More than seven years after Evanston Northwestern Healthcare Corporation (“ENH”) merged with Highland Park Hospital and more than three years after instituting litigation against the merger, the Federal Trade Commission (“FTC”) on August 6 concluded that the merger was anticompetitive and violated Section 7 of the Clayton Act.1 The decision may be appealed to the Seventh Circuit and, therefore, may not be the last word in this long saga, but the FTC’s 90-page single-spaced decision deserves close attention by hospitals and other health care providers that may contemplate a merger or acquisition in the coming years.

This hospital merger challenge, through administrative litigation,2 followed a string of losses by the FTC and the Department of Justice Antitrust Division in their efforts to enjoin proposed hospital mergers and acquisitions and a period of limited enforcement. Bush Administration antitrust offi cials decided to conduct a “retrospective” examination of consummated transactions; then picked Evanston Northwestern for challenge. The FTC’s decision may foreshadow renewed enforcement efforts.

Rather than order divestiture, as the government typically does when it fi nds a merger unlawful and as the Administrative Law Judge did in his 2005 decision, the FTC said it will require ENH to establish separate and independent negotiating teams to re-inject competition between the hospitals and allow managed care organizations (“MCOs”) to negotiate separately. The FTC concluded a “conduct” rather than a “structural” remedy was appropriate given the amount of time that has elapsed since the merger and because divestiture might be disruptive to improvements implemented post-merger. Although this novel remedy may open the door to similar approaches in which a merger may result in substantial effi ciencies, the FTC bent over backwards to characterize the case as “highly unusual.”

FTC Opinion

The FTC decision emphasizes important differences between hospital services and other markets, most signifi - cantly, the role of third-party payors. The FTC noted substantial changes in private health insurance over the past two decades, with a shift from indemnity plans to health maintenance organizations (“HMOs”) and preferred provider organizations (“PPOs”). The decision, therefore, focuses primarily on the impact of the merger on the hospitals’ leverage over MCOs. Nonetheless, the FTC did not address two important factors that could affect the analysis of actual competitive harm: (i) the mixed motives of the payors challenging the price increases; and (ii) the evidence in the record that, on balance, MCOs prefer to include every Chicago hospital in their networks, regardless of price. The FTC concluded that the exercise of market power would result in anticompetitive effects that eventually fl ow to individual consumers through increased insurance premiums or higher deductibles and co-pays, but in terms of analyzing the impact of the merger, the FTC looked at the post-merger prices charged to MCOs.

The Evanston Northwestern decision followed earlier cases in identifying the relevant product market at issue as acute inpatient hospital services, further broken down to primary, secondary and tertiary services. The FTC rejected ENH’s argument that outpatient hospital services should be included in the relevant product market because ENH set inpatient rates independent of its outpatient rates and without concern that patients would switch to outpatient services. The FTC recognized that there is no more substitutability between different types of inpatient services (e.g., a hip replacement surgery and a heart transplant) than there is between inpatient and outpatient services. The FTC went on to suggest that it might make sense to defi ne a broader “hospital services” product market, which would include the cluster of health care services that a hospital offers and for which hospitals compete only with other hospitals.

The FTC opinion arguably sidesteps the most important issue in the case, defi ning the relevant geographic market. The FTC identifi ed nine hospitals that are closer to the Evanston, Glenbrook and Highland Park Hospitals than they are to each other. The merged ENH accounts for only about 18% of the inpatient hospital beds in that group, a percentage that would not normally raise antitrust concerns.

Critically important for future hospital mergers, the FTC rejected the traditional approach to defi ning geographic markets for analyzing hospital mergers - examining patient fl ow data using the Elzinga-Hogarty test to determine whether a dominant fi rm in a geographic area might exercise market power. The Elzinga-Hogarty test has been criticized in the past as looking backwards, measuring patient fl ows pre-merger rather than taking into account the impact of the merger. The FTC here, however, rejected its application because it said patient decisions do not have a constraining effect because patients’ choices of hospitals are based not on price but on other factors, such as location and physician preferences. The FTC also noted that patients rarely directly pay the full cost of hospital services and reasoned that individuals do not choose distant hospitals in response to price increases. This analysis is confounded by the fact that if patients are truly not price-sensitive because of their insurance coverage, they can and will go to any hospital that may best suit their needs, especially in the Chicago market, which has four academic medical centers and multiple proximately situated community hospitals.3 The FTC discounted this detail by stating that the residents in the ENH area view time as money and, thus, are less willing to travel. It ultimately concluded that it must view patient fl ow data “with a high degree of caution.”

In fi nding the ENH-Highland Park merger unlawful, the FTC relied instead on the fact that the merged fi rm “substantially and immediately” raised its prices and econometric evidence that prices to third-party payors increased, controlling for “competitively-benign factors.” The economic testimony suggested that prices increased 9%-18%, depending upon which economist one listened to. That testimony was given considerable weight, allowing the FTC to conclude that the geographic market was narrow, since the whole purpose of the geographic market defi nition is to defi ne a territory where a “hypothetical monopolist” might raise prices. In other words, rather than rely on market definition and market shares to predict whether a merger may allow a price increase, the FTC relied on the demonstrated price increase by ENH to defi ne a narrow geographic market. The “hypothetical monopolist” is a construct adopted for the federal Merger Guidelines; consequently, its strongest advocates are the federal antitrust agencies. To date, it has not been widely embraced by the courts, and, prior to Evanston Northwestern, it has not been signifi cant in defi ning markets for any hospital merger case. In addition to the economic testimony, however, the FTC also points to documents from the hospitals’ fi les suggesting that they knew that the merger would limit competition and give them leverage over payers.

