By Paul Keckley

A study by Stanford researchers in the current issue of Health Affairs is likely to intensify growing tension between health insurers and hospitals.

At issue: the impact of physician-hospital consolidation, or vertical integration as some academics prefer to call the trend.

The researchers analyzed 2 million claims submitted to insurers by hospitals from 2001 to 2007, evaluating the impact on hospital prices, volumes (admissions), and spending for privately insured, non-elderly patients. Using data from Truven Analytics MarketScan.

They constructed county-level indices of prices, volumes, and spending and adjusted for enrollees’ age and sex. “We measured hospital-physician integration using information from the American Hospital Association on the types of relationships hospitals have with physicians.”

What they found is not surprising: vertical integration involving physician-hospital consolidation results in better care and higher costs. They found hospital prices increased 2%-3% each time physician-employing hospitals’ market share increased by one standard deviation. And overall spending on services at the hospitals that employed physicians increased while the utilization of services (volume) at those hospitals didn’t change.

They  concluded the following:

“We found that an increase in the market share of hospitals with the tightest vertically integrated relationship with physicians—ownership of physician practices—was associated with higher hospital prices and spending.

We found that an increase in contractual integration reduced the frequency of hospital admissions, but this effect was relatively small. Taken together, our results provide a mixed, although somewhat negative, picture of vertical integration from the perspective of the privately insured.”

What’s the significance of the study?

1-Hospitals and physicians will bolster their position that vertical integration is necessary to improved outcomes. The shift from volume to value via accountable care organizations, bundled payments, medical homes, and value based purchasing require closer collaboration between physicians and hospitals.

“Clinical integration” is central to each, and payers– Medicare and private insurers– are promoting these risk-based contracting efforts energetically while cutting reimbursement rates for services aggressively. So the provider position is this: ‘We get better results. We built what you said you wanted.

It’s costly to make the change, especially while since Medicare and Medicaid don’t cover our costs, demand is soaring and our bad debt from the uninsured increasing. You told us to build it, but you don’t want to cover our costs.’

2-Payers now have proof that vertical integration is increasing costs. Timing is everything, and concern about health cost is growing. Last month, the Bureau of Economic Analysis reported that overall health spending in the first quarter, 2014 increased 9.9%, the highest quarterly increase since the 1980s, and following the 4thQ increase of 5.6%. The Stanford study’s finding supports a vexing concern shared by most private insurers: consolidation among providers increases their leverage in negotiating.

Insurance companies think providers are inefficient and wasteful, so adding bargaining leverage to their already suboptimal cost-management proficiency makes matters worse…for everyone.Ultimately these costs are passed through in higher premiums.

So insurers reason: ‘providers are vertically integrating to protect their financial interests at our expense’.

So what’s it mean?

1-Physician-hospital consolidation will continue, but payers will increase incentives for cost-efficiency as models mature. Efficiency measures linked to supply chain costs, staffing and productivity, workflow and lean operating models will find their way into contracts with payers for accountable care organizations and bundled payments—the two most prominent levers payers are likely to pull.

The relative weight of cost containment measures in calculating bonuses and savings will increase relative to other measures. These risk sharing models will not go away, but how payers measure their performance, structure incentives, and monitor consolidation efforts will change.

2-Regulators will pay closer attention to vertical integration and provider consolidation. the US Federal trade Commission and the US Department of Justice are alert to the potential for provider cartels that discourage competition and produce imbalance between private payers and providers. Recent rulings in Idaho, Georgia and others point to heightened scrutiny.

3-New models of provider-payer collaboration and gain sharing will emerge, especially around targeted high cost populations. combining the financing and delivering of care to better align incentives between payers and providers seems inevitable, but a pluralistic payment system makes it problematic in most communities.

In most industries, customers pay a price for a service and a provider (seller) delivers based on an expectation of quality, service and price.

In healthcare, the separation between payer and provider, and the lack of transparency about prices, costs and anticipated outcomes (results) lends to the mess we’ve created. Might vertical integration of financing and delivery be a solution? Might the pursuit of value in healthcare be enhanced if in each community where two or more entities that finance (sell insurance) and deliver (providers) compete?

In most communities, providers grapple with multiple private payers while responding to the mandates of Medicare. Could it be simpler? Might employers that provide employee health insurance coverage find it easier to contract if they dealt with entities that could produce and manage the full array of services based on a predictable cost structure linked to results?

And might carve-outs for specific high cost populations contracted by high performing, fully integrated systems be an answer for managing costs while improving outcomes? Time will tell, but something’s got to give.

In Section 2718e of the Patient Protection and Affordable Care Act, a 56 word mandate for hospitals is set to take effect this October: it requires hospitals to post prices for a list of products and services annually. Big deal.  Hospital prices mean little since most health insurers negotiate discounts, and consumers without insurance coverage end up paying only a fraction of the posted price.

Publishing prices from the charge-master will not fix the mess.

So as health costs take center stage in the market, physician-hospital vertical integration is likely to increase as will criticism by payers that these are contracting cartels, not platforms that improve health and reduce cost synchronously. At the end of the day, based on the Stanford study, both are right. But being right doesn’t fix the problem.

Righteous indignation never results in a solution; rather, innovative, bold, fresh ways to clean up the mess is needed. That’s where we are.

Paul Keckley, PhD  (@paulkeckley) is an independent health care industry analyst, policy expert and entrepreneur. Keckley most recently served as Executive Director of the Deloitte Center for Health Solutions and currently serves on the boards of the Ohio State University Medical Center, Healthcare Financial Management Leadership Council, and Lipscomb University College of Pharmacy. He is member of the Health Executive Network and advisor to the Bipartisan Policy Center in Washington DC.  Keckley writes a weekly health reform newsletter, The Keckley Report, where an earlier version of this post appeared.