Health Insurance: Aetna and Local Arket Concentration

Transcription

1 Paying a Preiu on your Preiu? Consolidation in the U.S. Health Insurance Industry By Leeore Dafny, Mark Duggan and Subraania Raanarayanan* We exaine whether and to what extent consolidation in the U.S. health insurance industry has contributed to higher eployer-sponsored insurance preius. We exploit the differential ipact across local arkets of a large national erger of two insurers to identify the causal effect of concentration on preius. Using data for large groups, we estiate preius in the average arket were approxiately 7 percentage points higher by 2007 due to increases in local concentration between 1998 and We also find evidence that consolidation facilitates the exercise of onopsonistic power vis-a-vis physicians, leading to reductions in their absolute eployent and earnings relative to other healthcare workers. Although the ajority of healthcare spending in the U.S. is funneled through the private health insurance industry, few researchers have exained whether the industry itself is contributing to rising health insurance preius. This possibility has becoe ever ore salient as consolidations continue in this highly-concentrated sector. In 2001, the Aerican Medical Association (AMA) reported nearly half of the 40 largest Metropolitan Statistical Areas (MSAs) were highly concentrated, as defined by the Horizontal Merger Guidelines issued in 1997 by the U.S. Departent of Justice and the Federal Trade Coission. In 2008, the AMA expanded its annual report to include 314 geographic areas (ainly MSAs), 94 percent of which were found to be highly concentrated. 1 During this seven-year period, the average, inflation-adjusted * Leeore Dafny, Kellogg School of Manageent, 2001 Sheridan Road, Evanston, IL (eail: l- dafny@kellogg.northwestern.edu);mark Duggan, Wharton School, University of Pennsylvania, 3620 Locust Walk, Philadelphia, PA (eail: duggan@wharton.upenn.edu); Subraania Raanarayanan, UCLA Anderson School of Manageent, 110 Westwood Plaza, Los Angeles, CA (eail: subbu@anderson.ucla.edu). We are grateful for helpful coents by anonyous referees, Michael Chernew, Julie Cullen, Roger Feldan, David Levine, Chris Snyder, Alan Sorensen, seinar participants at Aerican University, Brown University, Colubia University, Dartouth College, the Departent of Justice, Harvard University, Ohio State University, UC Berkeley, UCLA, University of Rochester, University of Michigan, University of Wisconsin, Wharton, and participants at the 1

2 preiu for eployer-sponsored faily coverage rose 48 percent (to $12,680 in 2008) 2 while real edian household incoe declined by 2 percent to $50,303 (Census Bureau, 2009). Prior studies point to the potential for insurer consolidation to raise preius (e.g., Robinson (2004), Wholey, Feldan and Christianson (1995), and Dafny (2010)), however none attept to quantify this effect. 3 Fro a theoretical standpoint, the effect of concentration on insurance preius is abiguous. On one hand, increases in arket concentration ay allow health insurers to raise their arkups, leading to higher preius. On the other hand, increases in arket concentration ay strengthen insurers bargaining positions vis-a-vis healthcare providers, leading to reduced negotiated reiburseents and lower preius. In addition, there are any potential sources of efficiency gains fro consolidation, including econoies of scale Aerican Econoic Association Annual Meetings, the International Industrial Organization Conference, the Aerican Society of Health Econoists Conference, the 20 th Annual Health Econoics Conference, the University of British Colubia Suer Industrial Organization Conference, the Searle Center Syposiu on Antitrust Econoics and Policy, the NBER Suer Institute, the New Perspectives on Health and Health Care Policy conference at the Federal Reserve Bank of Chicago and the HEC Montreal Conference on the Industrial Organization of Healthcare. We thank Michael Chernew, Jose Guardado, Woolton Lee, and Dennis Scanlon for valuable discussions on key data sources. Dafny gratefully acknowledges funding fro The Searle Center on Law, Regulation, and Econoic Growth at the Northwestern University School of Law. 1 Copetition in Health Insurance: A Coprehensive Study of U.S. Markets, Aerican Medical Association, 2001 and These figures are based on the reported levels of the Herfindahl-Hirschan Index (HHI) for HMOs and PPOs cobined. Estiates are not strictly coparable over tie due to changes in ethodology and saple selection. For exaple, self-insured HMOs are generally included in 2001 but excluded in The Horizontal Merger Guidelines issued in 1992 and updated in 1997 define arkets with HHI > 1,800 as highly concentrated. A recent update adjusted this threshold to 2,500 (DOJ, 2010) and as a result the share of arkets in 2008 that would be highly concentrated is soewhat lower at 70 percent. 2 The corresponding increase for single coverage was 44 percent (Kaiser Faily Foundation/Health Research and Educational Trust Eployer Health Benefits Annual Survey, 2009). Preius include both eployer and eployee contributions, and are adjusted to 2008 dollars by the authors using the CPI-U. 3 Robinson (2004) shows that state-level insurance arkets are doinated by a sall nuber of firs, and observes that insurer profits increased rapidly over Wholey, Feldan and Christianson (1995) report that preius per HMO eber are negatively related to the nuber of copetitors facing the HMO in question, controlling for a host of HMO and arket characteristics such as per capita incoe, Blue Cross affiliation and HMO ownership status. Last, Dafny (2010) finds health insurers engage in direct price discriination, charging higher preius to firs with deeper pockets, as easured by operating profits. This evidence of price discriination iplies insurers possess and exercise arket power in soe local arkets, but does not yield an estiate of the contribution of iperfect copetition in this arket to preiu growth. 2

