Sample 3a
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Teacher notes
The following page provides you with a sample IA, graded under the new criteria and was part of the sample provided to workshop leaders, during the recent IB workshop training. Sample number 3a - microeconomics is designed to be graded alongside sample number 3b, 3c and (FIII).
Commentary
Title of the article: U.S. Sues to Block Anthem-Cigna and Aetna-Humana Mergers
Source of the article: New York Times https://www.nytimes.com/2016/07/22/business/dealbook/us-sues-to-block-anthem-cigna-and-aetna-humana-mergers.html (Accessed 15 January 2017)
Date the article was published: 21 July 2016
Date the commentary was written: 4 March 2017
Word count of the commentary: 796 words
Unit of the syllabus to which the article relates: Microeconomics
Key concept being used: Efficiency
U.S. Sues to Block Anthem-Cigna and Aetna-Humana Mergers
By LESLIE PICKER and REED ABELSON JULY 21, 2016 Lawsuits to Block Health Insurer Mergers
William Baer, the Justice Department’s antitrust chief, on lawsuits to block two mergers involving four of the nation’s five largest health insurance companies.
Within a three-week span last summer, four of the five biggest health insurers announced two mergers totaling $85 billion. Suddenly, what was five would be three, reshaping the industry. But on Thursday, antitrust regulators said, Not so fast.
United States Attorney General Loretta E. Lynch announced that the government had filed lawsuits to block the deals, between Aetna and Humana and Anthem and Cigna.
The proposed mergers, she said, “would leave much of the multi trillion-dollar health insurance industry in the hands of three mammoth insurance companies.”
“If these mergers were to take place, the competition among insurers that has pushed them to provide lower premiums, higher-quality care and better benefits would be eliminated,” she said.
The companies responded by vowing, in varying degrees, to fight the government’s challenge. Aetna, which had hoped to gain an advantage by being the first to reach a deal, aggressively defended its proposed merger, which it contended was different from the larger Anthem-Cigna deal that followed.
“I like my chances in front of a judge,” Mark T. Bertolini, chief executive of Aetna, said in an interview.
In a statement, Anthem said the Justice Department’s “action is based on a flawed analysis and misunderstanding of the dynamic, competitive and highly regulated healthcare landscape.”
The company said it was “fully committed” to challenging the lawsuit.
But Cigna, which has appeared to be a somewhat reluctant partner in the merger, said only that it was evaluating its options within the confines of the merger agreement but did not expect the transaction to close anytime soon, “if at all.” Anthem and Cigna declined to comment beyond their statements.
The health insurers have been concerned for a few years about how the government would respond to consolidation.
Anthem had mulled a merger with Cigna in 2014 but ultimately dropped the idea. They were forced to revive the combination after Humana put itself up for sale in early 2015 and “sparked a bidding frenzy in the industry,” according to the government’s lawsuit. The big five, including UnitedHealth Group, were desperate not to be left out of any potential deal-making.
After the passage of the Affordable Care Act, the Obama administration’s signature piece of legislation, federal officials have kept a close eye on the sweeping changes taking place in health care. One of the major provisions of the federal law was to encourage more competition among insurers to provide people with more choices and more affordable policies.
The health insurers were seeking to merge during an administration that has not been shy about quashing deals — especially in health care.
The government has blocked mergers among large hospital systems, as well as contributed to the scrapping of the $152 billion deal between Pfizer and Allergan for tax reasons. Large deals in the energy and retail industry were also abandoned this year over antitrust.
If both health insurance deals are withdrawn, 2016 would set a record for the volume of abandoned deals, according to data from Dealogic.
An Anthem office in Los Angeles. The health insurer said it would fight a Justice Department lawsuit to block its merger with Cigna “but will remain receptive to any efforts to reach a settlement.” Credit: Gus Ruelas/Reuters
“The Obama administration has had robust antitrust enforcement in the realm of mergers, particularly in health care,” said Matthew L. Cantor, a partner who focuses on antitrust issues at the law firm Constantine Cannon. “Anyone who’s going to attempt a horizontal merger should take note of that and particularly consider the antitrust merits of the deal.”
Mr. Bertolini of Aetna, however, had a much more skeptical view on Thursday. “There are a lot of politics in this,” he said.
From the moment they were announced, the proposed mergers were met with an outcry from critics, who said the deals would lead to higher prices for consumers and would stunt innovation by the companies. Congress held hearings, and there was a concerted push by consumer advocates and others to stop the mergers.
“The level of consumer opposition was impressive,” said David A. Balto, a lawyer and former antitrust official who helped lead the effort to oppose the mergers.
Erik Gordon, a professor of business and law at the University of Michigan, said the lawsuits suggested that the Justice Department looked at the two mergers together in the context of the whole industry, instead of more specific markets, making it harder to justify both deals.
Professor Gordon pointed to the broad statements about the health insurers contained in the suit, saying the government went beyond the typical legal arguments. It is the “most politicized antitrust case I’ve seen,” he said.
The Justice Department declined to comment on whether there was any political aspect to their decisions.
By looking at the deals in combination, the Justice Department makes a stronger case, said Thomas L. Greaney, the co-director of the Center for Health Law Studies at Saint Louis University and a former Justice Department lawyer.
“There is a tactical advantage to having both cases go on at the same time,” he said, adding that the case against one merger “poisons the other.”
The insurers may not have many options to push their deals through. At its news conference on Thursday, the Justice Department made it clear that the companies’ proposals had not assuaged their concerns about competition.
“There are some mergers that can be solved through divestitures, but we’ve seen nothing to suggest they can,” said William J. Baer, assistant attorney general for the Justice Department’s antitrust division.
As a result, the companies’ best bet may be to persuade a federal judge that they should be viewed as very different in nature.
