The Federal Trade Commission's challenge of a hospital merger in Grand Rapids, Mich., last month not only revealed the agency's view of what the deal would do to competition but also showed what it thinks of price promises made by hospitals trying to merge.
But that hasn't stopped a number of hospitals from at least trying, particularly at the state level, to get antitrust clearance for their high-market-share mergers. In fact, promises to freeze or limit prices have become the antitrust strategy du jour for a number of healthcare antitrust attorneys and their turf-hungry hospital clients.
At least seven sets of merging hospitals have tried, with a high degree of success, to exchange a price promise for antitrust clearance. Of the seven, six have occurred since December 1993, and all have involved mergers in small markets, including five two-hospital towns. The promises are designed to allay fears that the hospitals, once merged, will use their market power to arbitrarily raise prices to payers.
"The only thing that prompts hospitals to make a price promise is that it's necessary to do the deal," said Jeff Miles, an antitrust attorney with Ober, Kaler, Grimes & Shriver in Baltimore. "If there were no antitrust problems, you wouldn't see these types of provisions offered by hospitals."
That's because price controls can potentially limit the ability of a hospital-merged or otherwise-to respond to marketplace changes. Ironically, though, some of the promises that the merging hospitals have made not only allow them to raise prices faster than general inflation but could generate a windfall if a merger's cost-reduction objectives are achieved.
Miles represented three hospitals in and around Williamsport, Pa., that entered into an antitrust settlement with the state of Pennsylvania in 1994. The deal gave the hospitals a monopoly in Williamsport and control of three of the four hospitals and more than 90% of the 621 staffed inpatient beds in Lycoming County, Pa.
In return, the hospitals agreed for 10 years to limit increases in net inpatient revenues per admission to increases in the "hospital marketbasket index," as calculated by the American Hospital Association.
The index measures changes in hospital expenditures on common goods and services. For the 12 months ended September 1995, the AHA hospital marketbasket increase was 5.7%.
Such price promises are made for two reasons, Miles said. First, they're designed to generate employer and community support for a merger. Not only will that help on the local front, it will help when state or federal antitrust investigators come looking for local opposition to a deal, he said.
Second, price promises are offered as guarantees to law enforcement officials that, at least in the short run, the effects of a merger won't be anti-competitive, Miles said.
But the two largest hospitals in Grand Rapids, Butterworth Hospital and Blodgett Memorial Medical Center, failed on both fronts.
As a result, on Jan. 19 the five FTC commissioners in Washington voted 3-0, with two not voting, to challenge the deal, and the agency filed a motion in federal court for a preliminary injunction that would block the merger until the antitrust issues are resolved. A hearing on the motion is set for April 22 before U.S. District Judge David McKeague in Lansing, Mich.
A Butterworth-Blodgett merger would give the hospitals control of about two-thirds of the staffed acute-care beds in Grand Rapids. Both hospitals had high profit margins in 1994, 13% for Butterworth and 8% for Blodgett.
To dispel fear the merger would reduce competition and raise prices, the hospitals made a seven-year pricing commitment the "cornerstone" of their merger plan when it was announced last May. They vowed to freeze prices for the first three years of the merger and then limit price increases during the next four years to the annual Consumer Price Index, or general rate of retail inflation.
The CPI for 1995 was 2.5%, the smallest rate of inflation since 1986, when the CPI was 1.1%, according to data from the U.S. Labor Department.
The benchmark against which all price promises are measured is the hospital and related services component of the CPI, or the changes in retail prices consumers pay for hospital services. The hospital CPI was 4.6% in 1995, down from 5.5% the previous year.
The Grand Rapids hospitals hyped the price promise in advertisements, published brochures on the benefits of the merger, and sent their top leaders to more than 120 meetings and community forums to tout the deal.
"The pricing commitment is our way of saying we believe this merger will provide a significant benefit to west Michigan, and our boards are prepared to pass that savings along to the people and the businesses in our community," said Richard M. DeVos Sr., Butterworth's board chairman.
