United States: Appeals Court Decisions Strengthen FTC's Hand In Hospital Merger Challenges

David C. Kully is a Partner in our Washington, D.C. office and Christopher W. Carmichael is a Partner in our Chicago office.

HIGHLIGHTS:

  • U.S. Courts of Appeals for the Third and Seventh Circuits reversed district court denials of Federal Trade Commission (FTC) motions to enjoin hospital mergers, finding that hospitals compete principally with those nearby and distant hospitals are unlikely to constrain the prices insurers pay for access to the merging hospitals' facilities.
  • Hospitals contemplating a merger should be prepared to show that patients possess local alternatives to their facilities and insurers can offer successful plans that do not allow access to either of the merging parties' hospitals.

The fall of 2016 has proved to be a difficult time for hospitals seeking to complete mergers in the face of antitrust challenges brought by the Federal Trade Commission (FTC). After failing initially to persuade federal district courts to preliminarily enjoin mergers of hospitals in Harrisburg, Pennsylvania, and in Chicago's northern suburbs, the FTC succeeded on appeal in both cases.

The FTC challenged both mergers under Section 7 of the Clayton Act, which forbids mergers likely to substantially lessen competition. See 15 U.S.C. §18. The principal issue in both cases was the size of the geographic area in which the merging hospitals principally compete. The size of the geographic market matters because if the merging parties compete materially only with each other and other nearby hospitals, then their merger could leave few competitors in the geographic market. That would provide grounds for the FTC to claim that the hospitals could increase their prices after the merger. However, if other, more-distant hospitals serve as a competitive constraint on the merging parties, then the FTC's claims that the mergers would be likely to have anticompetitive effects would be much less plausible.

Both district courts observed that patients regularly crossed into and out of the geographic markets proposed by the FTC and concluded that the relevant geographic markets could not be as small as the FTC asserted. On appeal, however, the United States Courts of Appeals for the Third and Seventh Circuits found the district courts' analyses to be flawed and the FTC had established that the merging parties competed materially only in relatively small and highly concentrated geographic markets.

The FTC's success on appeal in these two cases will only embolden it as it weighs challenges to future hospital mergers. Although merger challenges always turn on the particular competitive conditions in the hospitals' specific local service areas, hospitals evaluating merging with nearby competitors should keep in mind the analytical approaches laid out in these decisions. Because the decisions of the Third and Seventh Circuits provide an analytical framework other courts are likely to follow, merging hospitals facing an FTC challenge should be prepared to present persuasive evidence that many patients do not favor the merging parties' local facilities for general acute care or that insurance companies serving those patients could successfully offer plans that do not include either of the merging parties' hospitals.

The recent election may not produce a change in the FTC's approach to hospital mergers. President-elect Donald Trump has publicly criticized some mergers and has expressed concern about concentration in some industries. In addition, former FTC Commissioner Joshua Wright, who is reportedly advising the President-elect's transition team, referred to the concentrated hospital industry as "noncompetitive" and supported the FTC's merger challenges in that industry in a Nov. 14, 2016, op-ed in The New York Times.

Summary of the Decisions

FTC, et al. v. Penn State Hershey Medical Center, et al., No. 16-2365 (3d Cir. Sept. 27, 2016)

The first of the two hospital merger cases decided by federal appellate courts in the fall of 2016 concerned the proposed merger of Penn State Hershey Medical Center and PinnacleHealth System, both of which operated hospitals in the Harrisburg area. The FTC and the merging hospitals agreed that the hospitals competed to provide "general acute care" services – medical and surgical services requiring an overnight hospital stay – to commercial payors, see Slip Op. at 14, but disagreed about the breadth of the geographic market.

The FTC, which bore the burden of establishing the contours of the geographic market, alleged a market encompassing four counties around the city of Harrisburg, see id. at 15, a "highly concentrated market" in which the merging hospitals held a 76 percent market share, see id. at 32. The district court rejected the FTC's proposed geographic market definition, pointing to evidence that 43 percent of Hershey's patients came from outside of the four-county area, that there were 19 other hospitals within a 65-minute drive of Harrisburg to which patients could turn to avoid a price increase, and that the merging parties had entered into agreements with large insurers guaranteeing that they would not raise their prices for several years. See id. at 15-16. The district court found the FTC's failure to delineate a relevant geographic market to be fatal to its challenge to the merger and denied the FTC's motion for a preliminary injunction. See id. at 16.

The Third Circuit disagreed with the district court's approach, finding that it "erred in both its formulation and its application of the proper legal test." Id. Rather than focusing on patients that come to Harrisburg hospitals from locations outside of Harrisburg, an approach the Third Circuit found "closely aligns with a discredited economic theory," the district court should have applied an analytical tool called the "hypothetical monopolist test" that is often used in antitrust merger cases to define relevant markets. Id. That tool asks whether a hypothetical monopolist in a proposed geographic market (or over a particular product asserted to constitute a relevant antitrust product market) could impose a small price increase without losing so many sales to suppliers outside of the proposed geographic market that the price increase became unprofitable for the hypothetical monopolist. Id. at 14-15. If enough purchasers buy from sources outside of the relevant market to make the price increase unprofitable, the proposed product market was defined too narrowly. Id.