The Aetna and Humana deal raises concerns largely in the private Medicare market. Those companies may have an easier time divesting themselves of assets to appease regulators.
The larger deal, between Anthem and Cigna, is more vulnerable because of its size and overlap nationally, where large employers have fewer options when they pick plans for their workers.
“There were substantial risks and they took risks,” said Mr. Cantor of Constantine Cannon. “The risks were very real.”
A version of this article appears in print on July 22, 2016, on Page B3 of the New York edition with the headline: U.S. Sues to Stop Mergers of Giant Health Insurers.
Commentary
Efficiency is not just referring to productive efficiency or lowest costs of inputs per unit of output, but also to allocative efficiency and dynamic efficiency. The healthcare insurance firms, who wish to merge, could argue that thereby the cost of insurance will be lowered. But the US antitrust department is opposed to the proposed merger because it believes that it will lead to less competition and therefore less allocative efficiency in the market, resulting in higher prices and fewer options for consumers.
According to the New York Times, the healthcare market is an oligopoly, meaning that it consists of a few dominant firms with high entry barriers and homogeneous products. If the two firms Aetna and Humana were to merge, as well as the other firms, Anthem and Cigna, there would be a decrease of overall larger firms in the market from five to only three. This leads to a decrease in the degree of competition within the market.
Assuming collusive behavior between the three remaining large firms, a monopoly diagram can be used to show the market, with all the firms acting together as a monopoly.
Firstly, assuming that the combined producers in the “monopoly” aim to maximize their profits, production will be where the marginal cost (MC) equals the marginal revenue at Qπ and Pπ. Thus, they will make a combined abnormal profit (or additional profit made on top of the normal profits required to continue running the firm in the long run) shown by the grey area. This profit can continue into the long run because they do not have any incentive to lower prices to compete with other firms.
But the allocatively efficient price is at Popt, where MC = price, assuming that the demand curve represents consumers’ marginal benefits. This price and Qopt represent where the wants of the consumers are best satisfied given the scarce resources and would happen if there is a lot of competition in the market. Therefore, the result of the mergers is higher prices for the consumers as well as fewer options over health care plans because it is likely that the oligopolistic firms will tend to have similar products.
In conclusion, these merged firms cannot achieve allocative efficiency, resulting in a welfare loss, where marginal benefits are greater than marginal costs, represented by the area shaded red on the graph above.
Another reason why the Justice Department (DOJ) wishes to block this merger is because if the firms remained non-collusive, as an oligopoly, the nature of homogeneous goods causes these firms prefer to use non-price competition in order to establish an advantage over the other firms. In particular, in the case of the healthcare firms, staying separate and retaining their oligopolistic aspects, will cause them to innovate so that they can differentiate their products as more superior to others, and even simply increase the quality of their services. This shows that oligopolies may be dynamically efficient. A quality that the DOJ argues will diminish if the firms are able to solidify their mergers.
Allocative efficiency is further compromised if the positive externalities of health care (such as a healthier population and less chance of disease epidemics) are considered. Due to the externality, the marginal social benefit (MSB) of health care is greater than the marginal private benefit (MPB), as shown in the diagram below.
Pm and Qm is where the market produces because demand= supply. But there is inefficient allocation, because the market should produce at Qopt, where MSB = marginal social cost (MSC). To persuade the consumers to demand this quantity, the price should be lower at Popt. Therefore, healthcare is underprovided from the point of view of allocative efficiency and there is a welfare loss of the shaded area.
Merger advocates argue that merging the insurance firms could fix this market failure, because the merged firms could work more efficiently together, reducing waste and increasing output. Additionally, the mergers could result in economies of scale enabling firms to decrease their costs while growing in size, which could lower prices. Furthermore, the abnormal profit could be used to fund innovation in response to the criticism made by the DOJ, who said the mergers would “stunt innovation by the companies”, to which Anthem representative replied, “(the DOJ’s) action is based on a flawed analysis and misunderstanding of the dynamic, competitive and highly regulated healthcare landscape.
In conclusion, while the DOJ argues that mergers between these firms will result in a lack of dynamic efficiency and allocative efficiency, causing higher prices and a lower quality of healthcare provision, those who defend it are also correct in saying that they could potentially fix the current market failure, as well as be dynamically efficient by using the abnormal profit they made for innovation.
Internal assessment criteria—SL and HL
Use the official IB economics IA criteria when assessing this work, available at: IA criteria
Portfolio (SL/HL)
Criterion A: Diagrams
Level descriptor
Both diagrams are well-drawn but the labeling and title of diagram 2 is not entirely relevant to the article. That said, the explanations are appropriate, clear, and correct. (2/3)
Criterion B: Terminology
Level descriptor
Appropriate terminology is used correctly. Definitions of crucial terms, such as oligopoly and allocative efficiency are provided and the understanding of other terms, e.g. positive externality is used appropriately. (2/2)
Criterion C: Application and analysis
Level descriptor
The commentary includes two different concepts - oligopolistic markets and positive externalities and both are primarily carried out correctly. No justification was provided for the assertion that firms would act collusively and the issue of whether or not there would be innovation required greater substantiation. (2/3)
Criterion D: Key concept
Level descriptor
Productive, allocative and dynamic efficiency were all covered in reasonable depth. The word “efficiency” was never used explicitly, but a valid and convincing attempt was made. (2/3)
Criteria E: Evaluation
Level descriptor
The candidate provided a balanced and reasoned approach in the judgments made. That said, the evaluation was largely “text-book” in its approach, rather than grounding it in the particular context of the health insurance market. (2/3)
General comments
The candidate picked a suitable article, selected an appropriate command term and produced a reasonable commentary. The overall score for this commentary was 10/14.
The second commentary in this sample can be accessed at: Sample 3b