, quality, and accessibility of care. The“iron triangle” means that, in equilibrium,increasing the performance of the health caresystem along any one of these dimensionscan compromise one or both of the otherdimensions, regardless of the amount that isspent on health care.

Such tradeoffs are not alwaysrequired, of course. For example, tyingpayments to health care providers to thequality of services provided could improveproviders’ incentives to contain costs andimprove quality. Better quality also couldbe achieved at less cost by reducingunnecessary services and managingconsumers with chronic conditions morecost-effectively. Competition has animportant role to play in accomplishingthese objectives.

2 W ILLIAM L. K ISSICK, MEDICINE’S

D ILEMMAS: INFINITE NEEDS VERSUS FINITE

RESOURCES (1994).

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Nonetheless, trade-offs among cost,quality, and access can be necessary. Thosetrade-offs must be made at multiple levelsby multiple parties. Some consumers mayprefer a “nothing but the best” package ofmedical care, but others are willing to trade-off certain attributes of quality for lowercost, or trade-off one attribute of quality foranother. For example, some consumers willbe more willing than others to travel inexchange for lower prices, while others maybe more willing to travel in exchange forhigher quality care. Good information aboutthe costs and consequences of each of thesechoices is important for competition to beeffective.

E. Societal Attitudes RegardingMedical Care

For most products, consumers’resources constrain their demand. Consumers and the general public do notgenerally expect vendors to provide servicesto those who cannot pay for them. Fewwould require grocery stores to provide freefood to the hungry or landlords to providefree shelter to the homeless. By contrast,many members of the public and manyhealth care providers view health care as a“special” good, not subject to normal marketforces, with significant obligational norms toprovide necessary care without regard toability to pay. Similarly, many perceiverisk-based premiums for health insurance tobe inconsistent with obligational norms andfundamental fairness, because those with thehighest anticipated medical bills will pay thehighest premiums. A range of regulatoryinterventions reflect these norms.

F. Agency Relationships

A large majority of consumerspurchase health care through multiple agents– their employers, the plans or insurerschosen by their employers, and providerswho guide patient choice through referralsand selection of treatments. Thismultiplicity of agents is a major source ofproblems in the market for health careservices. Agents often do not have adequateinformation about the preferences of thosethey represent or sufficient incentive to servethose interests.

III. HOW THE HEALTH CAREMARKETPLACE CURRENTLYOPERATES

Competitive pressures for costcontainment have spurred the developmentof new forms of health care financing anddelivery. Government payors have adoptednew forms of payments for health careproviders to slow health care inflation. Private payors have adopted systems, suchas managed care and preferred providerorganizations, to encourage or requireconsumers to choose relatively lower-costhealth care. Physicians have tried new typesof joint ventures and consolidation, andhospitals have consolidated through mergerand the creation of multi-hospital networks. These new organizational forms offer thepotential for reducing costs and increasingprovider bargaining power. More recently,strategies for improving the quality of healthcare have gained attention. Health caremarkets remain in flux.

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A. How Consumers Pay for HealthCare

Most Americans pay for health carethrough health insurance. Most Americansunder the age of 65 obtain health insurancethrough their employer or the employer of afamily member. Some Americans under theage of 65 obtain coverage through agovernment program or purchase anindividual insurance policy. Americansaged 65 and over are almost always coveredby Medicare. In 2002, the Census Bureauestimated that approximately 85 percent ofthe total U.S. population had healthinsurance coverage.

1. Publicly Funded Programs

Medicare. Medicare providescoverage for approximately 40 millionelderly and disabled Americans. MedicarePart A covers most Americans over 65, andprovides hospital insurance coverage. Although Medicare Part B is optional,almost all eligible parties enroll, givensubstantial federal subsidies to the program. Medicare Part B provides supplementarymedical coverage for, among other things,doctors’ visits and diagnostic tests. ManyMedicare beneficiaries also purchaseMedicare Supplemental Insurance(Medigap) policies or have coverage from aformer employer. Medigap policies arefederally regulated and must includespecified core benefits.

In 1997, Congress enacted Medicare+ Choice (M+C). M+C encouragedMedicare beneficiaries to join privatelyoperated managed care plans, which oftenoffer greater benefits (e.g., prescription drugcoverage) in exchange for accepting limits

on choice of providers. In 2003, Congressrenamed M+C Medicare Advantage, andenacted prescription drug benefits forMedicare beneficiaries.

Medicaid. Medicaid providescoverage for approximately 50 millionAmericans. Although the federalgovernment sets eligibility and serviceparameters for the Medicaid program, thestates specify the services they will offer andthe eligibility requirements for enrollees. Medicaid programs generally cover youngchildren and pregnant women whose familyincome is at or below 133 percent of thefederal poverty level, as well as many low-income adults. Most states have most oftheir Medicaid population in some form ofmanaged care. Medicaid pays for a majorityof long term care in the United States.

Payments to Health Care Providers: Past and Present. Prior to 1983, Medicare,as well as most other insurers, reimbursedproviders under a “fee-for-service” (FFS)system based on the costs of the number andtype of services performed. Despite somerestraints on how much a provider couldclaim as its costs, the result was to rewardvolume and discourage efficiency. Commentators argued that the combinationof FFS payment, health insurance, andconsumers’ imperfect information abouthealth care created incentives for providersto provide, and consumers to consume,greater health care resources than would bethe case in competitive markets. In addition,FFS payment dampened the potential foreffective price competition, because FFSguaranteed reimbursement for claimedcharges. Thus, providers lacked incentivesto lower prices.

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Hospitals and Ancillary Services. Inresponse to increasing health careexpenditures, Congress directed the Centerfor Medicare and Medicaid Services (CMS)to adopt the inpatient prospective paymentsystem (IPPS) as a means to create a morecompetitive, market-like environment forhospital reimbursement by Medicare. TheIPPS took effect in 1983. The diagnosis-related group (DRG) for the diagnosis atdischarge determines the amount that thehospital is paid. Each DRG has a paymentweight assigned to it, which reflects theaverage cost of treating patients in thatDRG. Hospitals receive this predeterminedamount regardless of the actual cost of care,although adjustments are made forextraordinarily high-cost cases (“outlierpayments”), teaching hospitals, and hospitalsthat serve a disproportionate number of low-income patients.

Similarly, Congress directed CMS tochange its payment system for hospital-based outpatient care provided to Medicarebeneficiaries. On August 1, 2000, thepayment system changed from a cost-basedsystem to the outpatient prospectivepayment system (OPPS), under which CMSreimburses hospitals based on one of about750 ambulatory payment classifications(APCs) in which an episode of care falls. Each APC has a general weight based on themedian cost of providing the service.

Congress also directed CMS to adoptprospective payment systems for skillednursing facilities and home health careservices, and those systems are currently ineffect. As of 2007, Medicare is scheduled tobegin a competitive bidding system todetermine which providers will offer durablemedical equipment to Medicare

beneficiaries.

