On May 9, 2016, U.S. District Judge John Jones III, of the Middle District of Pennsylvania, rejected a motion for preliminary injunction by the Federal Trade Commission (“FTC”) and the Pennsylvania Attorney General to halt the proposed merger between Penn State Hershey Medical Center (“Hershey”) and PinnacleHealth System (“Pinnacle”). The Court’s decision represents a potential setback for the FTC’s enforcement against hospital consolidation around the country. The opinion raises further questions about recent analyses endorsed by the agency and other federal courts when reviewing hospital mergers. The Court has extended the temporary restraining order in effect until May 27, 2016, to allow the FTC and the Attorney General to seek relief from the 3d Circuit.
- Historical background on FTC hospital merger enforcement.
From the 1980s into the early 1990s, the FTC successfully challenged several hospital mergers. However, from the mid-1990s into the early 2000s—during a period of significant reorganization in the healthcare sector—both the FTC and Department of Justice repeatedly lost. Courts, relying heavily on the Elzinga-Hogarty test, which evaluates the flow of patients in and out of proposed relevant markets, often concluded that, for example, the agency’s proposed markets were overly narrow, allegations of increased market share too high, and allegations of patient harm unsustainable.
In 2002, FTC Chairman Timothy Muris called for a retrospective by the agency on consummated mergers to evaluate the impact of hospital consolidation on pricing, patient care, and other important aspects of competition. This initiative, in consort with other parallel discussions looking at health care enforcement, demonstrated that the analytical approaches used did not properly reflect the commercial realities involved with hospital mergers.
The initiative, for example, identified that courts’ analyses of geographic markets led to overly broad markets that masked the anticompetitive effects of the mergers. Additionally, non-profit hospitals were found to potentially still use market power gained from a merger, rather than, as some courts and analysts believed, be constrained from doing so due to their public interest mission.
Perhaps most important, the initiative indicated the need for a more flexible approach in evaluating hospital markets. The FTC better understood that hospital competition typically occurs in two stages – first, hospitals compete to become part of a health plan; and, second, they compete for enrollees within a plan by providing superior service. Thus, while a new focus on payers’ relations with providers was a considerable departure from the FTC’s prior focus on patient choice, as FTC Chairwoman Edith Ramirez noted in 2013, the old approach “ignored that patients generally do not pay directly for health care services and have little incentive to switch in the face of a price increase.”
The result of the analysis was a paradigm shift in the agency’s thinking about how to analyze such mergers. For example, the FTC began to employ the hypothetical-monopolist analysis from the Horizontal Merger Guidelines when defining geographic markets, as was done in the agency’s successful challenge against the Evanston Northwestern Healthcare and Highland Park Hospital merger. The agency shifted the customer focus from the patient to the payer, arguing instead about the effect of the merged entity’s increased leverage over third-party payers due to the reduced ability of payers to exclude hospitals from plans. The agency also put a greater emphasis on competitive effects, such as more strongly requiring merger efficiencies be merger-specific and non-speculative.
- The FTC’s district court case against Hershey / Pinnacle.
The FTC expressed many of the same concerns it has raised in recent hospital deals in its challenge to the proposed Hershey-Pinnacle merger, including the impact of the merger on raising healthcare costs and reducing quality of care in the Harrisburg, Pennsylvania area.
Hershey is a 551-bed academic medical center in Hershey, Pennsylvania, is part of the Penn State College of Medicine, and offers a wide range of specialized and high-acuity services. Hershey also operates Central Pennsylvania’s only children’s hospital, one of the state’s three level I trauma centers, and the state’s only heart-transplant center outside of Philadelphia and Pittsburgh. Pinnacle is a 646-bed three campus system focused on acute care in community hospitals, offering some but limited higher-level services, including open-heart surgery.
The hospitals agreed to merge in June 2014 and notified the FTC in May 2015. The FTC and the Pennsylvania Attorney General filed an administrative complaint in December 2015, contending the merger violated Section 7 of the Clayton Act and Section 5 of the FTC Act. A separate action was also filed in district court to block the merger on the grounds that the merger would substantially reduce competition in the market for general acute care inpatient services sold to commercial health plans and their members. The FTC moved for a preliminary injunction to allow time for the administrative proceedings.
In the district court action discussed here, the Court rejected the FTC’s motion for a preliminary injunction. Much of the Court’s decision focused on market definition, which is common in hospital merger actions. But the court also discussed proposed efficiencies from the merger and adopted positions contrary to commonly-supported FTC positions in recent hospital merger challenges.
- Market definition.
The parties agreed that the product market should be defined as general acute services sold to commercial payers, which includes a cluster of medical and surgical services requiring at least a 24-hour stay at a hospital.
The parties, however, disagreed on the geographic market. The FTC argued the geographic market should be restricted to the Harrisburg area, where Pinnacle and Hershey are the primary hospital providers. In support, the FTC contended that very few patients would travel outside of that area for acute-care services requiring hospitalization. The hospitals pushed back, arguing that the FTC’s market was too narrow and disconnected from the commercial realities facing patients and payers.