3 in IT investing and disease anageent progras. Such efficiency gains would reduce optial preius. 4 The net effect on insurance preius is ultiately an epirical question. There are two key challenges to epirically estiating such a link: (1) adequate data and (2) plausibly exogenous variation in arket concentration. Regarding the first issue, coprehensive data on a large saple of healthplans are extreely difficult to obtain because contracts are custoized for each buyer across any diensions, renegotiated annually, and considered highly confidential. In addition, preius vary based on the deographics, health risks, and expenditure history of the insured population. Thus, it is difficult to calculate a standardized preiu to enable coparisons across eployers and/or arkets. With respect to the second challenge, highly concentrated arkets (or arkets that are becoing ore concentrated) are likely to differ fro other arkets in unobservable ways, aking it difficult to separately identify the effect of concentration fro other factors. We address these challenges as follows. First, we utilize detailed longitudinal data on the healthplans offered by a saple of ore than 800 eployers in 139 distinct geographic arkets in the U.S. The data span the nine years between 1998 and 2006, and represent approxiately 10 illion active eployees and their dependents in each year. Rather than attepting to standardize preius across different eployee populations, products, and plan designs, we focus on the growth rate of health insurance preius for the sae eployer in a specific geographic arket over tie, and exaine how this relates to the local arket structure of health insurers. Focusing on growth alleviates concerns about tie-invariant unobservable differences 4 Of course, rent transfers fro providers to insurers are not true efficiency gains, although they ay reduce preius. 3

4 in the risk profiles of eployee groups and the characteristics of plans they utilize that ay be correlated with preiu levels. We also control for the influence of tie-varying easures such as eployee deographics, the types of plans utilized (HMO, PPO, etc.), and the generosity of benefit design. After docuenting trends in the level and growth of concentration (as easured by the Herfindahl-Hirschan index (HHI), which is the su of squared arket shares) in 139 distinct geographic arkets, we estiate OLS odels of the relationship between preiu growth and concentration levels. We do not find evidence that preius are rising ore quickly in arkets that are becoing ore concentrated. While these estiates are useful for descriptive purposes, they are unlikely to provide causal estiates of the ipact of arket structure on preius. Differences in HHI across arkets or even changes in HHI within arkets - are likely to be driven by any factors that are not exogenous to preius. These include differences (or changes) in consuer preferences and constraints, product offerings and pricing strategies, and the arket conduct of hospitals, physicians, and other health care providers. For exaple, consider a arket with a struggling local econoy. In such a arket, consuers ay flock to low-priced carriers, bringing about an increase in local arket concentration and a siultaneous reduction in average preiu growth (relative to other arkets). This pattern does not iply consolidations in such a arket would reduce preiu growth, ceteris paribus. In order to address the endogeneity challenge and obtain a credible estiate of the ipact of concentration on preiu growth, we exploit sharp and heterogeneous increases in local arket concentration generated by the 1999 erger of two industry giants, Aetna and Prudential 4

5 Healthcare. Both were national firs, active in ost local insurance arkets, and thus the erger had widespread ipact. However, the pre-erger arket shares of the two firs varied significantly across specific geographic arkets, resulting in very different shocks to posterger concentration. For exaple, in our saple the pre-erger arket shares of Aetna and Prudential in Jacksonville, Florida were 19 and 24 percent, respectively, versus just 11 and 1 percent, respectively, in Las Vegas, Nevada. Holding all else equal, this iplies an increase in post-erger HHI of 892 points in Jacksonville, but only 21 points in Las Vegas. Focusing on the years iediately surrounding this erger, we exaine the relationship between preiu growth and HHI changes using these predicted changes as instruents for actual changes, and controlling as fully as possible for changes in the characteristics of healthplans (such as benefit design). The point estiates indicate that rising concentration in local health insurance arkets accounts for a nontrivial share of preiu growth in recent years. Specifically, our instruental variables estiates iply that the ean increase in local arket HHI between 1998 and 2006 (inclusive) raised preius by roughly 7 percent fro their 1998 baseline, all else equal. Given private health insurance expenditures of $490 billion in our base year 1998, if this result is generalizeable then the preiu on preius by 2007 is on the order of $34 billion per year, or about $200 per person with eployer-sponsored health insurance. 5 5 Source: National Health Expenditure Data provided by the Center for Medicare and Medicaid Services; available online at The vast ajority of this spending is due to eployer-sponsored plans; only 9 percent of the non-elderly privately insured have policies that are not eployent-based (Census Bureau, 2009). Additionally, this figure understates the size of the private health insurance industry as it excludes expenditures by Medicaid and Medicare anaged care plans. 5

