As finals week approach, I scrutinize the papers more closely looking for inspiration for examination questions. My eye was recently caught by an article in the NYT about most favored nation clauses and a suit brought against Blue Cross & Blue Shield (BCBS) in Michigan. The gist of the matter is this. BCBS asked hospitals it contracted with to serve their policy holders to give it most favored nation (MFN) status. There are two kinds of MFN. Regular MFN where the supplier promises the buyer it will always get a price no higher than lowest price the supplier offers to any other buyer. And, MFN+, where the supplier promises the buyer their price will be some % lower than the lowest price offered to any other buyer. BCBS apparently had MFN promises from 45 hospitals (all with < 100 beds) and MFN+ promises from >25 others which required BCBS to receive at least a 23% discount compared to other insurance providers. A full list of the relevant hospitals can be found here.
The benefits to a buyer from MFN status are well known. My colleague Sandeep Baliga has articulated them on his blog. It raises prices for BCBS’s competitors. Hospitals should also benefit, because it reduces their incentives to cut prices to fill beds. Why? A price to cut to another insurance provider in order to gain their business, requires a price to cut to BCBS as well. If BCBS fills a lot of beds, that might be sizable. It is, since BCBS is the largest provider in the region covering 60% of Michigan’s commercially insured residents. Indeed, BCBS should be willing to increase payments to hospitals to get a MFN. Thus, the effect of the MFN is to raise prices to all insurance providers, but raises the prices of BCBS’s competitors even more!
If you buy this, then hospitals should jump at the chance to offer BCBS MFN or MFN+ status. However, in order to get the 45 small hospitals I noted above to sign on, BCBS threatened to slash payments to them by 16% if they did not offer MFN status. We come now to the interesting issue that the newspapers have missed. When exactly does it make sense to demand an MFN and to offer one?
Let us look at the choice that faces an individual hospital. To simplify, suppose that 70% of the hospitals capacity is filled by by BCBS policy holders and the other 30% by policy holders of another provider, say RCRS. Suppose BCBS comes to the hospital and offers to increase the payment it makes in return for the hospital raising the price to RCRS even more. Should the hospital accept?
Case 1: RCRS can go elsewhere.
If the hospital accepts BCBS’s offer, RCRS sees a price increase. If it can find another hospital with capacity and low price, it leaves. In which case, the hospital is left with 30% unused capacity. Thus BCBS’s price must be large enough to compensate for the lost profits from RCRS’s departure. However, from BCBS’s point of view, RCRS’s costs are as they were before, and BCBS has just raised its costs!
Case 2: RCRS cannot go elsewhere.
Then, neither can BCBS. In which case the hospital is in the drivers seat when bargaining with BCBS and RCRS. It could raise prices anyway on both.
Lets try another tack. Could BCBS’s size and its threat to reduce payments (I presume by shrinking volume) persuade a hospital to offer it MFN status? Suppose, as one of the hospitals, I decline BCBS’s offer. It reduces the # of its policy holders that come to me. These policy holders have to go somewhere. Perhaps they go to a hospital that accepted BCBS’s offer. In which case RCRS will be looking to shift their policy holders from that hospital to mine perhaps, because I have a lower price. Again, if the numbers work out I have no reason to say yes to BCBS.
Perhaps, what is missing from the discussion are the policy holders. What if policy holders care about the hospital they will be sent to. So, if RCRS is turfed out of a hospital, its policy holders `stay behind’ as it were by switching to BCBS. This again puts bargaining power in the hands of the hospital, because insurance companies need the right mix of hospitals to attract policy holders.
So, why did the hospitals accept the MFN clauses.
5 comments
November 23, 2010 at 11:25 am
Mike Dienhart (EMP78)
Rakesh, I have always struggled with understanding the value of MFN clauses in practice. I have a team responsible for negotiating large ($100M+) equipment purchase agreements. Invariably, one of the first tactics suppliers use is to tell us that they can not offer lower prices due to an MFN clause with another (10x larger) customer. We tell them it’s their problem to solve, or else we’ll take our business elsewhere. The net result, over and over again with several different suppliers, is that they find a way around their MFN commitment. Typically this is through changing part names / order codes, or bundling equipment with services or other machinations.
In short, the supplier captured the value of “selling” an MFN agreement to their largest customer. But, that large customer isn’t realizing the promised value of their MFN clause – it isn’t raising our prices.
Perhaps I am naive, but despite the protestations of our suppliers when they state how much they don’t like MFN clauses, I believe they’re actually in the supplier’s best interest. The MFN clause with the very large customer creates a false sense of security for that customer – they stop pushing as hard on pricing assuming that they’re already getting the best price in the market. And yet, due to the complexities of contract language (which I have the pleasure of reading almost daily), they really haven’t achieved the floor price in the market.