Many business leaders said the commitments didn't go far enough, so last October the hospitals upped the ante. They promised to limit profit margins to the average of hospitals with bonds rated in the top 25%. The hospitals estimated that margin to be about 7.5% in 1995.
Ultimately, the enhanced pledge garnered some support for the merger, although many skeptics remained. Some believed the hospitals should be able to reduce prices, not just freeze them. And they wondered what would happen to prices and profits after seven years.
The strategy also targeted the FTC, which was investigating the deal.
"We wanted to reassure the FTC that in fact, we've said this in public...and the hospitals will not renege on the pricing commitment," said Blodgett's attorney, Kathleen Fochtman, who works for the Grand Rapids firm of Varnum, Riddering, Schmidt & Howlett.
That didn't work, either.
That the price promise didn't hold sway with the FTC should be no surprise, according to many veteran healthcare antitrust attorneys.
"The federal agencies have made it clear that when they review a merger, it's either thumbs up or thumbs down," said Douglas Ross, a healthcare antitrust attorney with Davis Wright Tremaine in Seattle. "From their perspective, if there's an antitrust problem, the deal shouldn't go through. If there's not a problem, it should go through without conditions."
Ross represented one of the two hospitals in Bellingham, Wash., whose 1989 merger became the first to trade antitrust clearance for limits on price increases. The hospitals-the only acute-care facilities in Bellingham-agreed to limit increases in their case-mix-adjusted inpatient prices to increases in a hospital marketbasket index published by HCFA.
According to preliminary data from HCFA, the index was 5.5% in 1995.
The unwillingness of the FTC and the Justice Department to consider price promises when they review the effects of a hospital merger was stated clearly to MODERN HEALTHCARE in interviews with federal officials.
"We don't think private promises can be relied on at all as evidence," said Connie Robinson, director of operations in the Justice Department's antitrust division. "Things change, including boards, people and business climates. Promises are not good enough to prevent anti-competitive behavior in the market."
Robert Leibenluft, who heads the FTC's healthcare antitrust division, echoed Robinson's skepticism: "It's hard to know whether to trust that commitment, even if it is in writing. What we're concerned with is letting the market decide prices. There's no substitute for the market."
There also are several practical problems with such price promises, he said.
First, the market, if free to operate, could force lower prices, but hospitals could use their price promises to keep rates at an artificially high level, he said. Also, after the agreement expires, the hospitals would be free to do anything they wanted with prices, absent any other market changes that occurred during the duration of the agreement, he said. Finally, neither the FTC nor the Justice Department desires or has the resources to regulate or monitor prices as part of individual antitrust settlements, he said.
It's no wonder, then, that merging hospitals with potential antitrust problems are running into the arms of state regulators, who seem to be more sympathetic to hospital price promises.
Cutting a deal with a state can protect merging companies from federal antitrust scrutiny under the "state action immunity" doctrine. Under the doctrine, which has developed through case law, activities that are permitted by a state, and actively supervised or monitored by the state, are immune from federal antitrust scrutiny. However, both prongs of the doctrine-permitted activities and active supervision-must be met before federal antitrust immunity is extended.
That was the strategy recently employed by two hospital systems in Harrisburg, Pa., that got state antitrust clearance and merged into Pinnacle Health System on Jan. 1.
The systems are Polyclinic Health System and Capital Health System. In Harrisburg, Polyclinic owns 453-bed Polyclinic Medical Center, and Capital Health owns 398-bed Harrisburg Hospital. Capital Health also owns 52-bed Seidle Memorial Hospital in nearby Mechanicsburg, Pa. The deal gave them control of two of the three hospitals and 88% of the 966 staffed acute-care beds in Harrisburg.
Rather than taking their chances with the feds, the systems approached the Pennsylvania attorney general's office, looking for a settlement that would let them merge but give the state some assurances that they wouldn't exploit their market share.