6 Although our focus is on the exercise of arket power by insurers in the output arket, consolidation ay also have iportant effects on input prices. Using data on earnings and eployent of healthcare personnel, we exploit the differential ipact across geographic arkets of the Aetna-Prudential erger to exaine whether there is a causal link between concentration and these outcoes. Our analysis suggests that the growth in insurer bargaining power following this erger reduced earnings and eployent growth of physicians, and raised earnings and eployent growth of nurses. This pattern of results is consistent with posterger substitution of nurses for physicians, and the exercise of onopsony power vis-a-vis physicians. The paper is organized as follows. Section I describes the data in detail. We exaine the association between local arket concentration and preiu growth in Section II. In Section III we investigate whether a causal relationship exists between these two variables using the variation across geographic arkets in the erger-induced increase in insurer concentration. Section IV contains our analyses of the relationship between concentration and healthcare eployent and earnings. Section V concludes. I. Data Our priary source is the Large Eployer Health Insurance Dataset (LEHID). LEHID contains inforation on all of the healthplans offered by a large saple of eployers between 1998 and 2006, inclusive. It is an unbalanced panel gathered and aintained by a leading benefits consulting fir. The data are proprietary, and eployers included in the dataset have 6

7 soe past or present affiliation with the fir. Online Appendix 1, which contains additional details of the data not presented here, illustrates that LEHID plans are on average very siilar to the plans offered by a representative saple of large eployers nationwide. The original unit of observation is the healthplan-year. A healthplan is defined as a unique cobination of eployer, arket, insurance type, insurance carrier, and plantype (e.g., Copany X s Chicago-area fully-insured Aetna HMO). There are 813 unique eployers, 139 geographic arkets, 2 insurance types (self and fully-insured), 357 insurance carriers 6 and four plan types (HMO, POS, PPO, Indenity) represented in the data. 7 Most eployers in LEHID are large, ulti-site, publicly-traded firs, such as those appearing on the Fortune 1000 list. The leading industries represented include anufacturing (110 eployers), finance (101), and consuer products (73), although nonprofit and governent sectors are also represented (43 in the governent/education category). Geographic arkets are defined by the data source using 3-digit zipcodes. According to the data provider, the 139 arkets reflect the geographic boundaries typically used by insurance carriers when quoting prices. Large etropolitan areas are separate arkets, and non-etropolitan areas are luped together within state boundaries (e.g., New Mexico Albuquerque and New Mexico except Albuquerque ). 8 The saple includes both fully-insured and self-insured plans. As these ters suggest, the forer is traditional insurance in which the insured pays the carrier to bear the risk of 6 Many of these carriers are third-party adinistrators, who rent provider networks and process clais for selfinsured eployers. 7 HMO and POS plans control utilization through priary care physicians ( gatekeepers ). HMOs only cover innetwork providers, while POS and PPO plans provide soe coverage for out-of-network providers. Indenity plans have no gatekeepers or network restrictions. 8 There is only one arket that crosses state boundaries, Massachusetts Southern and Rhode Island. A few rural areas of the U.S. are excluded. A ap of the arkets is available in Dafny (2010). 7

8 realized healthcare outlays. Many large eployers choose to self-insure, outsourcing benefits anageent, provider contracting, and/or clais adinistration but paying the realized costs of care. The percent of LEHID enrollees in self-insured plans increased fro 55 to 80 percent during the study period. In addition to the eleents that jointly define a plan, our data set includes the following variables: preiu, deographic factor, plan design factor, and nuber of enrollees. Preiu is expressed as an average aount per enrollee (i.e. a covered eployee); it therefore increases with the average faily size of enrollees in a given plan. Preiu cobines eployer and eployee contributions, and for self-insured plans it is a projection of expected costs per enrollee (including estiated adinistrative fees paid to an insurance carrier, as well as preius for stop-loss insurance, if any). Because the forecasts are used for budgeting and to establish eployee preiu contributions, they are carefully developed and vetted. Eployers often hire outside actuaries and benefits experts (such as our source) to assist in forulating accurate projections. Deographic factor is a easure that reflects faily size, age, and gender coposition of enrollees in a given plan. All of these characteristics are iportant deterinants of average expected costs per enrollee in a plan. Plan design factor captures the generosity of benefits within a particular carrier-plan type, with an ephasis on the levels of coinsurance, copayents, and deductibles. Both factors are calculated by the source, and the proprietary forulae were not disclosed to us. Higher values of either factor are associated with higher preius. 8

9 The LEHID also records the nuber of enrollees in each plan. This figure includes only eployees of the relevant fir; dependents are accounted for by the deographic factor described above. The total nuber of enrollees in all LEHID plans averages 4.7 illion per year. Given an average faily size of ore than 2, this iplies that ore than 10 illion U.S. residents are part of the saple in a typical year, representing approxiately 7 percent of those with eployer-sponsored insurance (ESI) during this period, and a uch larger share of those insured through large firs. We suppleent the LEHID data with tie-varying easures of local econoic conditions (the uneployent rate, as reported by the Bureau of Labor Statistics), a easure of healthcare utilization (Medicare costs per capita, as reported by the Centers for Medicare and Medicaid services), and the concentration of the hospital industry (HHI as calculated by the authors using the Annual Surveys of Hospitals adinistered by the Aerican Hospital Association). 9 As the first two easures are reported at the county-year level, and LEHID arkets are defined by 3-digit zipcodes, we ake use of a apping between zipcodes and counties and where necessary, use population data to calculate weighted average values for each LEHID arket and year. We perfor ost analyses using data aggregated to the eployer-arket-year level. Table 1 presents descriptive statistics for this unit of observation for 1998, 2002 and 2006, which represent the initial, iddle and final years of the saple respectively. Because our priary outcoe is growth in health insurance preius (in order to avoid cross-sectional 9 To calculate HHI for each geographic arket and year, we use data on the nuber of beds for all general hospitals located in the set of 3-digit zipcodes that define the arket, assigning hospitals with the sae syste ID to a coon owner. 9

