Boston’s concentrated market keeps state regulators busy with merger scrutiny

Conditions placed on the merger that formed the Boston area’s second-largest health system—Beth Israel Lahey Health—are the latest in a series of strict state oversight actions that will shape large regional health system deals for years to come.

State attorneys general have placed stringent conditions on recent transactions that significantly consolidated healthcare services to try to level the competitive playing field. Pricing, access and quality guardrails imposed by state authorities, coupled with state legislation, are expected to ratchet up regulation of these regional tie-ups.

“As the healthcare industry matures and hospital companies continue to get larger and become more important components of their communities, the attention from attorneys general and state authorities has continued to increase,” said Jordan Shields, partner at Juniper Advisory. “These enforcement actions build on themselves.”

The Boston area is anchored by academic health systems. Both complicated cases and less-acute care tend to be referred to these institutions, which carry higher fixed costs related to their research, teaching and expertise.

Spending per patient at the state’s most cost-efficient system is around a third lower than at the largest system—Mass General Brigham, formerly Partners HealthCare—analysis from the Massachusetts Health Policy Commission has shown. Mass General did not reply to requests for comment.

In proposing the creation of Beth Israel Lahey Health, system leaders argued that it needed to combine to check Mass General’s power.  It got the green light, but with some significant conditions including a seven-year cap on price growth.

“I wonder if the Beth Israel Lahey merger is suffering collateral damage from the state’s regret over letting Partners get so big,” said Joe Lupica, chairman of Newpoint Healthcare Advisors.

While more states are expected to borrow from Massachusetts Attorney General Maura Healey’s regulatory playbook, regulators must strike a balance between encouraging competition and allowing systems to bolster smaller hospitals and preserve access, M&A attorneys said.

“We have had several things happen over the past nine months—a pandemic, a change in administration, the threat of overturning the Affordable Care Act, the advent of technology like telehealth to expand service areas,” said Neil Olderman, a partner at Faegre Drinker Biddle & Reath. “You may have attorneys general look at what Massachusetts did as a starting point or blueprint, but the countervailing force is that there is a public policy need that will tailor an overly aggressive activist stance from authorities.”

The Federal Trade Commission opted, by a narrow margin, not to challenge the Beth Israel Deaconess Medical Center-Lahey Health deal after the Massachusetts attorney general reached a settlement with the merging parties. The new system launched in the spring of 2019.

One of the conditions outlined in the AG’s settlement was a 3% cap on aggregate price increases for services charged to commercial payers. Healey said that will prevent more than $1 billion of the potential cost increases over the cap’s seven-year span as projected by the Health Policy Commission. 

Regulators also required Beth Israel Lahey to coordinate services with its safety-net hospital affiliates—Lawrence General Hospital, Cambridge Health Alliance and Signature Healthcare Brockton Hospital—and boost access to mental health and substance use disorder treatment across the system. Beth Israel Lahey must continue to financially support its safety-net affiliates and community health centers, increase access in underserved communities, maintain historical service levels, and not limit the number of patients it serves from MassHealth—a combination of the state’s Medicaid and Children’s Health Insurance Program beneficiaries—among other conditions.

The resolution requires 10 years of third-party oversight to ensure compliance. Notably, there are certain triggers like significant swings in inflation that could spur a renegotiation.

“Something like this deal represents a reassertion of authority in the antitrust space,” said Mark Ustin, a regulatory lawyer and partner at Farrell Fritz, adding that the recent focus on value-based care has caused antitrust authorities to take a bit of a backseat. “This settlement supports other policy goals that other AGs may look to see if they can replicate in their states.”

The third-party monitor found that Beth Israel Lahey complied with all applicable stipulations in its first year as a combined system, according to its January report. “The initial reports seem to indicate they are in compliance with the terms they committed to,” said Alexis Gilman, an antitrust lawyer at Crowell & Moring. “But one of the concerns the FTC has with these settlements is what happens after these terms expire and you are left with a merged system that is in the position to extract higher rates.”

Beth Israel Lahey outlined a range of financial efficiencies afforded by the merger, according to its 2019 annual report. Although, it adjusted its annual target range of savings to $59.8 million to $86.4 million by year five of operations, down from the originally projected $88 million to $169 million, noting that it is too soon to estimate the realized savings thus far as it is just starting to roll out clinical integration initiatives.

