The proposed tie-up between Dallas-based Baylor Scott & White Health and Houston-based Memorial Hermann Health System poses an increasingly important antitrust question given the prevalence of cross-market hospital mergers, regulatory experts said.
The combination of the biggest systems in Texas would produce a 68-hospital organization with two health plans, about 73,000 employees and nearly $15 billion in annual revenue. It would be the seventh-largest not-for-profit system by revenue nationally based on 2017 data in Modern Healthcare's financial database.
But the not-for-profit health systems are not direct competitors, which generally satisfies the current analytical framework antitrust regulators use.
Still, it raises the question: Should a cross-market merger that could theoretically create market power without reducing competition between the two parties be prohibited, asked Michael Buchanio, a principal in West Monroe Partners' healthcare practice.
One study in this relatively unexplored realm found that if the merging hospitals were in the same state but 30 to 90 minutes apart, prices increased by about 7% to 10%. There were no significant price changes resulting from mergers between hospitals in different states, according to research conducted by Northwestern, Harvard and Columbia universities. Researchers said that market power may arise from combinations over broad geographic areas due to a common customer base, often large employers looking to cover their employees in different regions, which ultimately reduces competition.
Cross-market mergers “may indeed inhibit competition” and “a merger between hospitals negotiating with the same insurer can yield an increase in the hospitals' negotiated prices even if these hospitals are not substitutes,” the researchers said.
“Due to significant consolidation in the healthcare market along with price increases that tend to accompany that consolidation, the Federal Trade Commission has acknowledged the common customer effect and the need to investigate non-overlapping geographical mergers,” Buchanio said. “However, more research and analysis is needed before a cross-market-effects case can be argued in the federal courts within the antitrust enforcement framework.”
Expect regulators to delve deeper into cross-market mergers and take a retrospective look at completed deals similar to the FTC's complaint against Evanston (Ill.) Northwestern Healthcare Corp. when it acquired Highland Park (Ill.) Hospital in 2000, Buchanio added.
The FTC in 2004 alleged that the deal led to price-fixing, thus stunting competition. Rather than force divestiture, which an administrative law judge recommended, regulators ordered Evanston, now known as NorthShore University HealthSystem, to set up two independent contract negotiation teams to bargain with insurers.
“As long as hospitals are maintaining a healthy level of competition in the region, there should be a more open or cleaner path to regulatory approval,” said Gurpreet Singh, a partner at PricewaterhouseCoopers and its health services sector leader.
Because Baylor Scott & White and Memorial Hermann do not compete in their individual markets, they are less likely to be challenged by regulators, said Ken Marlow, chair of the healthcare department at law firm Waller Lansden Dortch & Davis.
Baylor Scott & White has 49 hospitals in central and northern Texas while Memorial Hermann has 19 hospitals in the southeastern part of the state. The merger needs approval from the state attorney general and the FTC, but because they are in contiguous regions that do not overlap, the organizations “don't anticipate that will be a huge problem,” said Deborah Cannon, board chair of Memorial Herman.
Notably, the merger between Downers Grove, Ill.-based Advocate Health Care and Milwaukee-based Aurora Health Care earned a quick approval from state and federal regulators who determined that the combination wouldn't have significant anticompetitive effects in the markets they serve. Advocate walked away from its plan to merge with NorthShore in March 2017 after a protracted antitrust review, ultimately leading it to scale up with a partner that didn't have an overlapping footprint.
“The cost of healthcare is the No. 1 issue in America, whether it's in Washington, D.C., or Austin, Texas, or in the benefits office of an employer here in Houston,” Jim Hinton, CEO of Baylor Scott & White, said during a news conference Oct. 1 after the organizations announced they signed a letter of intent. “So taking cost out of the system will be an important part of this journey as we come together.”
Hinton would be the CEO of the combined system. His office of the CEO would include Memorial Hermann CEO Chuck Stokes and Baylor Scott & White President Pete McCanna.
The board would be equally split between Baylor Scott & White and Memorial Hermann. Ross McKnight, chair of Baylor Scott & White's board, would also chair the combined system's board. A vice chair, selected by the Memorial Hermann board before the deal closes, would replace McKnight after his two-year term. The merged company would have executive and support staff based in Austin, Dallas, Houston and Temple.
The new corporate entity would operate under a new name, although Baylor Scott & White and Memorial Hermann facilities would maintain their brands in their respective local markets.
Together, the systems could expand their academic arms related to research and medical training and accelerate the implementation of new technology, Stokes said. “There is a lot of synergy and opportunity to do things in a different way. When we are independent of each other, it is harder to do that.”
While executives argue that scale will drive down costs and improve care, economists and policy experts contend more market share often leads to higher prices and consolidation does not necessarily produce better outcomes.
A recent working paper published in the National Bureau of Economic Research by academics at the University of Pennsylvania's Wharton School dampened the expectation that mergers will produce significant supply-chain savings.
Horizontal hospital mergers saved acquired hospitals $176,000, or 1.5% of supply chain spending, annually on average, representing only 10% of what is claimed in the merger justification, according to the paper that analyzed hospital supply purchase orders from 1,200 hospitals from 2009 to 2015. Those savings primarily affect neighboring systems that maximize price negotiations for high-tech physician preference items. But there is mixed evidence supporting acquirers' savings.
Baylor Scott & White and Memorial Hermann said they could not yet expand on what they would do with their two health plans, how long it would take for the merger to produce savings and how they plan to bridge the gap between different electronic health record systems.
Consolidated healthcare providers can have trouble hitting their estimated savings targets, particularly when the integration process isn't clearly defined during the negotiations. Merging IT platforms, for instance, can be extremely costly and delay return on investment.
Baylor Scott & White reported $291.9 million in operating income on operating revenue of $9.09 billion in 2017, down from $494.2 million in operating income on $8.37 billion in revenue for 2016. Its operating margin fell from 8.9% in 2015 to 5.9% in 2016 and 3.2% in 2017 as expenses outpaced revenue.
But the system's operating income of $494 million in the first nine months of fiscal 2018 was up 44.2% from the same period in 2017. It's operating margin was 6.9%, up from 5.1% in the prior-year period. Memorial Hermann posted $70.6 million in operating income on revenue of $5.06 billion in 2017, down from $225 million in operating income on revenue of $4.89 billion in the previous year.
For fiscal 2018, Memorial Hermann's unaudited operating income rose to $128.7 million on revenue of $5.26 billion. Both systems were buoyed by strong returns in the equities market. “The combination could lead to improved margins for Memorial Hermann and eventually cash flow to the combined entity,” Marlow said.
Texas is one of the fastest-growing markets in the country, although a declining oil and gas market has dampened the area's economy. About 17% of Texans are uninsured.
“It's a game of scale,” said Joe Lupica, chairman of Newpoint Healthcare Advisors. “There is a lot of personality involved in integration. The key is can they make decisions with logic that is not infused with emotion or tribalism.”
The big question is what the definition of “a market” is, Lupica said. “Would a statewide system create the kind of leverage with payers that might run afoul of antitrust laws?” he asked.
Executives noted that the two systems have about 5,000 job openings combined, although they did not specify whether the merger would lead to layoffs. Memorial Hermann laid off nearly 500 employees last year to become more “cost-efficient in an uncertain healthcare environment,” executives said.
They expect to sign a definitive agreement in early 2019 and complete the merger midyear. “This proliferation of regional mega-systems will only increase in frequency, despite the continued scrutiny of regulatory authorities,” Marlow said.