Both the IPPS and the OPPS haveconstrained expenditures more effectivelythan the cost-based systems they replaced. With the introduction of IPPS, the increasein hospital expenditures slowed, and averagelength of hospital stay declined. Theadoption of prospective payment for homehealth care services also had an immediateimpact on the number of beneficiaries thatreceived services and the average number ofvisits.

Any administered pricing systeminevitably has difficulty in replicating theprice that would prevail in a competitivemarket. Not surprisingly, one unintendedconsequence of the CMS administeredpricing systems has been to make somehospital services extraordinarily lucrativeand others unprofitable. As a result, someservices are more available (and others lessavailable) than they would be in acompetitive market.

Physicians. Medicare pays forphysician services using the resource-basedrelative value scale (RBRVS), a system forcalculating a physician fee schedule. CMScalculates the fee schedule on the basis ofthe cost of physician labor, practiceoverheads and materials, and liabilityinsurance, as adjusted for geographic andyearly differences.

2. Employment-Based Insurance

Employers offer insurance to theiremployees and retirees through varioussources, including commercial insurancecompanies, employers’ self-funded plans, orvarious combinations of the two. Employers

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that offer health insurance throughcommercial insurers usually negotiate onbehalf of their employees for a package ofbenefits at a specified monthly premium perperson or per family. Some employerschoose to self-fund (self-insure) byassuming 100 percent of the risk of expensesfrom their employees’ health care coverage. Some employers create self-insured plans,but contract with commercial insurancecompanies to act as a third-partyadministrator for claims processing, foraccess to a provider network, or to obtainstop-loss coverage. The applicability offederal and state laws and regulations varies,depending on the source of health carecoverage an employer makes available toemployees and retirees.

Not all employers offer healthcoverage, and some employers offercoverage only to full-time employees. Insome sectors of the economy, employment-based health insurance is less common. Thelarger the employer, the more likely it is tooffer health insurance. Premiums andcoverage vary widely. The number ofpeople with employment-based insurancefluctuated throughout the 1990s but hascurrently stabilized at approximately 61percent of the U.S. population.

The federal government subsidizesemployment-based health insurance throughthe tax code. Employer contributions forhealth insurance coverage are deductible toemployers, but are not considered taxableincome to employees and retirees. Theresult is that employees can obtain healthcare coverage through their employer withpre-tax dollars. Although it is commonparlance to speak of “employercontributions” to the cost of health care

coverage, employees and retirees ultimatelybear these costs in the form of lower salariesand benefits.

Payments to Providers. In someinstances, private payors have copied thepayment strategies of the Medicare programor have used Medicare payments as areference price for negotiation withproviders. For example, some payorsnegotiate either a specified discount or aspecified premium relative to the paymentthe Medicare program would make for aspecific episode of hospitalization orservice. To be sure, many payors do not relyon these strategies, and instead structuretheir own payment arrangements withproviders, including discounted per diempayments to hospitals and negotiateddiscounts off charges for other providers.

3. Individual Insurance

In 1999, approximately 16 millionworking-age adults and children – almost 7percent of the population under 65 –obtained health insurance coverage throughindividually issued, non-group policies. Commentators suggest that this smallmarket share is due, in part, to the taxsubsidies provided for employment-basedcoverage. Individual insurance policies aregenerally more expensive and lesscomprehensive than group policies.

4. The Uninsured

Approximately 15 percent of thepopulation, or 44 millions Americans,lacked health insurance at some point during2002. A study by the Congressional BudgetOffice found that 45 percent of theuninsured were without coverage for four

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months or less, and that only 16 percent ofthe uninsured (or approximately 6.9 millionAmericans) remained so for more than twoyears. The uninsured are more likely to beyounger and less likely to have a regularsource of care, less likely to use preventiveservices, and more likely to delay seekingtreatment. Studies indicate a variety ofadverse health consequences are associatedwith being uninsured.

Medical treatment for the uninsuredis often more expensive than care of theinsured, because the uninsured are morelikely to delay treatment and receive care inan emergency room. Hospitals typically billthe uninsured full price for the services theyreceived, instead of the discounted pricesthat hospitals offer insured patients pursuantto negotiated contracts with their insurers. The uninsured bear some of the costs oftreatments themselves and often cannot fullypay for the care they receive. The burden ofproviding this uncompensated care variessignificantly among providers and regions. For example, the burden of uncompensatedcare is greater in the South and West, wherea higher percentage of the population isuninsured, than in the rest of the UnitedStates. The costs of uncompensatedtreatments for the uninsured are either paidby taxpayers, absorbed by providers, orpassed on to the insured.

B. How Consumers Receive HealthCare: The Rise and Decline ofManaged Care

Burgeoning health care expendituresin the 1960s and 1970s led to numerousproposals to provide better incentives tocontain costs. Some commentators arguedthat organizations that agreed to meet the

health care needs of a consumer at a setprice for a set period of time offered asolution to this problem. Such prepaidgroup practices existed in some parts of theUnited States beginning in the early part ofthe 20th century, but Congress took asignificant step in this direction with passageof the Health Maintenance OrganizationsAct of 1973 (HMO Act). The HMO Actprovided start-up funds to encourage thedevelopment of HMOs, overrode State anti-HMO laws, and required large firms to offeran HMO choice to their employees. Theseforces set the stage for the development ofmanaged care organizations (MCOs). Managed care means different things todifferent people, and it has meant differentthings at different times. There is generalagreement, however, that MCOs integratethe financing and delivery of health careservices, albeit to varying degrees. In globalterms, managed care offers a more restrictedchoice of (and access to) providers andtreatments in exchange for lower premiums,deductibles, and co-payments thantraditional indemnity insurance.

MCOs historically relied on threestrategies to control costs and enhancequality of care. One is selective contractingwith providers that must meet certain criteriato be included in the MCO’s providernetwork. Selective contracting can intensifyprice competition and allow MCOs tonegotiate volume discounts and chooseproviders based on a range of discounts. When MCOs and other insurers have acredible threat to exclude providers fromtheir networks and send patients elsewhere,providers have a powerful incentive to bidaggressively to be included in the network. Without such credible threats, providershave less incentive to bid aggressively, and

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even MCOs with large market shares mayhave less ability to obtain lower prices.

Another strategy is to use incentivesthat shift some of the financial risk toproviders. Capitation, for example, paysproviders a fixed amount for each of thepatients for whom they agree to providecare, regardless of whether those patientsseek care or the costs of their care exceedsthe fixed amount. Some physician groupsparticipating in capitation arrangementsunderestimated these risks and wentbankrupt, and providers have becomeincreasingly reluctant to accept the risks ofcapitation in recent years. Direct financialincentives for providers in the form ofbonuses (or withholding a percentage ofpayment) based on meeting clinical orfinancial targets remain fairly prevalent,with considerable variation in their details.