Under an agreement cut with the state last July, the systems got state antitrust clearance but agreed to a number of conditions, including what some would consider a very generous limit on price increases. The agreement allows the systems' case-mix-adjusted net inpatient revenues per admission to rise by the CPI, or general rate of inflation, plus 2%.
If the agreement was in place last year, for example, the systems could raise their prices 4.5% this year-2.5% for inflation and the extra 2%.
The FTC subsequently cleared the deal last November, and a federal judge in Harrisburg approved the settlement in December (Jan. 22, p. 9).
"States don't take such an absolute view of a deal like the feds do," Ross said. "State officials have to live here, and they know the players. And they hate to say no to a merger, especially if it's supported by the community and local businesses."
Ross wasn't involved in the Harrisburg deal, but he's connected to it through the Bellingham settlement. Ross' co-legal counsel in Bellingham was Toby Singer, an antitrust attorney with the Washington office of Jones, Day, Reavis & Pogue. Singer also represented the Harrisburg systems in negotiations with the state.
Singer credited the Bellingham deal with creating a powerful tool that merging hospitals and their antitrust attorneys can use in trying to get antitrust clearance for a deal.
Singer's firm also represents the only two hospitals in Great Falls, Mont., which are seeking state antitrust protection for their merger. At deadline, clearance was pending under the state's healthcare antitrust exemption law. The hospitals had lobbied for the law, which grants antitrust immunity to providers that can demonstrate the benefits of their transaction, such as lower costs, outweigh any anti-competitive risks.
The two hospitals have promised to freeze prices for a year and then limit price increases to the CPI for the subsequent five years if they're allowed to merge. But, like the hospitals in Grand Rapids, they've run into a great deal of local skepticism (Oct. 16, 1995, p. 6).
"Price agreements are a way for a state to make hospitals live up to their promise to reduce costs," Singer said.
In the Harrisburg case, for example, the systems are required to generate at least $70 million in savings over the first five years of the merger. Absent the price promise, the systems could just pocket the savings, Singer said. Forcing the systems to control prices helps guarantee that the savings will be passed along to consumers, she said.
But, she acknowledged, it's also reasonable for the hospital systems: "The hospitals want to at least keep up with inflation."
Pennsylvania doesn't want to micro-manage a hospital's business, but in the Williamsport and Harrisburg hospital cases, the state needed to eliminate the ability of the hospitals to simply raise prices to offset the savings, said Carl Hisiro, chief deputy attorney general who heads the office's antitrust section.
Hisiro also defended the practice of conditionally clearing hospital mergers that may be illegal in the eyes of the federal government.
"We got something for our trouble," he said. "The feds just lost two merger cases, and now those hospitals can do whatever they want. Our citizens have received substantial guarantees that the hospitals won't act anti-competitively."
The FTC recently lost a hospital merger case in Joplin, Mo., and the Justice Department recently lost one in Dubuque, Iowa (Dec. 11, 1995, p. 14).
Measuring by which yardstick? Lest hospitals and their pinstriped lawyers think state antitrust officials just fell off the turnip truck, state enforcers are well aware of the variations in the different inflation indexes that can be used to control price increases.
Hisiro said he felt that using the CPI was a "fair measure" in the Harrisburg case, for example, because it reflects what consumers are paying for care.
"An extreme position would have been to limit price increases to the PPI (Producer Price Index)," Hisiro said.
While the CPI measures changes in retail prices, the PPI measures changes in wholesale prices. It tracks changes in net revenues received by a producer for goods and services.
Consequently, the PPI will never be higher than the CPI and, more than likely, will be lower. The CPI was 2.5% last year, while the PPI was 2.2%.
The state of Washington used the PPI in December 1993 in an antitrust settlement with the only two hospitals in Everett, Wash. In exchange for antitrust clearance, the hospitals agreed to limit increases in their case-mix-adjusted net inpatient revenues per admission to increases in the hospital component of the PPI. The specific index is the PPI for inpatient care provided by acute-care hospitals.
