Managed Health Care and Provider Integration: a Theory of Bilateral Market Power

Recent empirical studies point to the need for a model of bilateral market power between health plans and provider organizations. We develop such a model and use it to analyze the impact on cost and access of alternative contractual relationships between plans and providers. The plans differentiate themselves through distinct, albeit overlapping, provider networks of specialized, complementary inputs (physician groups and hospitals). We analyze subgame perfect strategic pricing equilibria for a range of possible contractual relationships between the upstream providers and the downstream insurers, including different internal organizational structures of vertically integrated health plans, such as groupand staff-model HMOs and PPOs. A decentralized market structure produces inefficiencies from pricing coordination failures. Integration may be able to overcome pricing inefficiencies, with performance affected by the internal organization of vertically integrated health plans. Providers and MCOs do not achieve maximum net revenue when they are monopolies or monopsonies, but rather at an intermediate level of market power. JEL CLASSIFICATION: I11.