Economic incentives cut against Anthem economist's claims

December 2, 2016

Anthem called its key expert economist, Dr. Mark Israel, to the stand today to discuss competitive effects of the still-possible merger with Cigna. Dr. Israel, Senior Managing Director at Compass Lexecon, presented his findings in direct contrast to Professor David Dranove, his counterpart testifying on behalf of the DOJ. Dr. Israel used a large data set of actual reimbursement claims from Anthem and Cigna in order to opine on the reality of the marketplace, veracity of efficiencies projections, and rebut some of Dranove’s arguments.

 

Judge Amy Berman Jackson asked Dr. Israel several direct questions during his testimony. In one segment in which he discussed economic concepts relating to scale, Dr. Israel sought to draw a distinction between illegal market power and pro-competitive volume. According to his model, a combined Anthem-Cigna could put downward pressure on provider reimbursements, which would move the price closer to the competitive price, calculated at variable cost plus a competitive margin.

 

Analysis then turned to the Horizontal Merger Guidelines, which draw lines estimating market power and competitive harm at various levels of concentration. Market power is the ability of a firm to raise prices above the market equilibrium. Dr. Israel noted that while there may be some increase in market power due to increased concentration in the relevant market, that would be offset by total cost savings from better provider rebates. He pointed to a place in the Horizontal Merger Guidelines where it was stated that buyer power can constrain and offset market power. Judge Jackson was visibly upset by this allusion, and with good reason. The buying power Dr. Israel described would be an ability of Anthem’s, not a constraint on it.

 

Setting aside the pass-through savings question which is pretty unique in this case, the monopoly/monopsony power of a combined Anthem and Cigna is relatively textbook-Industrial Organization. Industrial Organization uses a paradigm called Structure-Conduct-Performance (“SCP”), a way to frame markets and firm behavior to understand how firms set prices. Structure dictates conduct, the outcome of which is often measured in dollars and called “performance.” Dynamic firms assess performance to adjust conduct and achieve better results for their shareholders in the next quarter.

 

By merging with Cigna, Anthem hopes to change the structure of the market. Concentration, geography, and product characteristics would change as a result. Since concentration is often used as a proxy for market power, we can conclude that that would increase for Anthem as well. The question Judge Jackson was getting at was, What conduct will be enabled by Anthem’s increased market power? Dr. Israel gave us a straightforward answer: Anthem would change the price of an “input” by using its considerable size to renegotiate provider contracts. However, he asserted his model shows the prices are not so low as to be harmful to providers, contrasting with Prof. Dranove.

 

Anthem estimates this conduct will lead to medical cost savings over $2 billion. Judge Jackson asked what of that $2 billion was promised to shareholders, but no expert in the room could testify to that. Dr. Israel did, however, state that the better rates from providers would lead to more switching to Anthem. Anthem would grow to meet that business, as per much earlier testimony, creating a cycle in which scale begets scale and providers get squeezed.

 

Dr. Israel was clearly very prepared and believed in the strength of his model. But he invoked “widely accepted economics” on multiple occasions, yet failed to acknowledge that pressure on providers is a result of market power for national accounts. The idea that Anthem can offset market power in one place with market power in another place misunderstands both Industrial Organization and the Horizontal Merger Guidelines. Plus, just because Anthem would be limiting provider reimbursements now doesn’t mean it couldn’t keep going back with tougher contracts each time, further squeezing providers. The SCP paradigm shows that the incentives are there.

 

Judge Jackson stated today that she would like to get started writing her decision between phases one and two of the trial. That could be a matter of personal preference, planning ahead for holiday travel, or it could signal that she has already come to some important conclusions.

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