But don't cry for the hospitals in Everett. In 1995, that index was 3.1%. That's higher than both the overall PPI and even the CPI.
"The goal isn't to get an index that's as low as possible; it's trying to get the appropriate index," said Tina Kondo, an assistant attorney general in Washington in charge of the state's healthcare antitrust enforcement efforts.
After consulting with an economist and discussing various measures with the Everett hospitals, it was agreed that the hospital PPI was the fairest for all parties, she said.
"It leaves the hospitals some wiggle room but not too much," Kondo said.
The real test of the hospitals' true intent, Kondo said, will be what they do with their charges after the antitrust agreement expires Dec. 31, 2000.
As the seven-year Everett settlement indicates, another negotiating point in such agreements, in addition to price controls, is the length of the terms. To date, the agreements have varied from five years in Bellingham to 10 years in Harrisburg (with an option to terminate at five years) to indefinite, as in the case involving two North Carolina hospitals.
Under an antitrust settlement with the state signed late last year, the only two hospitals in Asheville, N.C., formed a merger-like partnership in exchange for a number of regulatory requirements. One stipulation requires the hospitals to limit their cost per adjusted discharge to the average such cost of comparable hospitals in North Carolina. If equivalent figures aren't available, cost increases would be limited to the medical service component of the CPI.
Although the terms of the agreement last as long as the hospitals maintain their partnership, the price limitation is fairly generous. The medical-care services component of the CPI typically exceeds the overall CPI itself.
For example, while the CPI ran at 2.5% last year, the medical-care services component of the CPI was more than 75% higher-4.4%.
Deferring to the feds. But not all state attorney general offices are as amenable as those in North Carolina, Pennsylvania and Washington.
The state of Michigan has resisted intervening in hospital merger cases. Michigan Attorney General Frank Kelley, who has just one part-time antitrust attorney on his staff, prefers to leave merger reviews to the federal government, said spokesman Chris DeWitt.
"From a practical standpoint, we do not have sufficient staff to oversee all the various mergers that may come up," DeWitt said.
If Michigan did have an active antitrust enforcement unit, "it could be a very different story" for Butterworth and Blodgett, Fochtman said.
The Grand Rapids hospitals also appealed to the state Legislature for help, but that effort went nowhere.
A coalition of four Grand Rapids hospitals, including Butterworth and Blodgett, helped draft a bill that would give the state ultimate approval power over not-for-profit hospital mergers. The bill was blocked by the chairman of the House health policy committee, John Jamian, who met with Grand Rapids business leaders and concluded that the bill could lead to a hospital monopoly in the city.
While some feel the pricing promises do not go far enough, the Grand Rapids hospitals said it's the best they can responsibly do given future uncertainties such as Medicare and Medicaid reimbursement levels.
"We felt it was a minimum price commitment. If we could do better, we would," said Bruce P. Hagen, Blodgett's executive vice president and chief operating officer.
One problem with pricing promises is that they are based on trust, not legal contracts, and that factor played a large role in the Grand Rapids case.
Scott Vander Linde, an economics professor at Calvin College in Grand Rapids, has observed that senior executives of large businesses who are board members of Blodgett and Butterworth tend to support the merger, while middle managers and heads of small business are wary.
"It becomes a question of perspective as to how long an operation based on trust would actually serve the community," Vander Linde said.
The hospitals argue that after the seven-year pricing commitment expires, they will continue to price responsibly because their board members, who are community leaders, will act in the best interest of the local citizenry.
Expect that theme of trust to emerge in court this spring.
Grand Rapids attorney Fochtman said McKeague, the federal judge who will hear the case, has met many of the hospitals' board members over the years.
That could bode well for the hospitals. The federal judge who recently threw out the government's antitrust lawsuit against the two Dubuque hospitals is a Dubuque native who was born at one of the hospitals and spent his entire legal career in Iowa.