The Federal Trade Commission (FTC) and Pennsylvania Attorney General (AG) have challenged the proposed combination of The Penn State Hershey Medical Center (Hershey) and PinnacleHealth System (Pinnacle) in Harrisburg, Pennsylvania. The FTC complaint alleges that the combination would create a dominant provider, reduce the number of competing health systems in the area from three to two, and result in a 64 percent share of the market for general acute care inpatient hospital services.

Hospitals and health systems pursuing mergers with a competitor should be mindful of the antitrust enforcement climate in health care and incorporate antitrust due diligence into their early transaction planning. Moreover, this case highlights that providers seeking to proactively alleviate the potential anticompetitive effects of a transaction should anticipate continued skepticism by the FTC of claims of procompetitive efficiencies and its dismissal of the merging parties’ newly negotiated, post-closing pricing agreements with payors.

Summary of Administrative Complaint

Parties and Transaction

Hershey is a nonprofit healthcare system headquartered in Hershey, Pennsylvania, about 15 miles west of Harrisburg. The system has two hospitals in the Harrisburg area: the Milton S. Hershey Medical Center, an academic medical center affiliated with the Pennsylvania State University College of Medicine, and the Penn State Hershey Children’s Hospital, the only children’s hospital in the Harrisburg area.  Hershey has 551 licensed beds and employs 804 physicians offering the full range of general acute care services.  In its 2014 fiscal year, Hersey generated $1.4 billion in revenue and discharged approximately 29,000 patients.

Pinnacle is nonprofit healthcare system headquartered in Harrisburg. Pinnacle’s system includes three hospitals in the Harrisburg area: PinnacleHealth Harrisburg Hospital, PinnacleHealth Community General Osteopathic Hospital, and PinnacleHealth West Shore Hospital. The system has 662 licensed beds divided among the three hospitals. In its 2014 fiscal year, Pinnacle generated $850 million in revenue and discharged more than 35,000 patients.

Pursuant to a letter of intent executed in June 2014, the parties would create a new legal entity to become the sole member of both health systems. The parties would have equal representation on the board of directors of the new entity.

Relevant Markets

The FTC complaint alleges that the appropriate scope within which to evaluate the proposed transaction is the market for general acute care (GAC) inpatient hospital services in a four-county area around Harrisburg. This alleged product market encompasses a broad cluster of medical and surgical diagnostic and treatment services that require an overnight in-hospital stay. Although the effect on competition could be analyzed for each affected medical procedure or treatment, the FTC considered the cluster of services as a whole because it considers the services to be “offered to patients under similar competitive conditions, by similar market participants.”

The FTC limited the geographic market to an area which includes Dauphin, Cumberland, Perry and Lebanon Counties. These four counties, according to the FTC, are “the area in which consumers can practicably find alternative providers of [GAC services].” Consequently, hospitals located outside of this area are not meaningful competitors to Hershey and Pinnacle.  The FTC’s theory relies on the fact that patients prefer to seek care relatively close to their home or workplace, especially when seeking emergency hospital services. In support of its alleged geographic market, the complaint asserts: (1) that a large percentage of the patients in the four county area seek GAC services within these four counties; (2) that hospitals located outside the four counties do not draw many patients from within the four county area; and (3) that health plans could not effectively market a network to employers and patients in the Harrisburg area that did not include a hospital in these four counties.

Market Share and Anti-Competitive Effects

According to the FTC’s complaint, the combined entity would be the largest general acute care system in the relevant market with a 64 percent market share. Pinnacle and Hershey currently represent 38 percent and 25 percent of the market, respectively. The FTC alleges that only one other hospital—Holy Spirit Health System with 15 percent of the market—is a meaningful competitor to the merging parties. The FTC explains that while there are two other hospitals in the Harrisburg area, both are community hospitals located outside of Harrisburg that draw relatively small shares (approximately 6 percent and 5 percent) from the overall area. As a result, the FTC characterizes the transaction as a reduction in competitors from three to two, and argues that the merger is presumptively unlawful under the FTC’s Merger Guidelines and the established case law.

The FTC alleges that Pinnacle and Hershey are close substitutes for each other and that both systems compete vigorously for inclusion in commercial health plan networks and for a health plan’s patients. The complaint cites various sources of evidence, including econometric analysis of patient draw data, the parties’ ordinary course documents, testimony and information from health plans. Reduced competition resulting from the proposed merger would have anticompetitive effects on both price and non-price features in the market, according to the FTC. The elimination of close competition between the two hospitals would increase the combined entity’s bargaining leverage with health plans, thereby leading to higher negotiated rates for consumers in either traditional fee-for-service arrangements or new reimbursement models. Health plans would no longer be able to play Pinnacle off of Hershey to obtain lower rates.

Further, with only one meaningful competitor left in the market, the FTC alleges that the combined entity would have less incentive to compete for a health plan’s patients by offering increased quality of care, patient satisfaction, improved facilities, better amenities, state-of-the-art technology and enhanced access. The FTC supported its allegations by referencing Pinnacle’s recent facility enhancements, patient satisfaction and quality of care initiatives aimed at attracting patients from Hershey to Pinnacle.