The Court agreed with the hospitals. First, the Court found that a substantial number of Hershey and Pinnacle patients either reside in, or travel to the hospitals from, locations outside the Harrisburg area. Second, over half of Hershey’s revenue originates in patients traveling from outside the Harrisburg area. And, third, there are 19 hospitals within 65 minutes of Harrisburg. Consequently, and given the largely rural nature of the community, patients could see these other hospitals as realistic alternatives in the event that the Harrisburg area was monopolized and saw an increase in prices.
The Court was also convinced that the hospitals had taken steps to ensure that post-merger rates did not increase with two of the area’s biggest payers, CBC and Highmark. Most notably, the hospitals executed a 5-year contract with Highmark, and a 10-year contract with CBC, requiring both that the hospitals continue to contract with the payers at existing rates for fee-for-service contracts, and preserve rate differentials between Pinnacle and Hershey. This is important as academic medical centers often have substantially higher rates than community hospitals, and merging Pinnacle into Hershey could yield the imposition of higher rates across-the-board. The Court explained that it would be imprudent to block a merger based on predictions of what might happen to rates in five years.
Having already rejected the FTC’s case, the Court nonetheless discussed the claimed efficiencies associated with the merger and constraints on the hospitals’ abilities to raise prices. In a Clayton 7 challenge, once the agency makes a prima facie showing that the combination could cause anticompetitive effects, the burden shifts to the defending hospitals to argue that on balance the merger would not cause harm to the market. This can be achieved such as by showing that the merger creates merger-specific efficiencies that offset the anticompetitive effects. Here, the Court identified three core positions, all in favor of the hospitals.
First, the Court noted that Hershey is capacity constrained, such that without the merger it would need to build a $277 million tower to increase the number of beds. The Court explained that the investment would strain Hershey’s financial resources—resulting in higher charges and lower quality investments—and negatively affect patients while the tower was in development.  By contrast, the Court explained that the merger would cause “near instantaneous benefits to Hershey’s patients,” and prevent “the outpouring of capital for the construction of the tower.” The Court disagreed with the FTC’s counter that Hershey could merely rely on grants and donations, and the Court further refused to second-guess the business judgment of Hershey executives that the tower was the viable alternative to a merger.
Second, the Court noted that the market had already seen consolidation and extensive “repositioning,” i.e., major business changes by entities seeking to provide more competitive or differentiated products. This is important as courts may sometimes treat, as was the case here, non-merging firms in the market as new entrants where the firms have repositioned their product lines. The Court also noted that the extent of repositioning in Central Pennsylvania served as a direct competitive effort to erode the merging hospitals’ patient base.
Third, the Court recognized that a shift is underway across the country, affecting Hershey and Pinnacle as well, as the industry moves away from fee-for-service to risk-based contracting, where providers carry more of the financial risk over patient care. For example, as the Court noted, by 2018, the federal government intends to shift over half of the federal government payments on health care to risk-sharing arrangements. While the Court agreed with the FTC that the hospitals could independently operate on a risk-based model, the Court nonetheless agreed that the merged entity will be better able to spread out the costs of population health management as required for risk-sharing arrangements.
The Court’s ruling offers an unexpected departure from recent appraisals of hospital merger cases.
First, the Court appears to have preferred explanations about efficiencies gained through scale over the FTC’s arguments that the merger would exacerbate concerns about capacity constraints and would not generate significant merger-specific efficiencies. For instance, if the hospitals could effectively and independently engage in risk-sharing contracting, the merger seems unnecessary to effectuate value-based arrangements. This would be consistent with the Ninth Circuit in Saint Alphonsus Medical Center-Nampa v. St. Luke’s Health System, Ltd., where the panel affirmed the lower court’s rejection of a merger-specific efficiency based on integrating a physician group into a larger network so as to be better positioned to transition to value-based care arrangements.
The Court also appeared to support the notion that long-term rate cap contracts set by the parties with their biggest payers would mitigate concerns arising from the merged entity’s increase in market power. However, on the flip-side, such contracts can prevent competition from putting pressure downstream on providers to lower their rates.
The Court’s comments on risk sharing raise another question as to whether particularized plans are actually needed to implement certain efficiencies. Courts, including the Ninth Circuit in St. Luke’s, have repeatedly rejected efficiencies that were not supported by substantive plans to achieve them. Yet, this Court’s position could stand for the proposition that, in the absence of specific plans, hospitals need only prove that greater scale would help them better achieve risk sharing arrangements should they eventually pursue them, voluntarily or otherwise.
On May 10, 2016, the FTC and the State of Pennsylvania Attorney General’s office asked the Court to enjoin the merger pending review of the Court’s order by the 3d Circuit. In response, the Court extended the current TRO for two weeks until May 27, 2016, to allow the FTC and the Attorney General to file an application with the 3d Circuit.
To read the Court’s order and opinion, please click here.