10 identification of the coefficients of interest), aggregating the data to the eployer-arket-year level enables us to use a uch larger proportion of the data. With the healthplan-level data, growth in preiu is undefined when an eployer terinates a particular plan. Analogously, new plans can only enter the analysis after ultiple observations are available. Changes to plan offerings are quite coon in our data (24 percent of plans in year t whose fir-arkets are still present in year t+1 no longer exist). Moreover, changes in arket concentration ay affect the insurance carriers and plan types chosen by eployers, so we do not want a priori to eliinate this substitution fro our saple. 10 Given this aggregation, both fully and self-insured plans ust be included together in the analysis saple to ensure the set of eployees represented over tie is stable (but for hiring, attrition, and changes in eployees decisions to take up eployersponsored insurance). INSERT TABLE 1 ABOUT HERE II. Is Preiu Growth Correlated with Local Market Concentration? In this section, we exaine the relationship between the growth in health insurance preius and local arket concentration. We begin by describing the distribution of arketlevel HHI and how this has changed over tie. Next, we estiate OLS regressions relating preiu growth at the eployer-arket level to the corresponding arket HHI. We include arket fixed effects in our odels, so that we identify the coefficient of interest using changes in within-arket HHI. The richness of the data also perits us to control for iportant tie- 10 This occurs very frequently in the LEHID. For exaple, consider eployer-arket pairs that are present in both 1999 and More than half of the plans offered by these firs in 1999 are no longer present in 2002, either because the eployer switched to different carriers or because it changed the type of plan with the sae carrier. 10

11 varying differences (such as the percent of enrollees in HMOs and the agnitude of copayents). Although interesting as a descriptive exercise, this analysis is unlikely to yield unbiased estiates of the causal ipact of changes in arket structure on preiu growth, as changes in arket structure are unlikely to be exogenous. A. Market Structure of Large Group Insurance Markets, During our 9-year study period, the average arket-level HHI (estiated using our saple, and scaled fro 0 to 10,000) increased fro 2,286 to 2, Using the categorization fro the Horizontal Merger Guidelines issued in 1997, the fraction of arkets falling into the top highly concentrated category (HHI > 1,800) rose fro 68 to 99 percent. The edian fourfir concentration ratio increased fro 79 to 90 percent. Thus, our data support the conclusions of well-publicized reports issued by the Aerican Medical Association and the General Accounting Office: local health insurance arkets are concentrated and becoing ore so over tie. 12 Figure 1 presents histogras of the arket-level changes in HHI, separately for , , and The larger increases tended to occur during the second half of the study period, but sizeable increases are present in the first half as well. Between 1998 and 2002, 53 percent of arkets experienced increases in HHI of 100 points or ore, and 25 percent saw increases of 500 or ore points. The corresponding figures for 2002 to 2006 are 78 and To gauge the ipact of this change on concentration, consider the following two exaples. A arket with five insurers, four of which have a arket share of percent, would have an HHI of 2,281. A arket with four insurers, three of which each have a arket share of percent, would have an HHI of 2, AMA ibid; GAO, 2009a. 11

12 percent, respectively. The Merger Guidelines provide a helpful frae of reference for interpreting these changes. According to the Guidelines, ergers resulting in an increase of 100 or ore points when HHI already exceeds 1800 are presued likely to create or enhance arket power or facilitate its exercise. There is wide variation in the agnitude of changes in HHI across arkets, notwithstanding the fact that ost are positive. INSERT FIGURE 1 ABOUT HERE The reasons for these changes in HHI can be subdivided into structural (related to entry, exit, and consolidation) and non-structural sources. Using data on fully-insured HMOs only, Scanlon, Chernew and Lee (2006) report that 61 to 65 percent of the variation in HHI between 1998 and 2002 is attributable to structural changes. These changes are also iportant in our saple: the ean nuber of carriers per arket declined fro 18.9 in 1998 to 9.6 in Of course, neither source of HHI change can be presued exogenous to other deterinants of preiu growth. Consuer preferences siultaneously deterine arket shares and preiu growth, and exit and consolidation of carriers ay be ipacted by expectations of preiu growth. B. OLS Estiates of the Relationship between Market Structure and Preius 13 As the data on HHI suggest, any of these carriers are quite sall. This is due to the presence of any sall self-insured plan adinistrators, particularly in the earlier part of the study period. Soe of these adinistrators ay not be active participants in a given arket, i.e. they rent networks fro other carriers so as to offer a particular client a consistent plan across all geographies. 12

