The Implications of Managed Care and Selective Contracting for Medical Groups*

Managed care organizations may exert monopsony power, reduce provider monopoly, or engage in bargaining with providers. Furthermore, managed care may be price-discriminating buyers or permit providers to be price-discriminating sellers. The relevant model is likely to depend on the market structure and state insurance regulations. The first empirical analyses in this dissertation test the idea that HMOs increase the price elasticity of demand for services provided by medical groups, but state selective contracting regulations prevent them. A new empirical industrial organization method is applied to data from the Medical Group Management Association to measure the elasticity of demand faced by individual medical groups. The results indicate that demand is almost fully elastic in markets where HMOs prevail and are permitted to selectively contract with a large number of competing medical groups, while it is relatively inelastic where none of these conditions are met. Results considering all markets in the US provide minimal evidence that this model prevails overall, where the coefficients are insignificant but directionally support the model. The weakness of these results suggests that HMOs may have other effects in the average market. The second set of empirical work considers whether groups reorganize their practices for efficiency or bargaining motives. Additionally, a theoretical model that allows medical groups to choose size for bargaining purposes is outlined. Estimations are performed both as a cross-section at the market level and as first-difference at the group level to determine whether groups add physicians, expand output, or become more prevalent or concentrated as HMO enrollment increases, particularly in non-regulated states. The results suggest that medical groups have lagged responses to managed care, where growth is greatest in competitive markets. This supports the view that groups respond for efficiency reasons. No support was found for the bargaining motive. The final empirical work examines medical group cost functions. The results suggest that a majority of groups practice on a downward-sloping segment of the average cost curve at outputs below the minimum efficient scale. These results collectively support the model that managed care can reduce physician market power and physicians respond for efficiency concerns. *This project was supported by grant number R03 HS11932 from the Agency for Healthcare Research and Quality