Lack of competition doesn’t just lead to higher prices, it stifles innovation

This week’s testimony in the merger trial of Anthem and Cigna has been more focused on innovation than the first week, which largely laid groundwork about the companies and the market. David Dranove, a prominent health care economist and the DOJ’s key expert economist, made the case that Anthem’s absorption of Cigna will deprive the market of innovation in future years. While it is true that Anthem could rise to the challenge and change health insurance for the better, we would never know what fruits may have been borne from competition between the two companies. Dranove’s is the classic innovation argument against mega-mergers such as Anthem-Cigna.

History shows that healthy competition is the best way to drive innovation. That’s especially important in the already-concentrated insurance market, known for high prices and less-than-satisfied customers. Eliminating head-to-head competition between two of the five major players in the industry makes the market fundamentally less healthy.

There is another, more nuanced reason this merger would stifle innovation, having to do with Anthem’s unique position in the market. Anthem is part of the “Blue” network (“Blue Cross”, “Blue Shield”, or “Blue Cross Blue Shield”), an association of small insurers which are banded together in order to provide nation-wide coverage for enrollees. Anthem, covering 14 states, is the largest “Blue” company.

In order to maintain their agreement, which falls somewhere between a trade association and a cartel, Anthem and the other Blue Plans agree to certain stipulations about how their respective businesses will operate. A particularly important rule in this case is the “national best efforts rule” which states that Blue Plans must generate ⅔ of their revenue from the Blue network -- the other ⅓ can come from other brands, the category to which Cigna would belong if the merger is approved.

Today, Mr. Schlegel, VP of Corporate Development for Anthem, stated that Anthem would have to immediately switch Cigna accounts in the 14 overlapping states. 23% of Cigna's total revenue would be switched to Anthem -- corresponding to a much higher share of corporate client revenue.

In response, DOJ tried to show that Anthem will deprive Cigna's innovation from the market as a result of the national best efforts rule. Anthem says that it will stay in compliance by switching some Cigna customers to Anthem -- from an innovative company to a more traditional insurer -- and by growing Anthem's new customer base.

This presents a problem for their argument that they are going to be innovative, because it will take years to integrate Cigna’s innovations into Anthem’s corporate structure. But to stay in compliance with the 2/3 rule, for every $1 of growth on the Cigna side, Anthem will have to grow by $2. If they cannot grow Anthem fast enough (something they could be doing now by courting business) they have an incentive to stifle innovation and growth for the Cigna brand in the 14 Anthem states.

Anthem is not going to be ready on day one to adopt Cigna’s innovative business structure. It could spend years directing business toward its Blue brand at the expense of innovation that could be provided by Cigna. Judge Jackson can block the merger and give the market a chance to work, by incentivizing and rewarding ingenuity through competition.