13 To explore the relationship between preiu growth and arket concentration, we begin by estiating equations of the following for: ( 1) ln( preiu) HHI, 1 X t-1 C et [ ς e t ][ plan type shares et et τ t λ plan design et ] et. In this specification, we odel preiu growth between year t-1 and year t for a given eployer e in arket as a function of lagged arket characteristics (including HHI) 14, conteporaneous changes in observable characteristics of the insured population (such as deographics), and year and arket fixed effects. Market characteristics are lagged by one year because preius are set prospectively, i.e. preius for 2006 are deterined in In addition to HHI, the arket-year covariates (denoted by X t-1 ) include the uneployent rate (to capture local econoic conditions), the log of per-capita Medicare costs (to capture trends in healthcare utilization), and the general, acute-care hospital HHI (to capture concentration in the provider arket, which could independently lead to preiu increases). Note these characteristics are included in level for (rather than first differences) to allow for a delayed response to changes in arket structure or in local econoic conditions. 15 In contrast, we anticipate concurrent preiu responses to changes in characteristics easured at the eployer-arket-year level ( Cet ), specifically deographic factor and the percentage of enrollees in self-insured plans. The year fixed effects capture average national 14 Fro a theoretical standpoint, HHI is a valid easure of copetition if firs copete a la Cournot. While the Cournot odel does not accurately describe the health insurance arket, we follow the lead of ost prior studies in the related literature, as well as the Horizontal Merger Guidelines, in adopting the HHI as a easure of copetition.. 15 Given the inclusion of arket fixed effects in equation (1), the coefficients on arket-year covariates (including HHI) are identified by within-arket changes in these variables. 13

14 changes in preiu growth, and the arket fixed effects capture differences in average growth rates across arkets. Finally, we also estiate specifications including the ters in brackets: eployer fixed effects, changes in the share of enrollees in each plan type, and changes in the average generosity of these plans. 16 INSERT TABLE 2 ABOUT HERE Results are presented in coluns 1 through 3 of Table 2. There is no significant association between concentration levels and preiu growth, and the estiates change little upon inclusion of additional controls. 17 Of course, causality can only be inferred fro this odel if within-arket variation in insurer concentration is uncorrelated with other unobserved deterinants of preius, and if variation in preiu growth does not induce variation in concentration. As previously noted, there are good reasons to doubt the validity of these assuptions. Hence in the section that follows we pursue an instruental variables approach. III. Do Increases in Local Market Concentration Cause Increases in Preius? In this section, we estiate the causal effect of changes in arket concentration on preiu growth by exploiting shocks to local arket concentration produced by ergers and 16 Note that eployer fixed effects will substantially affect the coefficient on HHI only if eployers with high or low growth in preius are systeatically located in arkets that have high or low levels of HHI. 17 The estiates are siilarly sall in agnitude and statistically insignificant if we use the change in HHI in place of the level of HHI as the key explanatory variable. For the ost part, the coefficient estiates on the arket-level control variables are statistically insignificant. The coefficient estiates on the eployer-arket controls are highly significant, and generally have the expected signs. For exaple, a shift fro 100% enrollent in POS plans (the oitted category) to 100% enrollent in HMO plans is associated with a 5 percent decline in preius. 14

15 acquisitions (M&A). 18 Because M&A activity in local or regional arkets ay itself be otivated by expected trends in preiu growth, we considered only large, non-local ergers as candidates for this analysis. We also ruled out ergers with insufficient pre or post periods (e.g., Aetna and NYLCare in 1998, the first year for which we have data), few overlapping arkets, or very sall shares in our saple for one of the erging parties (e.g., United Healthcare and MAMSI). Only one erger reained: the Aetna-Prudential erger of Post-erger, the new fir (known as Aetna ) was widely reported to be the nation s largest insurer, covering 21 illion individuals. 19 As we describe in detail below, there was substantial overlap in the local arket participation of Aetna and Prudential prior to the erger, generating the potential for sizeable post-erger changes in arket concentration. Online Appendix 2 provides additional discussion of the circustances surrounding the erger. Iportantly, there is no ex ante evidence that Aetna targeted Prudential because of expectations about preiu growth or changes in insurer concentration in affected arkets. Our analysis is subdivided into four sections. First, we estiate the ipact of the erger on arket concentration (the first stage analysis). In so doing, we docuent the range of preerger arket shares for Aetna and Prudential as well as the degree of pre-erger overlap. Second, we perfor a reduced-for analysis, in which we exaine the ipact of the erger on preiu growth. Third, we cobine these analyses to produce our estiate of the causal 18 Our approach is siilar in spirit to that of Hastings and Gilbert (2005), who use an acquisition of a West Coast refinery as a source of exogenous variation in the degree of vertical integration across retail gasoline arkets in 13 West Coast etropolitan areas. They find that non-integrated rival stations face higher costs, controlling for several tie-varying station characteristics. 19 Sanders, Alain L., Will the Aetna-Prudential Merger Hurt the Patient? TIME agazine, June 22,

16 ipact of concentration on preius. Last, we investigate the plausibility of alternative explanations for our findings. In particular, we estiate specifications to tease out the reaction of Aetna s rivals, as these responses are inforative vis-a-vis the arket dynaics. A. The Effect of the Aetna-Prudential Merger on Market Concentration Iediately prior to the erger in 1999, Aetna and Prudential were the third and fifth largest insurers in our saple in ters of the nuber of enrollees. All 139 arkets included plans offered by both firs. There was significant variation across arkets, however, in the preerger shares of each fir. We hypothesize that arkets served by both firs experienced increases in arket concentration iediately following the erger, and that these increases varied by the pre-erger shares of the two erging firs. Specifically, for every arket we calculate the siulated change in HHI ( si HHI ) as the erger-induced change in arket s HHI that would have occurred fro 1999 to 2000 absent any other changes, i.e. (2) si HHI 2 Aetna 1999 share Pru 1999 share 2 Aetna 1999 share Pru 1999 share 2* Aetna1999 share * Pru 1999 share 2 For exaple, if Aetna and Prudential had arket shares of 10 percent each in 1999, (scaled by 10,000 as discussed above) would equal 200. si HHI INSERT FIGURE 2 ABOUT HERE 16