The Third Circuit, in applying the test, focused on insurers instead of patients, because they "will feel the impact of any price increase," id. at 21-22, and concluded that a hypothetical monopolist over general acute care services in Harrisburg could profitably raise prices. The court credited testimony of insurers that they could not successfully market an insurance plan in Harrisburg that did not include at least one of the merging parties' hospitals, and evidence that the one insurer that tried to sell a low-cost plan that excluded the merging parties' hospitals lost half of its membership. Id. at 24.

The court found that "patient flow data" showing that many patients from outside of the Harrisburg area came to the merging parties' hospitals in Harrisburg did not establish that hospitals outside Harrisburg compete materially with hospitals in Harrisburg or that a hypothetical monopolist of hospitals in Harrisburg could not profitably raise prices. Id. at 19-20.

The court pointed to evidence that a high percentage of patients that live in Harrisburg obtained care at Harrisburg hospitals and that the preference of that "silent majority" for local hospital service meant that insurers had to offer access to Harrisburg hospitals in their plans in order to meet the needs of Harrisburg patients. Id. at 20-21.

Finally, the Third Circuit found that the existence of private contracts between the merging parties and some insurers, locking in the insurers' prices for several years, "have no place in the relevant geographic market analysis" because the question under the hypothetical monopolist test is whether a monopolist in Harrisburg could profitably raise prices – not whether the merging parties themselves might be constrained (by potentially unenforceable contracts) in their ability to increase prices to some insurers for some period of time. Id. at 26-27.

FTC v. Advocate Health Care Network, et al., No. 16-2492 (7th Cir. Oct. 31, 2016)

Just a month after the Third Circuit decision, the Seventh Circuit, on nearly identical grounds, found error in the district court's refusal to enjoin a hospital merger in Chicago's northern suburbs. At issue was the proposed merger of NorthShore University HealthSystem, which has four hospitals in Chicago's northern suburbs, and the Advocate Health Care Network, which operates two hospitals in the northern suburbs and seven other hospitals across the Chicago area. Slip Op. at 4.

The FTC and merging hospitals agreed that the merging parties competed to provide "inpatient general acute care services – specifically, those services sold to commercial health plans and their members," see id. at 10, and the principal dispute in the case concerned the breadth of the relevant geographic market. The district court rejected the FTC's geographic market comprising only Chicago's concentrated northern suburbs. See id. at 7. The district court believed that evidence showing many patients' second-choice hospital was one outside of the FTC's proposed geographic market established the market was too narrow, and the court found "equivocal" other evidence concerning the importance to many patients of having access under their health plans to local hospitals. See id. at 7-8.

Like the Third Circuit, the Seventh Circuit regarded the central issue on appeal to be the proper application of the hypothetical monopolist test to determine the size of the relevant geographic market and observed that the district court misunderstood the hypothetical monopolist test. Id. at 20. The Seventh Circuit also agreed with the Third Circuit that "insurers are the most relevant buyers," id. at 24, and credited testimony by insurance executives that, to offer a product marketable to employers in Chicago's northern suburbs, the plan had to offer access to at least one of the merging parties' hospital systems. Id. at 23.

The Seventh Circuit was persuaded by evidence that many patients demand access to hospitals close to their homes, id. at 22, and, like the Third Circuit, found that the district court's focus on hospitals outside of the narrow geographic market failed to properly account for the "silent majority" of patients who seek treatment from local hospitals. Id. at 25. This silent majority gives hospitals in Chicago's northern suburbs "market power over the insurers who need them to offer commercially viable products to customers who are reluctant to travel further for general acute hospital care." Id. at 25-26.

Finally, the Seventh Circuit found persuasive evidence that NorthShore raised prices after a prior merger of one independent north suburban hospital with NorthShore's then-existing three-hospital system. Id. at 19.

Impact of the Decisions

The Seventh Circuit's opinion recognizes that recent analyses of hospital mergers by the FTC and courts have focused less on the distance some patients travel for care – an approach that led to extremely broad geographic markets containing many hospital competitors – and more on the potential market power that the merging hospitals could exercise over local insurers that cannot offer marketable plans without access to their facilities. See id. at 16-19. The Third and Seventh Circuits in these cases both relied on evidence of patient demand for access under their insurance plans to their local hospitals and on insurers' inability to offer marketable plans without access to the merging parties' local hospitals. Hospitals contemplating a merger should not expect that evidence showing some patients travel significant distances to obtain specialized care will persuade the FTC that their merger should be allowed. These hospitals should study whether patients possess local alternatives to their facilities and if insurers can market plans that do not provide access to their hospitals.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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