A third strategy is utilization reviewof proposed treatments and hospitalizations. This strategy involves an appraisal of theappropriateness and medical necessity of theproposed treatment. Many MCOs and otherinsurers use utilization review in a variety offorms.

In recent years, many MCOs haveadopted a fourth strategy: increased cost-sharing. Cost sharing creates direct financialincentives for consumers – through varyingco-payments and deductibles – to receivecare from particular providers or inparticular locations.

By the late 1990s, managed care hadgrown so unpopular that commentatorsbegan to refer to a “managed care backlash.” Providers complained that their clinicaljudgments were second-guessed; consumers

complained that managed care wasrestricting choices, limiting access tonecessary medical care, and loweringquality. These concerns resulted in anumber of federal and state legislative andregulatory initiatives, as well as privatelitigation against MCOs.

Commentators report a substantialgap between consumer and providerperceptions, on the one hand, and managedcare’s actual impact, on the other. Theypoint to surveys and studies showing thatconsumers are generally satisfied with theirown MCOs, that MCOs do not providepoorer quality care than FFS medicine, andthat “managed care horror stories” are oftenexaggerated or highly unrepresentative.

In recent years, more restrictiveforms of managed care have been eclipsedby offerings with more choice andflexibility. These offerings include point-of-service (POS) plans, which allow patients toselect a primary care gatekeeper, yet use out-of-plan physicians for some services. Preferred provider organizations (PPOs) aresimilar to POS programs, but generally donot require a coordinating primary carephysician. Instead, PPOs have a panel of“preferred providers” who agree to acceptdiscounted fees. Some physicians who wishto avoid managed care entirely have begun“concierge practices,” where they providepersonalized care, including house calls, topatients willing and able to pay out of pocketfor health care costs.

Public and private payors are alsoexperimenting with payment forperformance (P4P) initiatives. Commentators and panelists generallyagreed that P4P should be more widely

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employed in health care. Many payors haveyet to adopt P4P programs, and someproviders have resisted such programs. Thedevelopment of P4P programs will requirebetter measurement of, and informationabout, health care quality.

IV. HEALTH CARE PROVIDERS: NEW DELIVERY SYSTEMS,NEW FORMS OFORGANIZATION, ANDCOMPETITIVE PRESSURES

A. Physicians

Spending on physician servicesaccounts for approximately 22 percent of the$1.6 trillion spent annually on health careservices. Total spending on physicianservices increased at an average annual rateof 12 percent from 1970-1993, and at 4 to 7percent a year since then. In response toincreased competitive pressures from MCOsand other payors to lower their prices, somephysicians have attempted to respondprocompetitively, while others have engagedin anticompetitive conduct.

Multiprovider Network JointVentures. Historically, physicians werepredominantly solo practitioners, but manyphysicians implemented network jointventures in response to managed care. The1980s saw the emergence of two types ofjoint ventures with physician members(Independent Practice Associations (IPAs)and Physician Hospital Organizations(PHOs)). In general, IPAs are networks ofindependent physicians that, among otherthings, may contract with MCOs andemployers. PHOs are joint venturesbetween a hospital (or more than onehospital) and physicians who generally have

admitting privileges there; hospital andphysician members sometimes contractjointly through the PHO with MCOs toprovide care to a population of patients.

IPAs and PHOs are often integratedto varying degrees financially (sharingfinancial risk) or clinically (using variousstrategies to improve the quality of care theyprovide) or both. Such joint ventures mayprovide various cost savings, such asreduced contracting costs, and clinicalefficiencies, such as better monitoring andmanagement of patients with chronicillnesses. IPAs and PHOs can also representattempts by providers to increase theirbargaining leverage with insurers. Somecontend that the primary advantage forphysicians and hospitals in forming a PHOis that the member hospital(s) andphysicians present a united front forbargaining with payors. In recent years, theuse of IPAs and PHOs has decreased, asMCOs and providers have abandonedcapitation arrangements.

One antitrust issue that physicianjoint ventures confront with respect to theircontracting practices is how to avoidsummary condemnation under the antitrustlaws. The Health Care Statements outlinethe key factors the Agencies will consider indetermining whether to apply the per se ruleor more elaborate rule of reason analysis toparticular conduct.3 These factors includethe degree of integration that the ventureachieves to obtain efficiencies and the extentto which joint pricing is reasonably

3 DEP’T OF JUSTICE & FED ERA L TRADE

CO M M’N , STATEM ENTS O F ANTITRUST ENFORCEMENT

POLICY IN HEALTH CARE (1996), available a t http://

www.ftc.gov/reports/hlth3s.pdf.

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necessary to achieve those efficiencies.

The “Messenger Model.” Arrangements to allow networks ofproviders to contract with payors, whileavoiding any agreement on price among theproviders, sometimes use a “messenger” tofacilitate contracting. The payor usuallysubmits a proposed fee schedule to an agentor third party, who transmits this offer to thenetwork physicians. Each physician decidesunilaterally whether to accept the feeschedule, and the agent transmits thosedecisions to the payor. Providers may alsoindividually give the messenger informationabout the prices or other contract terms thatthe provider will accept, and the messengeraggregates this information and markets it topayors. Health Care Statement 9 describeshow to avoid antitrust problems when usinga messenger model, and provider networkshave used the model successfully. Nonetheless, physician networks using so-called “messengers” to orchestrate orparticipate in price-fixing agreements haveresulted in considerable antitrustenforcement activity in recent years.

Physician Collective Bargaining. Some physicians have lobbied heavily for anantitrust exemption to allow independentphysicians to bargain collectively. Theyargue that payors have market power, andthat collective bargaining will enablephysicians to exercise countervailing marketpower. The Agencies have consistentlyopposed these exemptions, because they arelikely to harm consumers by increasing costswithout improving quality of care. TheCongressional Budget Office estimated thatproposed federal legislation to exemptphysicians from antitrust scrutiny wouldincrease expenditures on private health

insurance by 2.6 percent and increase directfederal spending on health care programssuch as Medicaid by $11.3 billion.

Licensing Regulation and MarketEntry. State licensing boards composedprimarily of physicians determine, apply,and enforce the requirements for physiciansto practice within a particular state. Variousstate licensing boards have taken steps torestrict allied health professionals andtelemedicine. Some states have limited orno reciprocity for licensing physicians andallied health professionals already licensedby another state. The Report discusses theanticompetitive potential of suchrestrictions, as well as their rationales. B. Hospitals

As with physicians, some hospitalshave responded to competitive pressures byfinding ways to lower costs, improvequality, and compete more efficiently. Somecommentators contend, however, that anumber of hospital networks are exercisingmarket power to demand price increasesfrom payors, and seeking to forestall entryby new competitors, such as single-specialtyhospitals.