Thus, the FTC concluded that the geographic market does not include the many hospitals in proximity to ENH. Indeed, the FTC’s decision foreshadows future merger challenges in which there may not even be an attempt to prove a relevant geographic market, and it will instead rely on evidence of actual or predicted “competitive effects” alone.

The FTC rejected all of ENH’s proposed defenses to the claim and any cited effi ciencies, which may have mitigated some of the anticompetitive effects of the merger. The FTC was simply not persuaded that most of the physical, technological and clinical improvements that occurred were “merger specifi c” and could not have been achieved without the merger. The FTC also rejected ENH’s argument that Highland Park Hospital was so weakened that, but for the merger, it would have ultimately failed.

Finally, the FTC concluded that there was insuffi cient evidence to demonstrate the quality improvements at Highland Park Hospital caused the price increases, and there was also insuffi cient evidence to demonstrate that the quality of health care services at Highland Park Hospital was improved relative to other hospitals as a result of the merger.

Implications

During the 1980s and 1990s, the hospital industry was a focus of merger enforcement activity, with the antitrust agencies prevailing in a number of federal court and administra-tive proceedings. In the late 1990s, the government had a notable streak of losses in court: in Sutter Health, Long Island Jewish, Butterworth, Freeman, Mercy Health and other cases. Those losses may have given some hospitals contemplating mergers a false sense of security.

In 2002, FTC Chairman Tim Muris announced that the FTC was in the midst of a retrospective study of consummated hospital mergers, which was aimed at examining effi ciencies and anticompetitive effects. Muris then cautioned that administrative litigation might follow, and suggested the result “may bolster the Commission’s position the next time it seeks a preliminary injunction against a proposed merger in federal district court.” Although Muris has since left the FTC, it is clear that the current commissioners remain interested in that goal.

The Evanston Northwestern opinion sets the stage for future enforcement efforts. First, the FTC clearly defi ned the market as acute inpatient hospital services sold to the thirdparty payors, differentiating inpatient hospital services from outpatient services for which hospitals may face competition from clinics and other outpatient facilities. Second, the FTC essentially rejected the established reliance on patient origin data to determine the geographic market. Further, the opinion and the separate concurrences of two commissioners foreshadow the possibility that in future merger analyses, the FTC might argue that it is not even necessary to prove a geographic market to demonstrate the anticompetitive effects of a merger, and a violation of Section 7 of the Clayton Act - even though the statute requires a substantial lessening of competition in a “section of the country.”

The FTC has set forth its view that the benefi ts of a merger must be signifi cant to overcome the potential for price increases resulting from increased leverage over managed care. Although important to society and the patient as the ultimate consumer, improved quality of health services alone are not likely to be suffi cient to mitigate anticompetitive effects of a merger and carry the day. Quality is but one dimension in which hospitals compete, and the benefi ts of a merger, including quality, must be verifi able, “merger specifi c” and greater than the anticompetitive effects. Hospitals must focus their attention on calculating potential cost savings and other demonstrable effi ciencies that the FTC may credit in its analyses.

Considerable weight is being given to the prevailing theories in Evanston Northwestern by FTC staff in current investigations. Whether these theories will be embraced by a court, especially the Seventh Circuit, is uncertain. Rejection of the Elizinga-Hogarty test, although fl awed, is a signifi cant departure from traditional hospital merger analysis. In addition, the FTC also departed from the prevailing standard for market defi nition in hospital merger cases4 by determining the geographic market based upon the area in which the “hypothetical monopolist” can raise prices rather than the geographic market where consumers can go for health care services. Although it is unclear how well these theories will withstand a court’s scrutiny, it is certain that the courts will allow some deference to these hypotheses upon review.

Lastly, the use of the injunctive remedy requiring ENH to establish two separate contracting mechanisms to insert some competition into the local area certainly appears less disruptive to ENH hospitals’ operations than a divestiture. Nevertheless, due to operational and practical considerations, the implementation and ultimate effi cacy of such a tool is truly uncertain. In addition, the use of such an unrealistic remedy will require the FTC to monitor the effect on pricing of the two contracting entities. If the remedy is ultimately successful, it may open the door to allowing hospitals to merge to garner effi ciencies while maintaining separate negotiating operations to preserve some semblance of competition. Although the FTC is clearly reluctant to do that, having suggested that remedy may be effective, the agency may fi nd it diffi cult to stop others that propose a similar course.

In many ways, the Evanston Northwestern opinion calls into question previous assumptions regarding the FTC’s scrutiny of hospital mergers, and thus requires a fresh analysis of any proposed hospital merger.