On February 25, the United States Department of Justice filed a complaint against United Regional Health Care System, the dominant hospital in Wichita Falls, Texas, alleging an antitrust violation in its contracting practices with commercial health insurers. United States v. United Regional Health Care System, no. 11-cv-30 (N.D. Tex. 2/25/11) At the same time, DOJ filed a proposed consent decree that would require United Regional to discontinue the contracting practices at issue. The action has attracted attention as a sign of increased antitrust enforcement under Obama administration. More particularly for insurance companies, DOJ’s allegations signal a particular antitrust risk.

The complaint focused on the insurers’ networks of health care providers. United Regional offered substantial discounts, in the range of 25%, if it was the only local hospital or outpatient surgical facility in an insurer’s provider network, but much smaller discounts, around 5%, if the insurer’s network includes one of United Regional’s local competitors. Most commercial health insurers serving the market decided to take the higher discounts that came with exclusivity.

On the basis of these facts, DOJ charged United Regional with illegal monopolization of the local markets for inpatient hospital services and for outpatient surgical services, in violation of Section 2 of the Sherman Antitrust Act, 15 U.S.C. § 2. Under the consent decree, United Regional will be prohibited from offering discounts to commercial health insurance companies that are conditioned on whether the insurer contracts with competitors or on the insurer’s purchases from United Regional exceeding certain thresholds.

DOJ did not name any insurance company as a defendant in this suit. The underlying theory of liability, however, could be grounds for claims, by government enforcement agencies or private plaintiffs, that an insurance company has entered a contract in restraint of trade, and has violated Section 1 of the Sherman Act, 15 U.S.C. § 1, if its network provider contracts contain discounts in return for exclusivity. Insurance companies looking to avoid antitrust risks need to understand the potential illegality of these contracts.

De Facto Exclusivity

None of United Regional’s network contracts contained express exclusivity terms. However, DOJ alleged that the different levels of discounts had the same effect as exclusivity terms.

Most insurers concluded that United Regional had to be included in their provider networks, because it was by far the largest hospital in the region and because it was the sole provider of several essential services, such as cardiac surgery, obstetrics and high-level trauma care. The issue for these insurers was whether to grant United Regional exclusivity or to include one or more of its competitors in the network.

A hypothetical illustrates the decision. An insurer might purchase hospital services worth $20 million before network discounts. Granting exclusivity to United Regional earns the insurer discounts of 25%, or $5 million, while non-exclusivity earns only 5%, or less than $ 1million, depending upon United Regional’s share. The difference between these two figures, more than $4 million, represents the discount that a competitor would have to offer to gain access to the insurer’s provider network. For a small health care facility, which might not provide $4 million of services in the aggregate to an insurer, matching the benefit of United Regional’s discounts is not feasible.

The theory of the DOJ complaint is that the antitrust laws should treat this arrangement the same as an express requirement of exclusivity. Exclusive dealing can be illegal under the antitrust laws when it forecloses a rival’s access to an input or to a distribution channel that is essential to the rival’s ability to compete. According to the complaint, participation in the provider networks of commercial insurers was essential to smaller hospitals’ ability to compete with United Regional, according to the complaint, and United Regional’s discount arrangements effectively foreclosed the smaller rivals from access to those networks.

Sales Below Cost

Courts seldom find an antitrust violation based upon a defendant’s discounting practices because cutting prices is the type of competitive activity that the antitrust laws are designed to protect and encourage. An exception is where pricing is shown to be predatory, which requires, among other factors, that the price is lower than the defendant’s cost of production. Sales below cost usually serve no purpose other than to drive competitors out of the market. United Regional was not selling its hospital services below its costs, even after the discount for exclusivity. DOJ contended that it did not need to show below-cost pricing because it had shown de-facto exclusivity.

Apparently DOJ was not fully confident that the court would accept that position, so it offered an alternative. The complaint alleged that United Regional’s prices were predatory under a “discount attribution” theory. Some lower federal courts have applied this theory recently to cases where a defendant offers discounts on a bundle of products but faces competition on only some of those products. The discount-attribution theory holds that the entire amount of the discounts should be applied only to the “contestable portions,” those products facing competition, before determining if prices are below costs.

Assume for example, that United Regional sells hospital services at rates before network discounts that yields $20 million in revenue, and those services cost $10 million to produce. If United Regional grants a network discount of 25%, equal to $5 million, it ends up with revenues of $15 million, which is still above its costs. Assume further that United Regional faces competition on only half of these services, worth $10 million, and that the cost of producing these services is $6 million. If the total discount of $5 million is attributed to this contestable portion, then these services are being sold below cost.

DOJ alleged that United Regional’s discounts followed this pattern. It faced competition on only a portion of its services, and application of the 25% exclusivity to this contestable portion resulted in sales below cost.

Caution for insurers

There will be no court decision on the validity of DOJ’s claims, provided that the court approves the consent decree proposed by DOJ. For health insurers, the case is a signal that granting exclusivity in provider networks can carry the risk of an investigation or enforcement action by an antitrust agency, as well as the potential of liability. These agreements are particularly risky when, as in the case of United Regional, the provider demanding exclusivity is the dominant hospital or medical center in a local market, rivals are too small to match the discounts, the provider faces competition on only a portion of its services and the discounts offered for exclusivity are substantial.