Hospital Networks. Over the past 20years, many hospitals have merged orconsolidated into multi-hospital networks orsystems. Although the Agencies hadconsiderable early success in challengingcertain hospital mergers, the Agencies andstate enforcers have lost all seven hospitalmerger cases they have litigated since 1994. Courts in these cases typically disagreedwith the Agencies on how to measurerelevant antitrust markets, how to assess theprospects for entry to remedy any

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anticompetitive effects, how to determinethe magnitude of any likely efficiencies, andthe relevance of the hospital’s nonprofitstatus. The Commission has undertaken aretrospective study to evaluate the marketresults in several consummated mergers, andone case is currently pending inadministrative litigation.

Initially, national systems acquiredhospitals throughout the United States, butrecent acquisitions have been morelocalized. Some believe that hospitalconsolidation generally has promoted thedevelopment of efficiencies and instilled lifeback into failing hospitals. They point to thesavings from consolidated operations thathospital networks may make possible. Others believe that a primary result ofconsolidation has been to create hospitalmarket power, thus allowing hospitals toincrease their prices. Hospitals claim thatrising prices result not from market power,but from a multitude of pressures theyconfront, such as shortages of nurses andother personnel, rising liability premiums,the costs of improved technology, and theobligations of indigent care.

Most studies of the relationshipbetween competition and hospital priceshave found that high hospital concentrationis associated with increased prices,regardless of whether the hospitals are for-profit or nonprofit. Some studies havefound that merged hospitals experiencedsmaller price and cost increases than thosethat have not merged, except in highlyconcentrated markets, where the pattern wasreversed. Another study found that somesystems’ acquisition of hospitals did notproduce efficiencies, because of a failure tocombine operations. Some have pointed out

that studies typically do not differentiateamong transactions that occur within localmarkets and those that occur across markets,such as national system acquisitions;different types of consolidations mightreflect very different hospital strategies andcould have different efficiency effects.

Entry: Specialty Hospitals. Specialty hospitals provide care for aspecific specialty (e.g., cardiac) or type ofpatient (e.g., children). Newer single-specialty hospitals (SSHs) tend to specializein cardiac or orthopedic surgery, andparticipating physicians often have anownership interest in the facility, for reasonsdescribed infra. Some contend that SSHshave achieved better outcomes throughincreased volume, better diseasemanagement, and better clinical standards.

Others disagree, suggesting thatphysician-investors send healthier, lowerrisk patients to their SSH and sicker patientsto a general hospital to enable the SSH toproduce service less expensively yet still bereimbursed at the same rates as the generalhospital. These commentators fear thatSSHs will siphon off the most profitableprocedures and patients, leaving generalhospitals with less money to cross subsidizesocially valuable, but less profitable care.

Some general hospitals facingcompetition from SSHs have removed theadmitting privileges of physicians involvedwith the SSH or otherwise acted to limitphysician access to the general hospital;other general hospitals have established theirown single-specialty wing to preventphysicians from shifting their patients to anew entrant. Some commentators state thatgeneral hospitals have used certificate of

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need (CON) laws to restrict entry by SSHs. There are relatively few SSHs, and the vastmajority are in states without CONprograms. Debate about SSHs continues. Arecently imposed Congressional moratoriumon physician referrals to SSHs in which theyhave an ownership interest and twoCongressionally mandated studies on SSHsand general hospitals will likely affect thefuture of SSHs.

Entry: Ambulatory Surgery Centers. Ambulatory surgery centers (ASCs) performsurgical procedures on patients who do notrequire an overnight stay in the hospital. Technological advances in surgery andanesthetic agents have made it possible forASCs to perform a wide range of surgicalprocedures. Medicare reimbursement hashad a profound effect on the number ofASCs and the amount and types of surgeryperformed in them.

Commentators express divergentviews on ASCs, with some focusing onlikely benefits to consumers includinggreater convenience, and others expressingconcerns about ASCs similar to thoseregarding SSHs. Hospital reactions to deterASC entry and restrict competition havebeen similar to those for SSHs.

Government Purchasing of HospitalServices. Government-administered pricingby CMS inadvertently can distort marketcompetition. For example, CMS neverdecided as a matter of policy to providegreater profits for cardiac surgery than manyother types of service, but the IPPS tends todo so. This pricing distortion creates adirect economic incentive for specializedcardiac hospitals to enter the market; suchentry reflects areas that government pricing

makes most profitable, which may or maynot reflect consumers’ needs andpreferences. When the government is thesole or primary payor for a service, such askidney dialysis or vaccines, paying too muchwastes resources, while paying too littlereduces output and capacity, lowers quality,and diminishes incentives for innovation.

Although CMS can set prices, itsability directly to encourage price and non-price competition is limited. With fewexceptions, CMS cannot force providers tocompete for CMS’s business or rewardsuppliers that reduce costs or enhancequality with substantially increased volumeor higher payments. CMS has limited abilityto contract selectively with providers or usecompetitive bidding. Even straightforwardpurchasing initiatives, such as competitivebidding for durable medical equipment(DME), have generated considerableresistance, despite the success of a pilotproject for DME competitive bidding thatresulted in savings of 17 to 22 percent withno significant adverse effects onbeneficiaries. Worse still, CMS’s paymentsystems do not reward providers who deliverhigher quality care or punish providers whodeliver lower quality care. As the MedicarePayment Advisory Commission reported,the Medicare payment system is “largelyneutral or negative towards quality . . . . Attimes providers are paid even more whenquality is worse, such as when complicationsoccur as the result of error.”4

4 MEDICARE PAYMEN T ADVISORY

COMM ITTEE, REPORT TO CONGRESS : VARIATION AND

INNOVATION IN MEDICARE 108 (2003), available at

http://www.medpac.gov/publications/congressional_r

eports/June03_Entire_Report.pdf.

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CMS has worked to enhance qualitythrough public reporting initiatives. Forexample, since CMS began public reportingof quality information on dialysis care in1996, the number of patients receivinginadequate dialysis or experiencing anemiahas declined substantially. Since 2002,CMS publicly reports on the quality of careprovided in nursing homes and by homehealth agencies. Recently, CMS joined withhospitals and the Quality ImprovementOrganizations in Maryland, New York, andArizona to design pilot tests for publiclyreporting hospital performance measures. The Medicare Prescription Drug,Improvement and Modernization Act of2003 creates modest financial incentives forhospitals to report such information.

Examples of other governmentinitiatives include New York State, whichbegan to publicize provider-specificoutcomes for cardiac surgery in 1989. By1992, one study found risk-adjustedmortality had dropped 41 percent statewide,giving New York the lowest risk-adjustedmortality rate for cardiac surgery in thenation. Studies show the mortality rate hascontinued to fall. Pennsylvania reportedlyexperienced similar improvements when itbegan collecting and publishing risk-adjusted report cards.