The system’s second annual report has been delayed until May due to COVID-19, but Beth Israel Lahey did not say whether it would ask for any other flexibility. A spokesperson said Beth Israel Lahey continues “to adhere to the conditions set in the Assurance of Discontinuance and (is) working collaboratively with the attorney general’s office, which recognized the need for a delay of the reporting deadline given the extraordinary disruptions in patient care and hospital operations caused by the pandemic.”

The biggest savings are expected to come from supply chain synergies. But economists have found that supply chain savings stemming from consolidation often fall short of initial targets.

“The Beth Israel Lahey settlement agreement with the attorney general is costly and ties the system’s hands for several years,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business. “There is a big risk to give up flexibility to deal with changing conditions, whether the changes are a pandemic that closes your positive cash flow service lines or are regulatory or payment changes.”

Like many U.S. markets, Boston is losing independent hospitals. Of the roughly 40 acute-care hospitals in the Boston-Cambridge-Newton, Mass., and New Hampshire service area, nearly half were not affiliated with a system in 2014. That share dropped to 25.6% as of 2019, according to Modern Healthcare’s analysis of Medicare cost reports.

Nationally there were about 100 hospital transactions in each of the past five years, many involving smaller community hospitals, Gilman said. “They are really struggling financially as care moves from inpatient to outpatient, as government reimbursement rates get pushed down, as small community hospitals negotiate with large insurers and as pressure mounts to keep up with new technology, value-based care and population health,” he said. “So they are looking to partner with larger hospitals to find efficiencies—layer on COVID and the associated decline in elective procedures and ER visits, (and) they are looking to partner just to keep the doors open.”

The Massachusetts Health Policy Commission outlined the degree by which the state relies on academic medical centers. More lower-acuity care has been referred to lower-cost settings recently, per the commission’s suggestion, albeit slowly. Beth Israel Lahey said that it has launched a virtual transfer center, unified management of neonatal programs and streamlined referrals across its Continuing Care network, among other initiatives that will continue to direct appropriate care to the lowest-cost settings. Meanwhile, there was no material elimination of clinical services, according to the report.

Consolidation has saved some hospitals and led to the closure of others, Gordon said. “The hospitals that have closed often were beloved to the local population but financially unsustainable for many years,” he said. “The fact that the hospitals were not financially viable doesn’t quell protests or political intervention.”

The conditions placed on the Beth Israel-Lahey transaction are one of several recent state regulatory and legislative actions that are poised to bolster enforcement efforts. 

Similar scenarios have played out in North Carolina, Pennsylvania, Tennessee, Texas, Virginia and other states. 

“Over the last four or five years we have seen a bit of an uptick in these settlements and certificate of public advantage approvals,” Gilman said. “State AGs are going to ensure that hospitals stay in the market and that competition remains robust. They’ll continue to closely monitor their markets and take action when necessary.” 

While she was California attorney general, Kamala Harris placed conditions on a 2015 merger between Daughters of Charity Health System and what is now Verity Health System, which is going through Chapter 11 bankruptcy restructuring. Harris mandated that the hospitals offer emergency and acute-care services for at least five years, maintain similar levels of care to Medicaid beneficiaries, not restrict care to the LGBTQ community and keep almost all staff.

California lawmakers recently proposed a bill, which is currently in committee, that would require the attorney general to sign off on any healthcare provider transaction exceeding $1 million. The legislation would give California Attorney General Xavier Becerra—who has been a strong advocate for limiting large systems’ monopoly power and was selected to lead HHS under President-elect Joe Biden—an “unprecedented expansion of authority,” experts said.

Under current California law, the standard of review is an easier bar to clear, said Paul Pitts, partner at the law firm Reed Smith. The attorney general typically only reviews transactions where not-for-profit entities sell “a material amount of assets,” like when they are sold to for-profit companies. “These standards are highly subjective and insert a great deal of uncertainty into a transaction,” he said in August. “Healthcare systems and private equity will be very reluctant to spend significant time and money negotiating and preparing a deal with this much uncertainty around their ability to close the transaction.”

Virginia Mason Health System recently announced plans to merge with a Washington state division of CommonSpirit Health; Washington’s attorney general has challenged physician group acquisitions by Catholic Health Initiatives, now part of CommonSpirit. Washington state has a bill similar to California’s that requires attorney general notification for deals between a Washington entity and an out-of-state entity, where the out-of-state entity generates $10 million or more in services for Washington residents. 

“We will continue to see careful and thorough AG reviews,” Juniper’s Shields said.