Insurer-Provider Networks in the Medical Care Market

Managed care health insurers in the US restrict their enrollees' choice of hospitals to specific networks. This paper investigates the causes and welfare effects of the observed hospital networks. A simple profit maximization model explains roughly 63 per cent of the observed contracts between insurers and hospitals. I estimate a model that includes an additional effect: hospitals that do not need to contract with all insurance plans to secure demand (for example, providers that are capacity constrained under a limited or selective network) may demand high prices that not all insurers are willing to pay. Hospitals can merge to form "systems" which may also affect bargaining between hospitals and insurance plans. The analysis estimates the expected division of profits between insurance plans and different types of hospitals using data on insurers' choices of network. Hospitals in systems are found to capture markups of approximately 19 per cent of revenues, in contrast to non-system, non-capacity constrained providers, whose markups are assumed to be about zero. System members also impose high penalties on plans that exclude their partners. Providers that are expected to be capacity constrained capture markups of about 14 per cent of revenues. I show that these high markups imply an incentive for hospitals to under-invest in capacity despite a median benefit to consumers of over $330,000 per new bed per year.