Some have criticized these findingson methodological and policy grounds. Forexample, critics suggest that some of theimprovement in mortality rates in New Yorkresulted from the migration of high-riskpatients to other states for surgery, and thatdata collection and risk adjustment methodswere flawed. A general criticism of such“report cards” is that they discourageproviders from treating higher risk patients.

More research is required to determine thebest methods for measuring and reporting onhospital quality.

Private Purchasing of HospitalServices. In recent years, contractingbetween hospitals and private payors hassometimes been controversial andcontentious. Some contend that manyhospital systems include at least one “must-have” hospital in each of the geographicmarkets in which they compete. A “must-have” hospital is one that health care plansbelieve they must offer to their beneficiariesto attract employers to the plan. Payorscomplain that hospital systems insist onincluding all or none of the hospitals in asystem in the payor’s coverage plan. Consumer pressure for open networks hasmade it more difficult for payors to excludean entire hospital system, and the presenceof a “must-have” hospital in the networkalso increases a hospital’s bargaining power. Although some commentators believe thatparticular hospitals and hospital systemshave the upper hand in bargaining in somemarkets, bargaining advantage variessubstantially within and among differentmarkets.

In a few markets, certain payors haveexperimented with “tiering” hospitals, whichresults in different consumer co-paymentsdepending on the hospital. Hospital tiersmay be established based on a variety ofcriteria. Tiering usually does not apply toemergency care and may depend on whereroutine and specialty services are offered. Tiering allows a payor to maintain a broadnetwork and include a “must-have” hospital,yet still create incentives for consumers touse lower cost hospitals. Hospitals usuallyresist tiering, in some cases negotiating

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contracts that prohibit tiering. Hospitalsexpress concern that low-cost facilities willbe mislabeled as low quality and high-costfacilities as inefficient, and that tiering mightforce poorer consumers to use only low-costhospitals.

Private-sector efforts are underwayto provide more information about quality. A number of private initiatives seek to makequality-related information available toemployers, health plans, and consumers. The Health Plan Employer Data andInformation Set (HEDIS), developed by theNational Committee for Quality Assuranceto assess health plans, uses more than 50measures of provider and plan performancein areas such as patient satisfaction,childhood immunization, andmammography screening rates.

Hospital Purchasing. Somehospitals have joined group purchasingorganizations (GPOs) to consolidate theirpurchases and achieve volume and otherdiscounts. GPOs have the potential to assisthospitals in lowering costs. There have beencomplaints about certain GPO practices. The Agencies investigate GPO practices thatappear to merit antitrust scrutiny. Themarket-share safety zones contained inHealth Care Statement 7 do not constrainAgency enforcement in cases involvinganticompetitive contracting practices.

Consumer Price and QualitySensitivity: The Need for BetterInformation. Tiering represents an attemptto force consumers to bear some of theincreased price associated with receivingcare at a more expensive hospital. Medicalsavings accounts, which combine a high-deductible insurance policy with a tax

advantaged fund for paying a portion ofuncovered costs, are intended to accomplishthe same goal for most health carepurchasing decisions. For such strategies towork, however, consumers will need reliableand understandable information about theprices and quality of the services amongwhich they must choose.

At present, most insured consumersare “rationally ignorant” of the price ofmedical services they receive, becauseinsurance largely insulates them from thefinancial implications of their treatment. Even if consumers were interested in theprice of their care, they would find it verydifficult to obtain the information. Thepricing of health care services is complicatedand frequently obscure. Thus, proposals toincrease consumer price sensitivity mustdevelop strategies to increase thetransparency of pricing.

An analogous finding emerges forquality measures. Although consumerstypically express interest in report cards,they often do not use such information toselect health plans and providers. If theinformation is usable, consumers will selecttreatments that accord with their preferences. Publicly available report cards can motivateproviders to address quality deficiencies,even when it does not appear that manyconsumers rely on that information. Not allconsumers must be well-informed for themarket to deliver an efficient level ofquality.

Pricing: Bulk Purchasing, PriceDiscrimination, Cost-Shifting, and Cross-Subsidies. Understanding health carepricing requires an understanding of fourterms: bulk purchasing, price

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discrimination, cost shifting, and crosssubsidies. The terms have distinctmeanings, although there is some overlapbetween cost shifting and cross subsidies. Bulk purchasing occurs when largeorganizations receive purchasing discountsbecause of the volume of their purchases. Price discrimination involves chargingdifferent consumers different prices for thesame services, based on differential demand. Cost shifting refers to raising the pricecharged to one group of consumers as aresult of lowering the price to otherconsumers. Cross subsidizing is the practiceof charging profit maximizing prices abovemarginal costs to some payors or for someservices and using the surpluses to subsidizeother payors or other clinical services.

Some panelists stated that cost-shifting is common in the medicalmarketplace, but most commentators andpanelists disagreed, and stated that bulkpurchasing discounts and pricediscrimination explain observable pricingpatterns. Panelists and commentatorsagreed, however, that there are a range ofsubsidies and cross-subsidies in the medicalmarketplace. For example, providers losemoney by treating the uninsured, but makemoney by treating the well insured. Anyadministered pricing system has difficultyreplicating competitive prices. Thus, notsurprisingly, under Medicare’s administeredpricing system, some services are muchmore profitable than others.

Congress has also created directsubsidies for certain hospitals. CMS paysmore to teaching hospitals (approximately$5.9 billion in 1999) and to hospitals thatprovide a disproportionate share of care tothe poor (approximately $5 billion per year).

The existence of subsidies and cross-subsidies complicates any plan to giveconsumers better price information andincrease their price sensitivity. Cross-subsidies can distort relative prices andmakes access to care contingent on matterssuch as the number of uninsured that seekcare, the wealth of the community, and thedegree of competitiveness of the market formedical services.

C. Pharmaceuticals

Competition between Brand-Nameand Generic Drug Manufacturers. Theavailability of patent protection createsinnovation incentives for brand-namepharmaceutical companies by excludingothers from making, using, or selling aclaimed invention for a specified period oftime. This protection helps ensure revenuesto pharmaceutical firms that they can use formore research. Patent law also requires thedisclosure of information about the patentedinvention that otherwise would remain atrade secret and thus encourages competitionto design around brand-name patents.

In 1984, Congress passed theHatch-Waxman Act, which has encouragedcompetition from lower-priced genericdrugs. Hatch-Waxman has shapedsubstantially the legal environmentgoverning Food and Drug Administrationapproval of generic drug products, andestablished a framework to balanceincentives for continued innovation bybrand-name firms with entry by generic drugfirms.

The Commission has pursued severalenforcement actions to remedy actions byparticular firms to game certain Hatch-

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Waxman provisions and deny consumers thebenefits of generic competition thatCongress intended. The Commission alsoissued a study in July, 2002 that addressesstrategies among drug companies to affectthe timing of generic drug entry prior topatent expiration. Congress has adopted thetwo major recommendations proposed inthis study to preclude certain abuses ofHatch-Waxman.