17 Figure 2 provides detail on the actual distribution of si HHI in the 139 LEHID arkets. There is significant variation in this easure, with 46 largely unaffected arkets ( si HHI < 10) and 42 highly-affected arkets ( si HHI 100). One state in particular stands out for its high levels of si HHI : Texas. Five of the six arkets in Texas have si HHI greater than 500. The high degree of overlap in Texas provoked action by the Departent of Justice. To address the concerns raised by the Departent, Aetna agreed to divest the Texas-based HMO businesses it had acquired fro NYLCare in We therefore exaine whether the consent decree in Texas successfully neutralized the effect of the erger in these arkets; to the extent it did, arkets in Texas can serve as a placebo group for the natural experient we study. We propose to use si HHI * post t as an instruent for HHI in equation (1), where post is an indicator variable for the post-erger years in the saple. To evaluate this instruent, we estiate the following equation using arket-year data, initially excluding observations fro Texas: (3) HHI λ τ si HHI * τ t t t t 20 DOJ alleged that after the erger, Aetna would have a arket share for fully-insured HMOs of 63 percent in Houston, and 42 percent in Dallas. DOJ stated that The required divestitures... will preserve copetition and protect consuers fro higher prices and deny Aetna the ability to unduly depress physician reiburseent rates. See Although the allegations pertained to Houston and Dallas, because Aetna divested all NYLCare plans in Texas, the consent decree affected the entire state. Source: Blue Cross and Blue Shield of Texas to Purchase NYLCare Texas Operations, Aetna press release, 9/14/1999, 17

18 The vectors denoted by and t represent a full set of arket and year fixed effects, respectively. By interacting si HHI with separate indicators for each year (except 1998, the oitted category), this odel investigates the possibility that trends in arket concentration ay have been different prior to the erger in arkets differentially ipacted by the erger. The estiated coefficients will also help to deterine the appropriate study period for our analysis. In this and all specifications including si HHI, we use a scale of 0 to 1 for this easure. INSERT FIGURE 3 ABOUT HERE Figure 3 graphs the coefficient estiates on the yearly interactions with si HHI, together with the 95% confidence intervals. The saple includes data fro 1998 to Estiates are presented in nuerical for in colun 1 of Table 3. Relative to the oitted interaction ter, si HHI * ( year 1998), only the interactions with indicators for 2000 and 2001 are statistically significant. At -0.10, the coefficient estiate for β in 1999 is sall and (insignificantly) negative, whereas estiates for β in 2000 and 2001 are large (0.49 and 0.46, respectively) and significant at the 5 percent level. The tiing is consistent with expectations: the erger was effectively cleared in July 1999, when the Departent of Justice subitted its Proposed Final Judgent. The coefficients in 2000 and 2001 are significantly saller than 1, iplying that eployers to soe extent substituted away fro Aetna and Prudential in the wake of the erger. In addition, there is likely attenuation bias due to easureent error, as we have only a saple (rather than a census) of insurance contracts. INSERT TABLE 3 ABOUT HERE 18

19 The coefficient estiates of β in 2002 are 2003 are both noisy and negative indicating that the erger-induced shocks to local concentration dissipated quickly. 21 In order to use the erger as an instruent for arket concentration, we ust therefore focus our analyses on the early years of our saple: for the first-stage odel, and for the second stage (because HHI ipacts preius with a lag). However, in Section B. below, we discuss reduced-for analyses of the longer-ter ipact of changes in siulated HHI on health insurance preius by extending the study period out to Next, we use data fro 1998 through 2001 to estiate a ore parsionious odel that replaces the individual year interactions with a single post indicator that takes a value of one during 2000 and 2001: (4) HHI t λ τ t si HHI * post si HHI * post * Texas post * Texas. 1 0 t t t t After estiating the baseline odel (which excludes the ters in brackets), we add the six Texas arkets to the saple and include a triple-interaction, si HHI * post * Texas t, to explore whether the post-erger ipact of si HHI differs in these arkets. We then add the ter post t * Texas to control for average changes in Texas as copared to other states during the post-period, although it ay be difficult to separately identify the coefficient on the two Texas interactions because there are only 6 Texas arkets and two post years. 21 This finding is consistent with reports fro industry experts. According to a 2004 Health Affairs article by Jaes Robinson, [G]ossip speculates [Aetna] would be lucky to still have 30,000 of the 5 illion it acquired fro Prudential. 19

20 The results are displayed in Colun 2 of Table 3. As anticipated, the coefficient on si HHI * post t is statistically significant: 0.52, with a standard error of The results in Coluns 3 and 4 show that the federal governent achieved its objective of neutralizing the erger s effect on arket concentration in Texas arkets. The triple-interaction ter for Texas arkets is negative and statistically significant in both specifications, and fully offsets the ipact of the erger. In both odels, we cannot reject the hypothesis that the su of the relevant double and triple-interaction ters equals zero. Observations fro Texas are therefore suitable for the placebo test (or falsification exercise) previously noted. If preiu growth has a siilar relationship with si HHI in Texas as in other parts of the U.S., then changes in insurer concentration ay not be driving the observed relationship. B. The Effect of the Aetna-Prudential Merger on Health Insurance Preius To investigate the effect of erger-induced increases in local arket concentration on plan preius, we estiate odels of the following for: 22 (5) ln( preiu) et si HHI [ ς e * post ][ plan type shares X si HHI * post * Texas post * Texas. 1 0 t t et t-1 C t et τ plan design t et λ ] et In light of the results fro the preceding section, we focus on the period between 1998 and 2002 (i.e. annual preiu growth fro , , , and ). Note that in this odel postt takes a value of one for the and changes, and is 22 In a copanion set of specifications (results available upon request), we define the outcoe variable to be ln(preiu) (rather than the change in this easure) and include arket tie trends. The results are siilar to those presented in this section. 20