The lack of competition between Pinnacle and Hershey due to the merger would especially impact price and non-price competition for high-end tertiary and quaternary services that smaller competitors in the market do not provide. As support, the FTC noted that Pinnacle had expanded its service offerings to better compete with Hershey and that both entities had expanded the availability of specialized service lines in new geographic areas to attract patients—the proposed merger would eliminate this competition and the creation of alternative service providers for patients in the market. Additionally, in some key geographic areas, the proposed merger would leave health plans and patients for only one choice for emergent care.

Pricing Agreements

In order to mitigate the potential anticompetitive effects of the transaction, Hershey and Pinnacle negotiated new agreements with payors that appear to have been intended to forestall payor opposition to the transaction and limit the merged system’s ability to leverage any additional bargaining power gained through the transaction, possibly by locking in premerger reimbursement rates for a set period of time. 

The FTC complaint cites four reasons why it believes that those new agreements would not prevent competitive harm.  First, the FTC believes these agreements were designed to prevent payors from opposing the merger and, therefore, are better characterized as strong evidence that payors believe the merger would result in anticompetitive harm. Second, the agreements do not address the change in bargaining leverage that would also apply to any new arrangements with payors, including risk-sharing or population health measures.  In the negotiation of any new arrangements, the combined entity would still be capable of leveraging its increased bargaining power to the detriment of the health plans and their members.  Third, these pricing agreements do nothing to preserve the non-price competition between the parties that has benefited patients through improved quality and increased service offerings.  Finally, when these agreements terminate, nothing prevents the combined entity from leveraging its increased bargaining power to raise rates.

Entry & Efficiencies

The FTC complaint alleges that new hospital entry in the Harrisburg area would not be likely, timely or sufficient to offset the transaction’s likely anticompetitive effects. In support, the FTC cites the expense and the length of time needed to construct a new hospital facility, and the fact that the parties were the only ones to construct new hospital facilities in the area in the past decade.

The FTC complaint alleges that the parties’ efficiency claims are not cognizable on the basis that they are overstated, speculative, unverifiable and not merger-specific. Further, the FTC alleges that one of the parties’ efficiency claims—that the transaction will enable the parties to transfer patients at Hershey Medical Center, which is near capacity, to Pinnacle, which has available capacity—would result in competitive harm. The FTC alleges that would force patients to go to a different hospital than the one they chose, and would reduce output, capacity and service since Hershey Medical Center would avoid constructing a new inpatient bed tower to address capacity issues.

Proceedings

The FTC filed an administrative complaint as well as motions for temporary and preliminary injunctions in federal district court. The AG joined the federal district court proceeding. U.S. District Judge John E. Jones III granted the antitrust enforcement agencies’ request for a temporary restraining order.  The motion for a preliminary injunction is pending. The parallel administrative trial is scheduled to commence in May 2016.

Key Implications

The FTC’s challenge of the Hershey/Pinnacle transaction reinforces recent enforcement trends that hospitals and health systems contemplating transactions should consider. First, the FTC is likely to carefully scrutinize, and potentially challenge, a transaction that involves: (1) two nearby hospitals, (2) in the same small to mid-size metropolitan area, (3) who serve as close competitors to each other for both payors and patients, (4) and serve a majority of the commercially-insured patient base.  This result stems from the FTC’s continued reliance on a traditional structural analysis of the market—market definition, market share computation, market concentration calculation—to allege that a transaction that violates the FTC’s 2010 Merger Guidelines is presumptively unlawful. 

Second, once a transaction is declared presumptively unlawful, the FTC shifts the burden to the parties to prove offsetting procompetitive benefits.  However, this challenge also demonstrates that proving procompetitive benefits is becoming more difficult for parties in hospital mergers because the FTC continues to discount claimed efficiencies as speculative, overstated and unsubstantiated.  The FTC’s claims are supported by its recent physician practice merger challenge in Nampa, Idaho, as well as its challenges of hospital merger challenges in Toledo, Ohio and Rockford, Illinois.

Third, it is noteworthy that the recently negotiated contracts between the parties with large commercial payors did not insulate the transaction from allegations of anticompetitive harm. The FTC perceives these contracts as evidence that the payors view the transaction as likely to generate anticompetitive harm.  While the FTC may acknowledge that these agreements prevent rates from rising for a particular period of time, it perceives those agreements to be insufficient to counter the increased bargaining leverage of the combined entity that will impact any new agreements with payors and will impact negotiations after the recently negotiated agreements expire.  The FTC’s position on this issue is consistent with its longstanding rejection of conduct-oriented settlements of potentially anticompetitive mergers of healthcare providers. 

Fourth, the Hershey/Pinnacle challenge represents a continuation of the FTC’s historical approach to assessing anticompetitive effects in hospital mergers.  The FTC continues to utilize a “two-dimensional” articulation of the competition: first assessing competition among hospitals to be selected as in-network providers for commercial health plans and, second, investigating competition among hospitals in the network on the basis of non-price features to attract patients. 

Finally, a critical component of the FTC’s investigation continues to be ordinary course business documents created by the parties describing the competitive landscape.  As in recent cases, the FTC’s complaint in this case cites and quotes from documents created by the parties in support of the allegations that the transaction will reduce competition and harm consumers.

In sum, this most recent FTC enforcement initiative is a reminder that when hospitals and health systems first contemplate a transaction, they should evaluate its competitive implications in light of the FTC’s heightened scrutiny of mergers involving healthcare competitors.