Current Policy Debates. Concernabout pharmaceutical prices in the UnitedStates has received much attention, anddiscussion continues about how best toaddress this issue. Certain policy choicescurrently under debate might lead toproblems similar to those that this Reportidentifies in other health care sectors. Forexample, price regulation to lowerprescription drug prices could lead toproblems with administered pricing similarto those described above. Governmentpurchasing that reflects monopsony powerwould likely reduce output and innovation.

PBMs. The use of pharmacy benefitmanagers (PBMs) as intermediaries betweenpharmaceutical managers and payors hasraised questions whether PBMs increase thecosts of pharmacy benefits. Pursuant toCongressional direction, the Commission isexamining one aspect of these concerns: whether costs are higher if a payor uses amail-order pharmacy integrated with a PBMrather than retail pharmacies or non-integrated mail-order pharmacies. Thisstudy is due in June, 2005. To date,empirical evidence suggests that PBMs havesaved costs for payors.

Direct-to-Consumer Advertising. Some suggest that direct-to-consumer

advertising has increased prices forconsumers or caused them to consumeinappropriate prescription drugs. Theavailable evidence does not support theseallegations. Indeed, competition can helpaddress these information problems bygiving market participants an incentive todeliver truthful and accurate information toconsumers. Nobel Laureate George Stigleronce observed that advertising is “animmensely powerful instrument for theelimination of ignorance.”5 Studies by theFTC’s Bureau of Economics have confirmedthat advertising provides a powerful tool tocommunicate information about health andwellness to consumers – and the informationcan change people’s behavior. Thus, goodinformation is a necessary building blockboth for consumer empowerment andenhanced health.

V. RECOMMENDATIONS TOIMPROVE COMPETITION INHEALTH CARE MARKETS

Competition has affected health caremarkets substantially over the past threedecades. New forms of organization havedeveloped in response to pressures for lowercosts, and new strategies for lowering costsand enhancing quality have emerged. Nonetheless, competition remains lesseffective than possible in most health caremarkets, because the prerequisites for fullycompetitive markets are not fully satisfied. This list of recommendations focuses onhow to encourage the development ofprerequisites to competition such as goodinformation about price and quality. TheAgencies recognize that the work remaining

5 George J. Stigler, The Economics of

Information, 69 J. POL. ECON. 213, 220 (1961).

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to be done is complex and difficult and willtake time. A renewed focus on theprerequisites for effective competition,however, may assist policymakers inidentifying and prioritizing tasks for the nearfuture.

Recommendation 1:

Private payors, governments, andproviders should continueexperiments to improve incentivesfor providers to lower costs andenhance quality and for consumersto seek lower prices and betterquality.

a) Private payors, governments, andproviders should improve measuresof price and quality.

As noted above, health care pricingcan be obscure and complex. Increasedtransparency in pricing is needed toimplement strategies that encourageproviders to lower costs and consumers toevaluate prices. Achievement of this goalwill likely require addressing the issue ofcross-subsidization, which encouragesproviders to use pricing that does not revealthe degree to which the well-insured may besubsidizing the indigent, and more profitableservices may be subsidizing less well-compensated care.

A great deal of work already hasbeen done on measuring quality. Qualitymeasures exist for a considerable number ofconditions and treatments. The Agenciesencourage further work in this area. TheAgencies suggest that particular attention bepaid to the criticism that report cards andother performance measures discourage

providers from treating sicker patients. If itis not addressed, this criticism couldundermine the perceived validity andreliability of information about quality.

b) Private payors, governments, andproviders should furnish more information on prices and quality toconsumers in ways that they finduseful and relevant, and continue toexperiment with financingstructures that will give consumersgreater incentives to use suchinformation.

Information must be reliable andunderstandable if consumers are to use it inselecting health plans and providers. Research to date indicates that manyconsumers have not used the price andquality information they have received tomake decisions about health plans andproviders. Additional research into the typesof price and quality information thatconsumers would use for those decisionsappears to be necessary. Furtherexperiments with varying co-payments anddeductibles based on price- and quality-related factors such as the “tier” of servicethat consumers choose can help giveconsumers greater responsibility for theirchoices. Such responsibility will also likelyincrease consumer incentives to useavailable information on price and quality.

c) Private payors, governments, andproviders should experiment furtherwith payment methods for aligningproviders’ incentives withconsumers’ interests in lowerprices, quality improvements, andinnovation.

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Payment methods that giveincentives for providers to lower costs,improve quality, and innovate could bepowerful forces for improving competitionin health care markets. Although payorshave experimented with some paymentmethods that provide incentives to lowercosts, no payment method has yet emergedthat more fully aligns providers’ incentiveswith the interests of consumers in lowerprices, quality improvements, andinnovation. At present, for example, mostpayments to providers have no connectionwith the quality of care provided.

A focus on the degree to whichproviders’ incentives are compatible withconsumers’ interests is important. Compatible incentives and interests are morelikely to yield better results; incompatibleincentives and interests are more likely tohave unintended consequences that can leadto worse results. Initiatives that address theuse of payment methods to align providers’incentives with consumers’ interests arenecessary. These experiments should becarefully analyzed to evaluate theirconsequences, both intended andunintended.

Recommendation 2:

States should decrease barriers toentry into provider markets.

a) States with Certificate of Needprograms should reconsiderwhether these programs best servetheir citizens’ health care needs.

The Agencies believe that, onbalance, CON programs are not successfulin containing health care costs, and that they

pose serious anticompetitive risks thatusually outweigh their purported economicbenefits. Market incumbents can too easilyuse CON procedures to forestall competitorsfrom entering an incumbent’s market. Asnoted earlier, the vast majority of single-specialty hospitals – a new form ofcompetition that may benefit consumers –have opened in states that do not have CONprograms. Indeed, there is considerableevidence that CON programs can actuallyincrease prices by fostering anticompetitivebarriers to entry. Other means of costcontrol appear to be more effective and poseless significant competitive concerns.

b) States should consider adoptingthe recommendation of the Instituteof Medicine to broaden themembership of state licensureboards.

State licensing boards aredisproportionately composed of licensedproviders, although some states requirebroader representation. Many state licensingboards have taken steps, such as restrictingallied health professionals (AHPs) fromindependent practice and direct access toconsumers, that significantly reduce certainforms of competition. State licensure boardswith broader membership, includingrepresentatives of the general public, andindividuals with expertise in healthadministration, economics, consumer affairs,education, and health services research,could be less likely to limit competition byAHPs and new business forms for thedelivery of health care, and are less likely toengage in conduct that unreasonablyincreases prices or lowers access to healthcare.

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c) States should considerimplementing uniform licensingstandards or reciprocity compacts toreduce barriers to telemedicine andcompetition from out-of-stateproviders who wish to move in-state.

