CORPORATE ENVIRONMENT OF HEALTH SERVICES

Corporate Environment of Health Services



Corporate Environment of Health Services

Introduction

Recent research has illuminated the effect of transaction costs on the form of contracts, the glue that holds the economic system together. This paper is a contribution to that literature, focusing on the nature of corporate contracts for employee health care. Health care is an exceedingly complicated service, and contracting for the health care of the employees of a large corporation is a complex and costly matter. We expect therefore to find contracts for health care services that take account of high transaction costs.

Large firms have shifted the vast majority of their employees from indemnity contracts to managed care in the past decade ([Marquis and Long, 1999 and Maxwell et al., 2001]). Firms traditionally had devoted little attention to the purchase of group indemnity contracts providing health insurance for their workers. The rapid expansion of managed care has led to an accompanying transformation of health care purchasing. In a managed care environment, firms are not simply buying insurance, but they also are obtaining access to particular networks of hospitals and physicians. Firms appear to be transferring contracting practices from their overall procurement strategies to health care purchasing.

If this supposition is correct, then the literature on contracts should help us to understand the nature of these contracts. The theoretical literature describes a continuum of contracting types within a transaction cost framework. We analyze corporate contracts for health care in this framework in order to incorporate the range of contracts we observe among America's largest companies. Because of the nature of our data, we can describe the distribution of contract types, not simply its central tendency. We report here results from a comprehensive survey of health care contracting among the Fortune 500 companies.

The application of transaction costs to contracting theory, associated with Oliver Williamson and Oliver Hart, views contracts as a way to avoid hold up and similar problems of bad faith between contracting parties. The theory envisages a continuum of contracts that ranges from arms-length transactions to ongoing relationships. Following Williamson, relations between contracting parties can be ranked by how many relationship-specific investments are involved. The harder it is to shift from one supplier to another, the more contracts will look like a partnership or even vertical integration. Contracts for simple goods, by contrast, can be short and direct, briefly setting out terms and conditions that promote the desired transaction. The contracting continuum of Hart and Williamson ends in vertical integration, but industrial companies and health care providers operate in two distinct parts of the economy. Even though theory suggests that vertical integration between them could be desirable in the presence of high transaction costs, it is unlikely that many industrial companies would think it wise to invest in the rapidly changing health care industry. In our comprehensive survey we found only a few examples of this kind of vertical integration. We therefore hypothesize a continuum in which a form of partnership rather than vertical integration stands at the ...