Hospitals' Negotiating Leverage with Health Plans: How and Why Has It Changed?

Despite efforts to reduce hospital utilization and length of stay, hospital care continues to account for a substantial portion of total health care expenses (Levit et al. 2002; Agency for Healthcare Research and Quality 2000). In addition, spending on hospital care is on the rise once again. In 2000, hospital inpatient and outpatient services accounted for 43 percent of the growth in total health care spending, more than twice the share of the 1999 increase (Strunk, Ginsburg, and Gabel 2001). Over the past three decades, public and private purchasers turned to managed care plans to stimulate greater hospital competition and reduce hospital expenditures and costs.1 Two techniques managed care plans used to achieve these goals were selective contracting and utilization management. As we discuss further in the background section, these techniques and other market dynamics weakened hospitals' negotiating leverage with plans. The purpose of this paper is to provide a recent but longitudinal description of managed care plan–hospital contracting. In particular, the paper focuses on hospitals' market power in contract negotiations with plans.2 Plan–hospital negotiations continue to be a critical nexus where competitive market forces meet in the managed care world, with significant implications for the organizations involved, the patients and communities they serve, and health care expenses. Market power is defined as the degree of control or influence an organization has over another organization (Scott 1987; Emerson 1962).3 Control or influence is shaped by the willingness and ability of one organization to sanction (i.e., punish or reward) another organization that it interacts with to attain key goals, such as survival, growth, or increased margins. The origin of market power is the dependency one organization has on the resources controlled by another. Two specific questions about hospitals' market power are addressed in this paper. First, how has hospitals' negotiating leverage with managed care plans changed from 1996 to 2000? Second, what factors explain any changes in hospitals' negotiating leverage between 1996 and 2000? Our findings suggest that many hospitals' negotiating leverage increased significantly since 1996, with the largest gains occurring over last two years. While almost all hospitals were “contract takers” in 1996, some hospitals are now “contract makers or breakers.” The negotiating leverage of other hospitals has improved as well, although less dramatically. Two types of evidence support this conclusion. First, serious contract disputes were much more frequently reported in 2000 compared with 1996. The prevalence of these disputes across diverse markets signals hospitals' increased willingness to exercise market power, as well as their assessment that they have the ability to do so given current market conditions. We observed contentious disputes in 7 out of 12 markets, and reports of other serious contract disputes throughout the country have appeared in the trade literature (for example, see Benko and Bellandi 2001). In some cases, hospitals terminated contracts, a behavior unheard of in the mid-1990s. Second, different types of respondents all perceived that hospitals were “winning” disputes. They noted that hospitals have been able to secure payment rate increases and significantly influence other contract terms. While there is variation across markets and within the hospital sector, a major change over the past five years is that many hospitals are now willing, and successfully able, to exercise market power in contract negotiations. We argue that between 1996 and 2000, significant changes in three areas converged to increase hospitals' market power: the policy and purchasing context in which plan–provider contract negotiations take place, the managed care plan market, and the hospital market. We identify specific changes in each of these three areas noted by interview respondents and largely supported by secondary quantitative data and describe how they impact hospitals' negotiating leverage with plans. Our findings are consistent with prior research. Many previous studies documented factors that result in plans' increased negotiating leverage with hospitals. This recent, longitudinal study shows that many of these factors are still important but that the direction of change has reversed, shifting market power back to many hospitals. These findings also provide insight into why hospitals are now more willing to exercise market power; hospitals may have had some ability to exercise market power several years ago but they did not use it. Recently, hospitals' increased financial distress and a sense of opportunity converged, leading them to exercise their leverage with plans.