21 otherwise equal to zero. 23 As in the OLS regressions presented in Section II, we begin with a parsionious specification that controls for lagged arket covariates and changes in eployerarket characteristics, as well as fixed differences across years and arkets in average preiu growth (captured respectively by year and arket fixed effects, denoted t and ). INSERT TABLE 4 ABOUT HERE The results are reported in Colun 1 of Table 4. The estiated coefficient on si HHI * post t is positive and statistically significant. Given the ean si HHI of (across all 139 geographic arkets), the point estiate of iplies that, in a typical arket, the erger induced an average preiu increase of approxiately 0.25 percent in both 2001 and 2002, and thus a total increase of approxiately 0.50 percent. The point estiate changes little upon inclusion of eployer fixed effects (colun 2), and as expected the standard errors decrease. Adding controls for changes in the generosity of plans (colun 3) also has little ipact on the estiate. Next, we study the pattern of preiu growth over tie by replacing the ter si HHI * post t with si HHI * t (interactions with individual year duies, with 1998 as the oitted year). The results, in colun 4, provide two key insights. First, there is no evidence of a pre-trend in preiu growth; that is, the estiated reaction to the erger is not due to a pre-erger trend in arkets with large overlapping Aetna and Prudential arket shares. Second, the effect of the erger on preiu growth is very siilar in both post years. 23 Recall the last year of the erger-induced HHI increase was 2001, and preius for 2002 are set in

22 This finding strongly suggests that the ipact of the erger is appropriately odeled, i.e. that concentration affects the growth rate rather than the level of preius. 24 If the saple is extended to 2006, we find the coefficients reain of siilar agnitude for two ore years, and then fall down close to zero. 25 The fact that the coefficient estiates reain positive and do not becoe negative suggests soe aount of hysteresis: consolidation results in a higher rate of preiu growth, and even when circustances change (in this case, the effect of the erger on concentration eventually disappeared) preius reain elevated. 26 Coluns 5 and 6 of Table 4 present the results of the falsification test enabled by the divestiture requireent in Texas. To execute this test, we add Texas observations to the saple and estiate the full odel (as in Colun 3) with the addition of a triple interaction ter, si HHI * post * Texas. 27 The estiated coefficient on this ter is highly significant and t negative (-0.24), and alost perfectly offsets the ain effect of si HHI in this specification (0.19). Although the result is not robust to including a separate ter for post t * Texas (colun 6), this is not surprising given there are only six arkets in Texas and just two post years. On 24 An alternative explanation is that an increase in concentration does raise the level (rather than the growth rate) of preius, but it takes ultiple years to reach the new level. 25 To be precise, the coefficients on interactions of the siulated change in HHI with indicators for 2003 and 2004 are and respectively, and are both significant with p< As noted earlier, the results of the first stage necessitate a study period ending in However the results just described suggest the estiates will be conservative. 27 Note a second-order interaction (i.e. post t *Texas ) is arguably not necessary in this odel as arket fixed effects already control for differences in average annual growth rates across arkets. 22

23 net, the results suggest that the arket power effect of the erger in Texas was indeed neutralized by the DOJ s actions. 28 C. IV Estiates Table 5 presents the first-stage, reduced for, and second-stage odels corresponding to our IV estiate; the reduced-for odel is repeated fro colun 3 of Table 4. At 0.39, the estiated effect of lagged HHI on preiu growth is positive, statistically significant, and roughly twice as large as the reduced for estiate. This is anticipated given the first-stage coefficient of 0.48 reported in colun INSERT TABLE 5 ABOUT HERE Because our estiates suggest that changes in HHI affect the growth rate (rather than just the level) of preius, to estiate the average effect of consolidation over the entire study period, we ust consider the tiing of consolidation between 1998 and As previously noted, the average increase in HHI across all arkets was 698 points during this period. If this increase were evenly distributed over tie, the effect of consolidation on preius during our 28 As an additional extension of the reduced-for analysis, we exained whether the ipact of the erger was greater in arkets with higher initial levels of concentration. Unfortunately, coefficient estiates on siδhhi *post t *initial HHI (and variants thereof) were very iprecise. 29 Note this first-stage coefficient differs slightly fro the coefficient obtained using arket-year data, as the unit of observation is the eployer-arket-year. 23

