Beware of Guardian Angels

According to the Wall Street Journal, the CEO of CVS justifies the merger with Anthem by saying the “ultimate goal is to reduce health care spending by steering patients to lower cost settings.” That would be laudable if it was the real justification. Students of economics know that the primary duty of a CEO is to increase shareholder value which comes via increased profitability.

The two objectives do not have to be in conflict but there is reason for not being convinced that the delivery of lower cost is the primary driver. Although the Justice Department approved the merger, Judge Richard Leon apparently is not convinced which is why he is reviewing Justice’s approval. Although judges routinely approve such mergers once they have DOJ approval, Judge Leon has made clear that he has concerns and wants to make sure that the merger is in the public interests.

Health care costs have been rising faster than inflation and over the past 5 years increases have ranged between 5% and 7%. In part this is due to the health care delivery system and in part due to the incentives created by employer provided insurance. In addition to mergers that are increasing concentration, physicians aligned with hospitals are referring patients to in-house labs for tests and patients are less concerned about total costs of tests and prescriptions than their out of pocket costs.

Dr. Scott Atlas of the Hoover Institute has cited data showing that the “monthly cost of common drugs could vary by more than a factor of 10 in the same city.” That would not happen in a competitive market with transparency. .

The CVS-Anthem merger and Cigna’s acquisition of Express Scripts, one of the nation’s largest pharmacy benefit manager, are signs of the increasing concentration. A study by this Commonwealth Fund found that the health care markets became more concentrated after 2010. It concluded that “As market concentration in the health care system accelerates, more consumers and employers across most of the country are left with higher prices and fewer choices.”
This provides a context for Judge Leon’s review. The potential effects of the vertical integration reflected in CVS acquiring Anthem and Cigna acquiring Express Scripts could be a way to wring costs out of the system. But there could also be anti-competitive reasons that allow the firms to increase profits while pushing higher costs on to third party providers. Nobel Laureate George Stigler identified three reasons for vertical integration—to practice price discrimination, put an obstacle in the way of potential entrants, and to eliminate monopoly.

In the CVS case, the merger with Anthem allows for price discrimination and creates an obstacle to competitors. Pharmacy Benefit Manager firms like CVS’ Caremark negotiate discounts with drug producers and then pass these discounts along to insurance companies, either up-charging the drugs or retaining portions of the discounts in order to secure profit. Since CVS Anthem now captures the entire discount, it is in a position to underprice competitors that have not merged. Increased concentration is not likely to be in the consumers best interest because according to one economist “eventually these mergers will make it harder for new insurers to enter the market since they won’t be able to negotiate lower drug prices than larger firms. That reduces competition, and having fewer competitors often leads to prices going up.”

So, beware of guardian angels who claim that they want to save you money.

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Author: billo38@icloud.com

Founder and president of Solutions Consulting which focuses on public policy issues, strategic planning, and strategic communications.

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