On June 14, 2016, U.S. District Judge Jorge Alonso, of the Northern District of Illinois, denied a motion for preliminary injunction by the Federal Trade Commission (“FTC”) and the Attorney General for the State of Illinois, seeking to block the proposed merger between Advocate Health Care and the NorthShore University Health System (“NorthShore”) in the Chicago metropolitan area.[1] According to Judge Alonso’s opinion released on June 20, the Plaintiffs failed to prove a relevant geographic market, the lack of which the Court deemed fatal to the Plaintiffs’ case.[2]

This loss could be a blow for the FTC’s health care competition enforcement program. It is the agency’s second loss in district court this year in a hospital merger challenge. Additionally, as we noted in our May 13, 2016 blog post concerning the FTC’s earlier loss on the Hershey merger—now on appeal to the Third Circuit—both cases reflect push-back by courts against what to this point have been highly successful FTC market definition and consumer harm arguments in hospital merger cases.

  1. Background

Defendants Advocate Health Care Network (“AHCN”) and Advocate Health and Hospitals Corporation (“AHHC,” and together with AHCN “Advocate Health”) together operate a non-profit health system and the largest hospital system in the Chicago metropolitan area, with twelve hospitals and over 250 health care practice sites generating $5.2 billion in revenue.[3] NorthShore is a non-profit health system in the greater Chicago area, with four general acute-care (“GAC”) hospitals generating $1.9 billion in revenue.[4]

In September 2014, Advocate Health and NorthShore entered an affiliation agreement combining the entities to become Advocate NorthShore Health Partners (“ANHP”).[5] The merger would yield a fifteen GAC hospital system in Illinois—the eleventh largest non-profit hospital system in the United States—generating around $7 billion in revenue.[6]

Advocate Health asserted the merger was to create a new low-cost, high performing network throughout the Chicago area, which required the combination with NorthShore.[7] Similarly, NorthShore wanted to engage in large-scale, risk based contracting, but lacked the necessary geographic coverage and population health management tools available at Advocate Health. [8]

In December 2015, the FTC filed an administrative complaint challenging the merger under Section 7 of the Clayton Act and Section 5 of the FTC Act.[9] In parallel, the agency and the State of Illinois brought the district court action, discussed here, to enjoin the merger under Clayton Act Section 7.

  1. Market Definition and Competitive Effects

Courts evaluating hospital mergers focus heavily on assessing the right market definition, both in terms of the proper combination of competing products or services, and the geographic boundaries for that competition. The market definition is important because it can influence the court’s decision about competitive effects and the presence of harm for consumers.

As with the case against Hershey, the Defendants and the FTC agreed on a commonly-used service market definition. They both viewed the market to be “GAC inpatient hospital services sold and provided to commercial payers and their insured members,” which includes a broad cluster of medical and surgical treatment and diagnostic services often requiring a 24-hour stay in a hospital.[10] The FTC also expressly excluded outpatient services, as well as other specialized care (e.g., tertiary and quaternary services) from the relevant markets.[11]

As was also the case with Hershey, and many other hospital merger challenges, the parties disagreed about the definition of the geographic market. The FTC contended the geographic markets should be the outer boundaries of the hospitals most in direct competition.[12] Specifically, the FTC believed the market should be the “North Shore Area,” including all of NorthShore’s four hospitals and two of Advocate Health’s.[13] The FTC submitted the work of an economic expert, Dr. Steven Tenn of Charles River Associates, in support of its market definition. A few key points of his analysis discussed by the Court are worth highlighting:

  • Tenn included in the market only “local hospitals,” and excluded “destination hospitals.” The rationale was that relevant payers were concerned with plans that incorporated hospitals in the northern Chicago suburbs, which would by definition not include non-local destination hospitals, such as Northwestern Memorial Hospital.[14]
  • Tenn included only hospitals with at least 2% share in the area from which “relevant Advocate and NorthShore hospitals attract patients.” The rationale was that hospitals with at least 2% market share would reflect the most competitive alternatives to relevant Advocate Health and NorthShore hospitals.[15]
  • Tenn only included hospitals that overlapped, i.e., drew patients from the same area, with hospitals from both Advocate Health and NorthShore. The rationale was that a significant fraction of patents view NorthShore and Advocate Health as primary and secondary alternatives, and thus it seemed reasonable to look in areas with only overlapping competition.[16]

Dr. Tenn—in testing his definition based on a hypothetical monopolist approach—found that 48% of the patients in the North Shore area would divert to one of the eleven hospitals captured within his market.[17] Dr. Tenn believed such a high level of intra-market diversion validated the market definition.[18]

Consequently, the FTC alleged the merger was presumptively unlawful, reflected in the parties’ combined market share of 55%, and the significant increase due to the merger in Herfindahl-Hirschman Index market concentration measurements.[19] Furthermore, the FTC contended the loss of competition between Advocate Health and NorthShore would eliminate crucial price competition between the relevant hospitals on fee-for-service contracts.[20] The FTC additionally claimed the merger would reduce incentives at NorthShore and Advocate Health to compete on quality and service.[21]

Defendants disagreed with the Plaintiffs’ geographic market definition and arguments about competitive effects. They argued that excluding destination hospitals and other related entities made the market impermissibly narrow, which would if true artificially exacerbate the extent of foreclosure of competition within the market.[22] For example, Dr. Tenn’s diversion ratios demonstrated that the excluded Northwestern Memorial Hospital was actually the second or third alternative choice for patients using five of the six party hospitals in the Plaintiff’s alleged market.[23] Also, the Defendants argued that the Plaintiffs’ market should but did not include hospitals that were outside the market but were fed GAC patients from affiliated outpatient and other clinics within the market.[24]

The Court—agreeing with the Defendants—found Dr. Tenn’s methodology flawed and rejected the Plaintiffs’ geographic market definition.[25] The Court disagreed with Dr. Tenn’s exclusion of destination hospitals, finding that Dr. Tenn: (a) provided no economic basis for the exclusion; (b) improperly assumed the answer to the question under investigation (i.e., what are the reasonable substitutes for the parties’ hospitals); (c) improperly assumed, despite equivocal evidence, that patients prefer to receive GAC services near their homes; and (d) failed to consider commercial realities, including that payers contract for inpatient and outpatient services, outpatient service use is rising while inpatient utilization is falling, and outpatient services are a key driver for hospital admissions.[26] The Court similarly disagreed with Dr. Tenn’s third criterion—limiting the market to only hospitals that overlap with hospitals from both parties—contending that, instead of analyzing data to determine next best alternatives to the parties’ hospitals, Dr. Tenn merely assumed the answer.[27]

  1. Summary and Concluding Observations

Both Hershey and Advocate Health are temporarily enjoined, pending emergency appeals by the FTC to the respective Courts of Appeal. It is possible that the appellate courts may overturn the lower court decisions. If so, this would arguably support the FTC’s approach to defining hospital markets that was born in the mid-2000s, and turned a decade of FTC merger challenge failures into almost ten years of success. However, if sustained, the agency may be forced to again retool its analytical approach to defining hospital markets and analyzing the competitive effects of hospital mergers.

To read the Court’s opinion, please click here.