Oligopoly dynamics and merger patterns in U.S. health insurance markets

Market Model Patterns of Change

Business description and general pattern of change of the market model

healthcare industry is fast paced and is uniquely characterized by rapid growth and development of new products and services. Insurance providers in the U.S. healthcare industry are the focus of this paper with the market model being an oligopoly where several large firms exist and control the market dynamics Baughman 3.

The industry has been characterized by hundreds of mergers with the latest figure being 500 mergers for the 10-year period between 1998 and 2008 Austin and Hungerford 9.

There are many smaller companies in the industry with the large players being UnitedHealth Group, WellPoint, Cigna, Aetna and Humana. These large companies collectively have a market share of about 33% of the U.S. population. The remaining market share is held by the smaller companies. Small insurance providers are increasingly becoming unable to invest in the technology and infrastructure that they need to provide quality services thus they are running out of business. Mergers with smaller insurers, however, have been the main driver of business for these large corporations.

Short-run and long-run behaviors of the model

In the short-run, the companies will be able to operate at a profit provided the demand for their products remains high relative to the company's operational costs. The company will face cash flow problem if it is unable to generate sufficient revenue to cover their variable costs which may lead them to operate at a loss where the revenue is unable to meet the operational costs.

There is no single theory which supports the oligopolistic behavior in any market in the long-run. However, the kinked-demand theory of oligopoly is best applicable in this situation. The model makes the assumption that when one company raises its prices, the others will simply ignore this increase while others will reduce their pricing. This results in a kinked demand curve for the company that increased price at the current equilibrium price Maskin and Tirole 572.

By applying this assumption in the health insurance market, it comes to be that any company that increases their price will lose their market share and suffer huge loss of demand because the prices of its competitors will remain relatively low. At the same time, any company that reduces their pricing will only experience a small increase in demand of their products or services but there will be no increase in market share since all the competitors will match this price reduction Frasco 140.

This will lead to the company having a kinked demand curve which will be flat above the company's current price since the increase in price will result in loss of market share. Below the current price, the curve will be steep since a reduction in price increases demand but does not increase market share Dossche, Heylen and Poel 724()

This theory thus predicts that the health insurance companies will need to rely on the non-price competition in order to boost their sales volumes, revenue and profits since there is price stickiness in the market. The companies will thus compete on product differentiation variables such as quality and added value.

Modification of data to make it relevant to decision-making

Data that will be collected include medical loss ratio which is the total health benefits that are paid out to the insured parties divided by the income on premiums. This is commonly used as an indicator of profitability and efficiency of administrative measures in the health insurance industry. The most recent values of medical loss ratio show that Obamacare has helped to save more than 1.5 billion dollars which made the medical loss ratio to be 85% among the large insurers compared to the 80% requirement the Commonwealth Fund 1.

In order to make the data collected relevant for decision-making, the data will need to be translated in terms of market power by comparing it against the industry average. By having a low medical loss ratio, the company is able to gain higher profits. This is then combined with other key financial figures such as operational costs to get a better view of the company's costs and how these can be reduced.

Pricing strategy of competitors

The health care industry in general is based on value-based competition since as earlier discussed pricing does not play a major role in influencing the market share of a company. The quality of premiums provided and any improvements in client processes of claims are the major factors that influence consumer demand and lead to increased consumer satisfaction. Rivers and Glover (634)

argue that each of the consumers in the health insurance industry is not concerned on price only. They are also concerned on other factors such as quality of cover, communication, delivery of services and other factors. These are the major drivers of competition. Therefore competitors use value-based pricing where the price is determined by the value of the service being provided. A service that has more value-added services will have higher pricing and vice-verse since the price creates an image of the product or service being of higher value. This pricing strategy also enables the competitors to keep their medical loss ratio low since with more value-added services, the companies will need to payout more to the insured parties.

Suggested pricing policy

For the business chosen, the suggested pricing policy is the value-based pricing policy which is in use by the competitors. The major reason for this suggestion is that in this oligopolistic industry, price does not play a major role in influencing the demand and market share of the company. This pricing policy should also be coupled with price lining where the company should provide different levels of insurance coverage at different pricing. This will enable the company provide its consumers with a wider variety of products or services from which to choose to enable them gain market share.