Network Formation and Bargaining in Vertical Markets: The Case of Narrow Networks in Health Insurance

“Network adequacy regulations” expand patients’ access to hospitals by mandating a lower bound on the number of hospitals that health insurers must include in their networks. Such regulations, however, compromise insurers’ bargaining position with hospitals, which may increase hospital reimbursement rates, and may consequently be passed through to consumers in the form of higher premiums. In this paper, I quantify this effect by developing a model that endogenously captures (i) how insurers form hospital-networks, (ii) how they bargain with hospitals over rates by threatening to drop them out of network or to replace them with an out-of-network hospital, and (iii) how they set premiums in an imperfectly competitive market. I estimate this model using detailed data from a Massachusetts health insurance market, and I simulate the effects of a range of regulations. I find that “tighter” regulations, which force insurers to include more than 85% of the hospital-systems in the market, raise the average reimbursement-rates paid by some insurers by at least 28%. More moderate regulations can expand the hospital networks without leading to large hikes in reimbursement-rates. ∗Kellogg School of Management, Northwestern University. Email: [email protected]. I thank David Dranove, Igal Hendel, Leemore Dafny, Peter Klibanoff, and William Rogerson. I also thank Daniel Barron, Brad Buxton, Hasat Cakkalkurt, Johnny Chan, Gautam Gowrisankaran, Thomas Jungbauer, Robin Lee, Serima Nazarian, Aviv Nevo, Christopher Ody, Robert Porter, Michael Powell, Elena Prager, Mar Reguant, Mark Satterthwaite, Matt Schmitt, Mark Shepard, Amanda Starc, Yuta Toyama, Nathan Wilson, and seminar participants at Northwestern. All errors are mine.