24 study period would be approxiately 13 percent. However, consolidations tended to occur later in the study period, yielding a cuulative estiated effect of approxiately 7 percent. 30 For the sake of coparison, we also present coefficient estiates obtained using OLS odels, in which lagged HHI is the predictor of interest. As noted before, OLS estiates are likely to be downward-biased, understating the actual ipact of changes in arket concentration on preius. Indeed, the coefficient fro the OLS odel (presented in colun 4) is near zero (and iprecisely estiated). Hausan specification tests reject the null assuption of consistency for this odel (p<0.01), underscoring the need for instruental variables estiation. Collectively, the results presented in this section show that consolidation does result in a preiu on preius. We arrive at this conclusion by exploiting arguably exogenous increases in local arket concentration caused by the nationwide erger between two large insurance firs, Aetna and Prudential. Two key results indicate our conclusions are not driven by unobserved factors correlated with the pre-erger arket shares of Aetna and Prudential. First, there is no evidence that concentration or preius in arkets with higher si HHI were trending differently before the erger took effect. Second, we find no response in Texas, where the erger was effectively blocked by the Departent of Justice. These tests support the use of si HHI as an instruent for lagged HHI. In Online Appendix 4, we 30 Details of our calculation are available in Online Appendix 3. If one assues that an increase in concentration between t and t+1 affects preiu growth for only 2 years (i.e. until t+3, rather than indefinitely), then the iplied increase in preius caused by the increase in HHI between 1998 and 2006 is soewhat lower at 5 percent. 24

25 exaine the ipact of consolidation on health plan characteristics other than price, such as plan design and the share of eployees enrolled in HMOs. 31 D. Alternative Explanations The findings suarized above are consistent with the exercise of arket power in the wake of consolidation. However, the pattern of results is also consistent with alternative explanations, in particular a istake in Aetna s post-erger pricing strategy, and/or increases in insurance quality (and therefore price). In this section, we discuss the evidence with regard to these alternative hypotheses. Our results show that prices increase on average in arkets with higher si HHI. If this price increase is priarily due to actions by Aetna, then Aetna s subsequent loss of arket share would suggest the price increase was unsuccessful, i.e. they were not able to exercise arket power following the erger. On the other hand, if copetitors followed suit by increasing their prices as well, that would suggest that Aetna s action softened copetition arketwide, iplying the presence (and exercise) of arket power. To investigate whether Aetna s copetitors increased their preius in response to the erger, we estiate a set of specifications analogous to those in Table 4 for the 61 percent of eployer-arkets that were not served by either Aetna or Prudential at the tie of the erger in 31 Aong other results, we find that eployers reduced the generosity of plan design. This is consistent with efforts by eployers to reduce the burden of higher insurance preius through so-called benefit buybacks. We ephasize that our preiu results do control for changes in plan design. We find a soewhat counterintuitive shift away fro HMOs; however we discuss plausible explanations for this pattern in Online Appendix 4. 25

26 1999. Our point estiates for the coefficient of particular interest ( fro equation 4) are siilar to the estiates for the full saple, as shown in Online Appendix 5. This iplies that insurers not directly involved in the erger responded to the erger-induced change in concentration by raising their preius, which supports the arket-power explanation for our findings. Iportantly, when we restrict the saple to eployer-arkets that were served (either partially or fully) by Aetna or Prudential at the tie of the erger, our estiates for are approxiately twice as large. This suggests that the erged entity increased its preius ore than its copetitors in arkets where Aetna and Prudential had significant overlap, which is consistent with the erged entity exercising price leadership and its oligopolistic rivals following. Last, it is notable that preius reained elevated in high- si HHI arkets through at least 2006, notwithstanding Aetna s loss of arket share by This hysteresis in arket price is again consistent with a new oligopolistic pricing equilibriu facilitated by Aetna s original exercise of arket power. The second alternative explanation, that Aetna raised quality and copetitors followed its lead, is less aenable to exploration using our data. Conceptually, there are at least two reasons to question this hypothesis. First, quality is lupy (e.g. enhancing consuer access to clais) and far ore difficult to calibrate across different arkets than price. Second, quality changes take tie to ipleent and to counicate to the arketplace, and the ipact of the erger on price occurs within the first year. These points notwithstanding, quality reains an iportant oitted factor in our analysis. 26

27 IV. Evaluating the Effects of Insurer Consolidation on Providers Thus far, we have exained the ipact of arket structure in the insurance industry on downstrea buyers, specifically of group plans. However, the degree of copetition in the insurance industry will also potentially affect upstrea suppliers, such as healthcare providers, pharaceutical firs, and edical device anufacturers. To the extent that suppliers have few outside options, a lack of vigorous copetition aong insurers ay lead to onopsonistic practices. Capps (2009) reviews the theoretical and practical iplications of onopsony in the context of health insurance ergers. 32 Concern about insurers onopsonistic practices has eanated not only fro provider organizations such as the Aerican Medical Association and the Aerican Hospital Association but also fro state and federal regulatory authorities. In fact, the DOJ s foral coplaint regarding the Aetna-Prudential erger alleged that the erger would enable Aetna to exercise onopsony power against physicians, allowing Aetna to depress physicians reiburseent rates in Houston and Dallas, likely leading to a reduction in quantity or degradation in quality of physicians services A nuber of recent studies exaine the effect of insurer bargaining power on hospital prices, including Feldan and Wholey (2001), Sorensen (2003), Shiazaki, Vogt and Gaynor (2010), and Ho (2009). 33 See Coplaint, U.S. vs. Aetna Inc. (ND TX, 21 June 1999). More recently, the DOJ required a siilar divestiture before approving a 2005 erger between United Health Group Inc and Pacificare Health Systes Inc. Both divestitures were driven by concerns about the effect on physician services in specific arkets (See Coplaint, U.S. vs. UnitedHealth Group Inc. and Pacificare Health Systes Inc., Dec 20, 2005). 27