When used properly, telemedicinehas considerable promise as a mechanism tobroaden access, lower costs, and improvehealth care quality. When used improperly,telemedicine has the potential to lowerhealth care quality and to increase theincidence of consumer fraud. To fostertelemedicine’s likely pro-competitivebenefits and to deter its potential to harmconsumers, states should considerimplementing uniform licensure standards orreciprocity compacts. Uniform licensurestandards and reciprocity compacts couldoperate both to protect consumers and toreduce barriers to telemedicine. Stateregulators and legislators should explicitlyconsider the pro-competitive benefits oftelemedicine before restricting it. Similarconsiderations apply to the potential forlicensure to restrict competition from out-of-state providers who wish to move in-state.

Recommendation 3:

Governments should reexaminethe role of subsidies in health caremarkets in light of theirinefficiencies and potential todistort competition.

Health care markets have numerouscross-subsidies and indirect subsidies. Competitive markets compete away thehigher prices and supra-competitive profitsnecessary to sustain such subsidies. Suchcompetition holds both the promise ofconsumer benefits and the threat of

undermining an implicit policy ofsubsidizing certain consumers and types ofcare.

Competition cannot provideresources to those who lack them; it does notwork well when certain facilities areexpected to use higher profits in certainareas to cross-subsidize uncompensatedcare. In general, it is more efficient toprovide subsidies directly to those whoshould receive them, rather than to obscurecross subsidies and indirect subsidies intransactions that are not transparent. Governments should consider whethercurrent subsidies best serve their citizens’health care needs.

Recommendation 4:

Governments should not enactlegislation to permit independentphysicians to bargain collectively.

Physician collective bargaining willharm consumers financially and is unlikelyto result in quality improvements. There arenumerous ways in which independentphysicians can work together to improvequality without violating the antitrust laws.

Recommendation 5:

States should consider thepotential costs and benefits ofregulating pharmacy benefitmanager transparency.

In general, vigorous competition inthe marketplace for PBMs is more likely toarrive at an optimal level of transparencythan regulation of those terms. Just ascompetitive forces encourage PBMs to offer

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their best price and service combination tohealth plan sponsors to gain access tosubscribers, competition should alsoencourage disclosure of the informationhealth plan sponsors require to decide withwhich PBM to contract. To the extent theCommission’s Congressionally mandatedstudy of PBMs provides relevantinformation to the issue of PBMtransparency, it will be discussed in theCommission’s study report.

Recommendation 6:

Governments should reconsiderwhether current mandates bestserve their citizens’ health careneeds. When deciding whether tomandate particular benefits,governments should consider thatsuch mandates are likely to reducecompetition, restrict consumerchoice, raise the cost of healthinsurance, and increase thenumber of uninsured Americans.

State and federal governmentsmandate numerous health insurance benefits. Proponents argue that mandates can correctinsurance market failures, and that therequired inclusion of some benefits in allhealth insurance plans can be welfareenhancing. Opponents argue that the casefor many mandates is anecdotal, and thatmandates raise premium costs, leadingemployers to opt out of providing healthinsurance and insured individuals to droptheir coverage. Opponents also note thatproviders of the mandated benefit areusually the most vigorous proponents ofsuch legislation, making it more likely thatthe mandated benefits may constitute

“provider protection” and not “consumerprotection.” The Commission has submittednumerous competition advocacy letters onthis issue in the last fifteen years, focusingon any willing provider and freedom ofchoice provisions.

For mandates to improve theefficiency of the health insurance market,state and federal legislators must be able toidentify services the insurance market is notcurrently covering for which consumers arewilling to pay the marginal costs. This taskis challenging under the best ofcircumstances – and benefits are notmandated under the best of circumstances. In practice, mandates are likely to limitconsumer choice, eliminate productdiversity, raise the cost of health insurance,and increase the number of uninsuredAmericans.

State and federal policy makersshould consider ways of evaluating theserisks in their decision making processes andreconsider whether current mandates bestserve their citizens’ health care needs.

VI. AGENCY PERSPECTIVES ONISSUES IN ANTITRUSTENFORCEMENT IN HEALTHCARE

The Agencies have been active fornearly 30 years in health care markets,challenging anticompetitive conduct andproviding guidance to consumers andindustry participants. This section outlinesthe Agencies’ perspective on several issuesin antitrust enforcement in health caremarkets.

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A. Perspective on Physician-RelatedIssues

Physician Joint Ventures and Multi-provider Networks. Health Care Statement8 provides that “physician network jointventures . . . will not be viewed as per seillegal, if the physicians’ integration throughthe network is likely to produce significantefficiencies that benefit consumers, and anyprice agreements (or other agreements thatwould otherwise be per se illegal) by thenetwork physicians are reasonably necessaryto achieve those efficiencies.” Health CareStatement 8 further notes that financial risk-sharing and clinical integration may involvesufficient integration to demonstrate that theventure is likely to produce significantefficiencies.

1st Observation:

Payment for performancearrangements among a group ofphysicians may constitute a formof financial risk-sharing.

In determining whether a physiciannetwork joint venture is sufficientlyfinancially integrated to avoid per secondemnation, the Agencies will considerthe extent to which a particular payment forperformance (P4P) arrangement constitutesthe sharing of substantial financial riskamong a group of physicians, and therelationship between the physicians’ pricingagreement and the P4P program.

2nd Observation:

The Agencies do not suggestparticular structures with which to

achieve clinical integration thatjustifies a rule of reason analysis ofjoint pricing, but the analysis ofwhether a physician network jointventure is clinically integrated maybe aided in some circumstances byasking questions like thoseoutlined in Chapter 2.

Attempts to achieve clinicalintegration were discussed at length at theHearings. Panelists described a wide varietyof factors as possibly relevant to evaluatingclinical integration. Panelists andcommentators asked the Agencies to definethe criteria that the Agencies will considersufficient to demonstrate that a particularventure is clinically integrated. TheAgencies do not suggest particular structureswith which to achieve clinical integrationthat justifies a rule of reason analysis of jointpricing, because of the risk that it wouldchannel market behavior, instead ofencouraging market participants to developstructures responsive to their particular goalsand the market conditions they face. As anaid to analysis, Chapter 2 of the Reportincludes a broad outline of some of the kindsof questions that the Agencies are likely toask when analyzing whether a physiciannetwork joint venture is clinically integrated.

B. Perspective on Hospital-RelatedIssues

Hospital Mergers. The Agencieswill continue carefully to evaluate proposedhospital mergers and to challenge those withlikely anticompetitive effects. Certain issuesaddressed in hospital merger cases arediscussed below.

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3rd Observation:

Research on hospital productmarkets is encouraged.

In most cases, the Agencies haveanalyzed hospital product markets as a broadgroup of acute, inpatient medical conditionswhere the patient must remain in a healthcare facility for at least 24 hours fortreatment, recovery or observation. TheAgencies continue to examine whethersmaller markets exist within the traditionalcluster product market definition or otherproduct market adjustments might bewarranted, and encourage research on thesematters. For example:

• The percentage of total health carespending devoted to outpatient careis growing. The Agencies encourageresearch on whether servicesprovided in outpatient settings mayconstitute additional relevant productmarkets, and if so, whether thoseservices might be adversely affectedby a hospital merger.

