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New Scrutiny for Hospital Mergers

Article · November 29, 2016

Mergers and acquisitions of hospitals, health systems, and physician organizations across the country have become routine. The Federal Trade Commission has challenged some deals — albeit a mere fraction of the total — on grounds of anticompetitiveness. But the agency has focused exclusively on M&A of competitors located in the same market, who compete for the same patients. A new study finds that mergers of health care providers operating in different areas (or with different service lines) — known as “cross-market mergers” — can lead to increased prices for consumers. Should the FTC expand the scope of its reviews?

“Vigorous enforcement of the antitrust laws is more important than ever,” says Federal Trade Commission Chairwoman Edith Ramirez. Her agency has been busy in recent years as local markets have consolidated, and the “rapid rate of consolidation may be even accelerating,” Ramirez says, noting an 18% increase in hospital mergers in 2015 over the prior year, and 70% more M&A than 2010. In 2015 alone, there were 102 transactions involving 265 hospitals around the country, according to Irving Levin Associates, which tracks health care transactions.

Across the country, large systems have been acquiring or merging with smaller hospitals. Numerous studies since the 1990s show significant pricing impacts as a result.

In 1999, the Sutter Health system acquired Summit Medical Center in Oakland, California, located a short distance from its Alta Bates Medical Center in Berkeley. The merger went forward despite opposition from the California Attorney General and resulted in price increases between 29% and 72% for patients — the largest for any comparable hospital in the state, according to an FTC analysis.

In fact, Sutter-Summit was but one of several deals that enforcement officials tried but failed to block during the late 1990s and early 2000s. The tide turned with the Evanston Northwestern Healthcare–Highland Park Hospital merger. The FTC filed suit in 2004 to dissolve the union, having found evidence of significant post-merger price increases without substantial quality improvements. The FTC successfully argued that the hospitals had gained market power and used it to force price increases onto local insurers. Although the system was allowed to remain intact, the judicial decision established an important precedent.

Since the Evanston Northwestern–Highland Park case, the FTC (often accompanied by state attorneys general) has successfully challenged several deals, including Inova Health System–Prince William Hospital in northern Virginia in 2008, ProMedica Health System–St. Luke’s Hospital in Ohio in 2011, and Penn State Hershey Medical Center–PinnacleHealth System in Pennsylvania just last month.

The Hidden Impact of Cross-Market Mergers

To date, the FTC’s hospital merger lawsuits have focused on what are termed “horizontal mergers” — combinations within the same local area, such as the proposed Rockford, Illinois–area merger between Rockford Health System and OSF Healthcare in 2011. New research suggests enforcers may now need to shine a spotlight onto mergers of hospitals that are further apart, and which may not compete for the same patients but are valuable to an insurance plan spanning a broad geographic area.

Harvard Business School Professor and NEJM Catalyst Lead Advisor Leemore Dafny, together with co-authors Kate Ho of Columbia University and Robin Lee of Harvard University, describe these arguments in a study about “cross-market mergers,” which they define as mergers involving hospitals more than 30 minutes apart. They studied the change in prices following cross-market mergers in the same state versus across different states. Hospitals in the same state negotiate more often with the same insurers, which in turn are offering plans to employers whose employees work or live in multiple in-state hospital markets. (Even a given metropolitan area can have multiple hospital markets, as these markets are often relatively small.) As a result, the researchers say, merging hospitals can gain and exert potent, and potentially illegal, leverage when bargaining with insurers, and thereby realize inflated profits.

In the paper’s examination of 500 hospital mergers nationwide from 2002 to 2012, more than half fell into the category of cross-market mergers. Those with same-state overlap led to price increases of roughly 7% to 10% on average, the authors report. There was no significant price change for hospitals gaining a partner out of state. Dafny says she believes those market implications are continuing since the time period in the study.

“There is a whole set of potentially problematic mergers that flies under the radar,” Dafny says in an interview. “Cross-market is a different frontier, and it is time to turn attention to it.”

Since its publication in March, the study by Dafny, Ho, and Lee has made waves within antitrust circles. Some experts are calling it groundbreaking and a definitive call for the FTC to step up its investigations, while others criticize the paper for failing to address issues beyond economics, such as quality or value in care.

Dafny and her co-authors say in the paper that they have developed economic models and empirical evidence to support their claims.

