Health Insurance Pre - Exchanges A Market Design Approach to Insurer - Provider Network Formation

I propose a centralized marketplace, a pre-exchange, for health insurer-provider network formation and examine its welfare impact. Current network formation is highly decentralized and contracting is bilateral within each insurer-provider pair. The key innovation of the pre-exchange is the introduction of explicitly multilateral contracting. In particular, providers set prices that depend both on the identity of the insurer as well as the identities of the other hospitals in the insurer’s network. I refer to this as network-specific pricing. I argue that the introduction of network-specific pricing enhances efficiency and dramatically lowers equilibrium health care prices. I first introduce a theoretical model that illustrates the general tension that results from the key features of the current market structure: network access, bilateral contracting and perpatient pricing. I then demonstrate how the pre-exchange results in lower equilibrium provider prices. The main theoretical insight is that bilateral pricing produces a strategic externality that providers “price out” with network-specific prices. In a companion paper, I evaluate the impact of introducing a pre-exchange using recent data from Massachusetts. ∗December 18, 2012 †The companion paper, Part II: Empirics, can be found at my website listed below. ‡[email protected], http://www.kellogg.northwestern.edu/faculty/sweeney/, Northwestern University, Kellogg School of Management. I would like to thank Rakesh Vohra, David Dranove, Michael Whinston, Mallesh Pai, Chris Ody, Umberto Garfagnini, Aviv Nevo, Jeff Ely, Alex Frankel, Pablo Montagnes.