• In recent years, single-specialtyhospitals have emerged in numerouslocations. The Agencies encouragefurther research into the competitivesignificance of SSHs, includingwhether payors can disciplinegeneral acute care hospitals byshifting a larger percentage ofpatients to SSHs.

• The Agencies encourage additionalresearch to validate or refute theanalytical techniques for definingproduct markets suggested byvarious commentators and panelists.

4th Observation:

Hospital geographic marketsshould be defined properly.

The definition of hospital geographicmarkets has proven controversial. Inconnection with this Report, the Agenciesundertook a substantial analysis of how bestto determine the contours of the relevantgeographic market in which hospitalsoperate, consistent with the processdescribed in the 1992 Horizontal MergerGuidelines (Merger Guidelines). TheAgencies’ conclusions are:

a) The “hypothetical monopolist” testof the Merger Guidelines should beused to define geographic markets inhospital merger cases. To date, theAgencies’ experience and researchindicate that the Elzinga-Hogarty testis not valid or reliable in defininggeographic markets in hospitalmerger cases. The limitations anddifficulties of conducting a propercritical loss analysis should be fullyconsidered if this method is used todefine a hospital geographic market.

b) The types of evidence used in allmerger cases – such as strategicplanning documents of the mergingparties and customer testimony anddocuments – should be used byCourts to help delineate relevantgeographic markets in hospitalmerger cases. Evidence regardingthe willingness of consumers totravel and physicians to steerconsumers to less expensivealternatives should also beconsidered by Courts.

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c) The Agencies encourage additionalresearch to validate or refute theanalytical techniques for defininggeographic markets suggested byvarious commentators and Hearingsparticipants.

5th Observation:

Hospital merger analysis shouldnot be affected by institutionalstatus.

The best available evidence showsthat the pricing behavior of nonprofits whenthey achieve market power does notsystematically differ from that of for-profits. The nonprofit status of a hospital should notbe considered in determining whether aproposed hospital merger violates theantitrust laws.

6th Observation:

The resolution of hospital mergerchallenges through communitycommitments should be generallydisfavored.

The Agencies do not acceptcommunity commitments as a resolution tolikely anticompetitive effects from a hospital(or any other) merger. The Agencies believecommunity commitments are an ineffective,short-term regulatory approach to what isultimately a problem of competition. Nevertheless, the Agencies realize that insome circumstances, State AttorneysGeneral may agree to communitycommitments in light of the resource andother constraints they face.

C. General Issues

7th Observation:

The safety zone provision ofHealth Care Statement 7 does notprotect anticompetitivecontracting practices of grouppurchasing organizations.

Health Care Statement 7 and itssafety zone aim to address monopsony andoligopoly concerns with the formation of aGPO. This statement does not address allpotential issues that GPOs may raise. TheAgencies believe amending the statement toaddress some, but not all potential issues, islikely to be counterproductive. Health CareStatement 7 does not preclude Agency actionchallenging anticompetitive contractingpractices that may occur in connection withGPOs. The Agencies will examine, on acase-by-case basis, the facts of any allegedanticompetitive contracting practice todetermine whether it violates the antitrustlaws.

8th Observation:

Countervailing power should notbe considered an effective responseto disparities in bargaining powerbetween payors and providers.

Although there appear to bedisparities in bargaining power betweensome payors and some providers, theavailable evidence does not indicate thatthere is a monopsony power problem inmost health care markets. Even if it wereassumed that providers confront monopsonyhealth plans, the Agencies do not believethat allowing providers to exercise

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countervailing power is likely to serveconsumers’ interests.

9th Observation:

Private parties should not engagein anticompetitive conduct inresponding to marketplacedevelopments.

The permissibility of unilateral andcollective provider conduct in response tomarketplace developments (including P4P,tiering, SSHs, and ASCs) is raised in severaldifferent settings in the Report. Generallyspeaking, antitrust law permits unilateralresponses to competition. If there is specificevidence of anticompetitive conduct byindividual providers or provider collusion inresponse to marketplace developments, theAgencies will aggressively pursue thoseactivities. 10th Observation:

The state action and Noerr-Pennington doctrines should beinterpreted in light of theprinciples that justified thosedoctrines in the first place.

The state action and NoerrPennington doctrines curb competition lawto promote important values such asfederalism and the right to petition thegovernment for redress. Inappropriatelybroad interpretations of these doctrines canchill or limit competition in health caremarkets. It is important to recognize boththe genuine interests these doctrines serve aswell as the anticompetitive consequencesthat result from an overly expansiveinterpretation of their scope.

11th Observation:

Remedies must resolve theanticompetitive harm, restorecompetition, and prevent futureanticompetitive conduct.

Remedies are a critical issue inimplementing an effective competitionpolicy. Optimal enforcement must steerbetween over-deterrence and under-deterrence. Over-deterrence may occur ifconduct that is not, in fact, anticompetitiveis challenged, or if excessive sanctions areimposed on anticompetitive conduct. Under-deterrence may occur ifanticompetitive conduct is not identified andaddressed, or if inadequate remedies areimposed in response to such conduct. TheAgencies must avoid both of these extremesto effect optimal deterrence, whilerecognizing that bringing cases helps createa “compliance norm.”

The Agencies view allanticompetitive conduct as serious, and willseek appropriate sanctions. In general, muchmore stringent measures are necessaryagainst those who violate the antitrust lawsrepeatedly or flagrantly and those whofacilitate anticompetitive conduct bymultiple parties. The Division will alsopursue criminal sanctions in appropriatecases. Disgorgement and/or dissolution willbe sought in appropriate cases.

VIII. CONCLUSION

The fundamental premise of theAmerican free-market system is thatconsumer welfare is maximized by opencompetition and consumer sovereignty –even when complex products and services

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such as health care are involved. TheAgencies play an important role insafeguarding the free-market system fromanticompetitive conduct, by bringingenforcement actions against parties whoviolate the antitrust and consumer protectionlaws. To be sure, in some instancescompelling state interests may trump or limitfree-market competition. The Agencies playan important role here as well, by makingpolicy makers aware of the costs ofimpediments to competition, and byadvocating for competitive market solutions.

The Agencies do not have apre-existing preference for any particularmodel for the financing and delivery ofhealth care. Such matters are best left to theimpersonal workings of the marketplace.What the Agencies do have is a commitmentto vigorous competition on both price andnon-price parameters, in health care and inthe rest of the economy. Much remains tobe accomplished to ensure that the marketfor health care goods and services operatesto serve the interests of consumers. ThisReport identifies concrete steps to improvecompetition in the health care marketplace,and improve the application of competitionlaw to health care.