“We wanted to be thorough and substantial and not just wave hands,” Dafny says. “We began with the current methodology that is formally in place. And we expanded it, because that methodology doesn’t really consider the insurance market; it just looks at the end–patient user market.”

“The economics had not been fully developed before this paper, and we view these mergers on a case-by-case basis,” says Michael Spector, an attorney who specializes in antitrust cases with America’s Health Insurance Plans, the national trade association for the health insurance industry. “But I share [Dafny’s] urgency in terms of further incorporating this into the FTC’s analyses; looking at the potential harm of these types of mergers, it certainly changes the landscape and dynamic of health care. What the paper does [that] is new, it puts the economic theory out there.”

“The FTC aren’t regulators, they can’t just stop a transaction. They have to prevail in court,” says Spector. “One of the things needed to prevail in court is to have a good economic theory, and a little less Greek letters, and so I think it’s really important and useful to the agencies.”

Richard H. Cunningham, a lawyer with Gibson, Dunn & Crutcher in Denver who focuses on a wide range of antitrust issues, is a former Senior Trial Counsel within the FTC’s Bureau of Competition. He says the agency has done a “credible job” at trying to ferret out antitrust violations but believes that Dafny’s study may open more doors for enforcement.

“To their credit, [the FTC] has spent a lot of time building economic models, building the data analysis, and a lot of theory, and they have tested it. The economic model is still the agency’s approach, and they are very transparent about it,” Cunningham says.

Still, Cunningham says the cross-market mergers paper “is asking a really provocative question: ‘Are you missing something, FTC? Are there other competitive dynamics that you are not capturing?’”

But David A. Argue, an antitrust attorney with Economists Incorporated, a consulting firm in Washington D.C., says he is reluctant to embrace the idea. He wrote in a paper that the courts have shown “skepticism toward cross-product market arguments.”

“I’m not sure the theory holds up; there are some conceptual problems,” Argue adds in an interview. He believes the Dafny study lacks precision on certain aspects of mergers that must be evaluated, such as quality of care.

As an example, he points to a federal appeals court ruling in Idaho that overturned a lower court ruling that the market power held by St. Luke’s Health System for physician services in Boise gave it the ability to raise prices for ancillary services. “Absent a finding of market power in ancillary services, the [court] reasoned, St. Luke’s could not harm competition in that market,” Argue wrote. Although this case wasn’t precisely a cross-market issue, there were legal similarities, he says.

The Difficulty of Enforcement

The FTC could argue that they are keeping plenty busy with horizontal mergers. The agency has filed legal challenges in three such cases in the past year alone, and all have had their share of complications.

To take one example, the FTC objected to the proposed merger of the 393-bed St. Mary’s Medical Center and the 303-bed Cabell Huntington Hospital, both in Huntington, West Virginia, on the grounds that the combined entity would hold a 75% market share of inpatient admissions. The state legislature effectively bypassed the FTC by passing a law designed to exempt the proposed acquisition from state and federal antitrust laws.

And in the other two cases, federal district judges denied the FTC’s requests for preliminary injunctions to prevent the mergers from closing before the agency could try their cases. One of those decisions (Hershey-PinnacleHealth) has since been overturned on appeal. The other (Advocate Health Care Network–NorthShore University Health System in Illinois) was partially overturned, and a determination on an injunction is now pending.

Although the FTC may appear to have its hands full, in a recent speech Ramirez acknowledged the need to investigate the cross-market, or “non-overlapping,” mergers.

“While we have focused our enforcement efforts on horizontal mergers between competing health care providers, we also hear concerns that provider consolidation in non-overlapping geographical or product markets may also lead to higher prices,” Ramirez said at an American Bar Association conference last May. “This is an issue that [we are] continuing to explore in an effort to determine whether the antitrust laws are implicated.”

While there is uncertainty for the FTC’s legal challenges, as well as how Dafny’s theory will be embraced, there already is some movement among law enforcement. In Massachusetts, Assistant Attorney General Karen Tseng, who runs the health division, says this new information about cross-market mergers will likely expand her office’s work. Other attorneys general offices have shown interest in Dafny’s study.

For her part, Dafny notes that “breaking new ground in antitrust is challenging, particularly as the old ground is so hard to defend. Both federal and state agencies need more resources to support their investigations and to enforce competition laws that keep health care and other markets robust.”

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