Competition between Managed Care Organizations and Indemnity Plans in Health Insurance Markets

Abstract

This paper examines a model of competition between two types of health insurers: Managed Care Organizations (MCOs) and “Conventional Insurers." MCOs vertically integrate health care providers and pay them at a competitive price, while conventional insurers work as indemnity plans and pay the health care providers that are freely chosen by their policyholders at a wholesale price. This first difference is called input price effect. Moreover, we assume that policyholders put a positive value on providers. diversity supplied by their health insurance plan and that this value increases with their probability of disease. Due to the restricted choice of health care providers in MCOs, a risk segmentation occurs: policyholders who choose conventional insurers are characterized by a higher risk. Surprisingly, our results point out that the effects of this input price and risk segmentation can be countervailing and do not necessarily work in the same direction. More precisely, we show that vertical integration in health insurance markets can create an anti-raise rivals’ cost effect. Consequently, our results reveal that the penetration of vertical integration may decrease conventional insurers’ premiums, which is a sufficient condition to be Pareto-improving. After more than three decades of vertical integration waves, our model may also explain why we observe an interior equilibrium in which conventional insurers have survived.

Keywords: Vertical Integration, Managed Care Organization, Competition Policy

JEL Classification: L42, I11, G22