As a customer, we don’t attempt to negotiate for MFN clauses, and we assign zero value to them when they’re offered. We’ve seen firsthand that they’re basically valueless to us because suppliers are able to write language that enables them to price around those commitments. I would think that was a matter of our failure to negotiate airtight language, except that clearly their other customers (many of whom are much larger and have more highly paid lawyers) haven’t succeeded in realizing the value of the MFN clauses that they “bought” – as evidenced by our own lower pricing.
November 26, 2010 at 11:37 pm
rakesh vohra
Dear Michael
Good to hear from you. You’ve raised another issue about MFN clauses. Are they really a CREDIBLE commitment to not lowering prices? Perhaps it depends on the nature of the product or service. For example, with offerings that involve a degree of customization it may be difficult to write down a watertight MFN clause. However, with a standardized offering (aspartame?) it may be easier.
December 16, 2010 at 12:31 pm
Jacquelyn (TMP 2001)
This issue is particularly relevant to me because I negotiate managed care contracts for rural hospitals. I agree with you wholeheartedly that hospitals should not sign a contract with a MFN clause. I think fear is a predominant motivating factor for most hospital CFOs who sign these deals. They fear that BlueCross will walk away if the hospital refuses to agree to the MFN clause. They also fear that by asking that the clause be removed, they are signaling to BlueCross that they’ve got a better deal in place with another payor. Rural hospitals in particular cannot afford to lose their largest payor. However, BlueCross and other payors need as many hospitals “in network” as possible because patients can end up at any hospital due to emergency admissions. So, particularly if a hospital is in a remote location, a BlueCross or any other payor is not going to walk away from that hospital without some kind of discount in place.
One reason to remove the MFN clause from agreements is the administrative time and effort required to comply with the clause. Although not always carried out to the letter of the language in the agreement, the contract requires hospitals to prove to BlueCross annually that they do not have a better deal in place with another payor. All managed care contracts contain different reimbursement methdologies. So, at first glance, the deal with BlueCross may appear to be the best, but when you do the math on the other deals, you may find one where another payor ends up getting a better deal on c-sections, for example. Then, the hospital has to pay BlueCross a penalty. At the end of the day, I think it gives BlueCross too much of a hand in the hospital’s business and creates an unnecessary burden on the hospital to comply.
December 28, 2010 at 11:49 am
rvohra
Dear Jacquelyn
Your observation about rural hospitals is interesting because it suggests that the rural hospitals because of their `scarcity’ have some leverage when bargaining with BCBS. Yes, BCBS is big, but BCBS needs the hospital in its network. I wonder why they don’t use it?
Your remarks about the transaction costs of honoring the MFN clause were also eye opening. Do you have any sense of what these would typically amount to?
December 28, 2010 at 5:58 pm
Jacquelyn (TMP 2001)
Dear Professor Vohra,
Most urban or suburban hospitals employee a small department of people whose sole job is negotiating contracts with insurance companies. The managed care department usually reports to the CFO of the hospital. At least from my experience, the most knowledgeable hospital financial professionals do not want to negotiate contracts or feel comfortable in that realm. Rural hospitals, on the other hand, most often can’t hire a full-time managed care professional. So, the hospital CFO will handle the contracts and most will usually agree to the terms presented to them, because the negotiators for the payors present the contracts as “take it or leave it” deals. Many of those deals are left in place for years. A seasoned managed care negotiator will know from experience that any contract is negotiable and they’ll know what language and rates are reasonable. The contracts can be from 30-60 pages long or longer, and in order to ensure a fair deal, the negotiator needs to know every word in those contracts and find any clause where the payor can alter payment methodologies at will. And negotiations may also drag on for six months or more. Based on my experience, I think the average hospital CFO does not want to risk losing an insurance contract or step into an arena where they don’t feel comfortable, so they sign agreements. And in defense of managed care professionals like myself, it takes a lot of time and effort to negotiate a good contract. It would be a huge undertaking for a hospital CFO to take on that role in addition to his/her normal responsibilities.
As for the transaction costs of honoring the MFN clause, I am just now working on an agreement with that language in it for the first time in my career. And, the MFN clause language has been in this hospital’s contract for the past four years. In that time, BCBS has never asked the hospital to comply with the extensive requirements contained in the MFN clause. I think this could be due to one of the following reasons: 1)The hospital is so small that BCBS just doesn’t care if they have the best deal, 2)BCBS knows, based on their claims experience with the hospital, that they have a sweet deal that doesn’t need to be proven, 3)BCBS enforces the MFN clause randomly year to year, or 4)BCBS actually doesn’t enforce the MFN clause requirements or they do for only the largest hospitals. All of my managed care work up until now has been for hospitals in two states where payors do not include the MFN clause in contracts. I just reviewed a contract for a hospital in a different state where I first came across the MFN clause. We’re working now to get rid of the language.
Thank you for discussing this issue. I don’t often see managed care issues discussed in this forum.