Don’t Blame Private Equity When Investors Exploit Bad Healthcare Policy
In recent months, commentators and advocacy groups have sounded the alarm about the growing role of private equity in healthcare markets. Concerns about consolidation are warranted but should not inspire calls for moratoria on acquisitions or private equity investment. Aiming to reduce consolidation, some states have already begun adopting regulatory frameworks to limit consolidation activity. Most recently, Indiana joined 18 other states that empower attorneys general to scrutinize healthcare mergers and acquisitions that might result in monopolistic or anti-competitive outcomes.
These approaches are well-intentioned but misguided. Attempting to rectify perceived market failures, states are expanding bureaucratic barriers and government interventions, efforts that will only exacerbate inefficiencies. In short, while some consolidation is indeed a problem, introducing new regulations is not the solution. Instead of restricting market freedoms and deterring investors, state leaders should investigate the underlying forces that create arbitrage opportunities, and legislators should craft statutory solutions to the structural problems in healthcare markets that arbitrage exploits.
Where opponents of private equity fail prescriptively, they often succeed diagnostically. Healthcare consolidation is happening, resulting in fewer independent providers and greater market concentration. This is a classic kind of market failure–monopolistic or oligopolistic markets lack competitive incentives and have the advantage of setting prices. The result is higher prices (which drives up overall cost), reduced access, and declining quality of care. Innovators or new market entrants are either blocked outright or deterred by high barriers to entry, and the consequences are not trivial: declining quality of care, fewer rural care options, and increased healthcare prices.
Ongoing regulatory proposals, such as the law being implemented in Indiana, exacerbate this crisis. Erecting government barriers to market movement only cements the status quo in an already highly consolidated market. Moreover, history suggests that market regulatory bodies are quickly captured by incumbents, enabling big power players to continue their consolidation unchecked. University of Chicago Economist George Stigler, argued in his seminal 1971 paper, “The Theory of Economic Regulation,” that “as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.” In other words, such regulations could become weapons used against smaller competitors rather than tools for their protection.
Fortunately, private equity arbitrage exposes the structural market deficiencies that lawmakers must urgently address. Rather than attack private equity, which accounts for only 3.3% of the healthcare system, states should reform reimbursement policies to mitigate the financial crises that invite private equity interventions.
Safety-net hospitals, in particular, face dire financial straits due to lower reimbursement policies than their surrounding competitors, especially in regions with a high proportion of Medicare and Medicaid patients or where uncompensated care is frequent–something known as a “bad payer mix.” This leads to lower revenues and an inability to pay the same wages as their better-mixed counterparts and invest in new technologies. “Bad payer mix” hospitals then face a negative feedback loop as poor competitiveness, at least perceptively, diminishes the comparative quality of care. This further exacerbates the bad payer mix because patients who can pay for better care opt for hospitals with better services and staff. Consequently, costs at safety-net hospitals (driven by their “good payer mix” counterparts) tend to exceed revenues, driving instability and the need for external financial assistance.
In response to financial pressures, some distressed hospitals turn to real estate investment trusts (REITs) facilitated by private equity firms for a bailout, hoping to stabilize their operations. Often, however, they are still failing. This capital formation strategy provokes criticism of private equity firms and REITs, both labeled as nefarious for their perceived exploitation of distressed hospitals. The problem is not with REITs and private equity but outdated and non-market-based reimbursement models and unaccountable governance policies that fail to create fairness and yield unstable markets. Misplaced blame obscures these underlying causes and diverts attention from necessary systemic reforms.
State governments should solve pervasive hospital distress not by restricting private equity but by addressing root causes—namely, flawed reimbursement policies. States can implement transparency in pricing and enable patients to realize savings on the commercial side through mechanisms like reference-based pricing. Under a reference-based pricing regime, for example, if an MRI is reimbursed at $2,000 but can be obtained for $1,000, and the patient’s deductible is $1,000, that patient would pay nothing. Over time, these savings would reduce healthcare prices across the board, stabilizing the financial situation of troubled hospitals.
Additionally, phasing in site-neutral payments based on payer mix would eliminate extra fees currently incurred by patients of physician clinics affiliated with hospitals. Intuitively, this could hurt safety net hospitals but, over time, site-neutral payments would reduce overall healthcare costs and help to level the playing field for hospitals burdened with a poor payer mix. Finally, reforming state-directed payments to only those safety net hospitals, which often exacerbate the payer-mix crisis, could foster stability and fairness. By focusing on systemic changes rather than market restrictions, state lawmakers can improve competitiveness and sustainability in the long run.
While it is easy to blame private equity, investment dollars should be considered an exciting opportunity under the right circumstances. Lawmakers can reorient private equity resources from arbitrage and toward innovation by addressing the underlying issues in healthcare reimbursement policies and market structures. Investors capitalize on broken markets in the status quo, exploiting inefficiencies and discrepancies. However, if foundational problems were resolved and markets made more stable, private equity firms could instead focus on innovations that enhance quality and reduce costs. This kind of capital realignment would benefit all stakeholders, yielding a more efficient, effective, and fair healthcare climate.
Columbia University economist Joseph Stiglitz distinguishes between market failures and government failures. Market failures include phenomena such as the tragedy of the commons, monopoly, and moral hazard. Government failures occur when bad public policy yields these same outcomes.
In healthcare markets, we are witnessing a government failure masquerading as a market failure. Lawmakers should thus refrain from raising regulatory barriers that perpetuate inefficiencies. Instead, legislators should rectify the underlying structural issues that create legal arbitrage opportunities for private equity firms. In so doing, state policy can foster a healthier and more competitive marketplace that benefits consumers and innovators.
America’s healthcare economy faces structural flaws that will not be fixed overnight. Rather than implement onerous regulations that only distort and exacerbate underlying problems, state lawmakers must address root causes. We must cure the disease, not just medicate the symptoms.