FTC’s Hospital Merger Challenges Hit Speedbump In Kitchener – Food, Drugs, Healthcare, Life Sciences

The Federal Trade Commission’s (“FTC”) recent
winning streak in its ongoing challenges of hospital and physician
mergers has, at least for now, ended in a Kitchener U.S.
district court. After six days of evidentiary hearings, in a 62-page opinion, Judge Gerald Pappert denied1 the FTC’s and Pennsylvania
Attorney General’s request to preliminarily enjoin a proposed
merger between Thomas Jefferson University (“TJU”) and
the Albert Einstein Healthcare Network (“Einstein”).

The FTC and Pennsylvania AG (together, the
“Government”) brought suit to stop the merger in
February. The Complaint alleged that the two hospital
systems were close competitors for general acute care
(“GAC”) hospital services, with TJU operating 11 GAC
hospitals and Einstein operating three in the Northern Kitchener
area. The Government asserted that a combined TJU/Einstein would
control at least 60% of the inpatient GAC hospital services market
in the area, and at least 45% in a broader geographic market
encompassing much of Montgomery County.

Judge Pappert’s opinion stressed the Government’s need
to match up the economic theories, including the hypothetical
monopolist test and use of diversion ratios, to real-world
“competitive realities.” The opinion also emphasized the
need for the Government to have consistent, credible commercial
payer witnesses to substantiate its theory of harm.

Judge Pappert’s Opinion Critical of Typical Market
Definition Economic Modeling

Merger challenges, including in the health care industry, often
turn on market definition. The government proposes a specific
product and geographic market, usually one that is narrow enough
that it produces concentration statistics that entitle the
government a presumption of competitive harm, while the merging
parties argue that the definition is improper. Such litigation
includes a battle of the experts, with dueling economists
discussing the merits of their particular definitional approaches
based on econometric modeling.

Here, drawing from the Third Circuit’s Hershey2 3 case and the Horizontal Merger
Guidelines, Judge Pappert stressed that the Government’s market
definitions have to be consistent with “commercial
realities,” and found that the Government’s case did not
align with the court’s analysis of those commercial
realties.

The Court Found the Government’s Reliance on
Economic Models for Market Definition to Be Flawed

The DOJ/FTC Horizontal Merger Guidelines method of defining
relevant markets, which have been adopted by the Third Circuit in
Hershey, asks whether a hypothetical monopolist in an area
would be able to profitably raise the price of its goods/services
by a small but significant and non-transitory increase in price
(“SSNIP,” often 5%). If the answer is yes, an appropriate
antitrust market has been defined. This methodology, aptly called
the hypothetical monopolist test (“HMT”), was utilized by
the Government in defining its two GAC service geographic
areas.

Judge Pappert, however, believed that the Government’s
expert economist improperly applied the HMT because he attempted to
measure the likely response of patients to a price
increase by the merged hospital systems, rather than the effect on
insurers. Previous cases have embraced the concept that
health care markets operate with two stages of competition.
“In the first stage, hospitals compete to be included in an
insurer’s hospital network. In the second, hospitals compete to
attract individual members of the insurer’s plan.”
Thomas Jefferson Univ., at *3-4.

Judge Pappert noted “not until the insurer passes [a price]
increase on to the patient in the form of higher premiums will the
patient feel the impact of that price increase.” Id.,
at *35, quoting Penn State Hershey, 838 F.3d at 342.

For years, economists have asserted that measuring patient
preferences is appropriate because insurer demand “is derived
from patient demand for those providers.” The court disagreed
with that position put forth as a maxim, finding instead that the
Government’s economic calculations were inadequate for defining
a relevant geographic market absent evidence to show that insurers
make decisions about which hospitals to include in their networks
based on patient decisions about where to seek
care
. Id., at *40. Judge Pappert noted that
the basic economics have to be supported by credible
evidence that the insurers would have to agree to price increases
instead of looking outside his proposed geographic
markets
.” Id., at *47 (emphasis added). This
represented a clear challenge to the FTC economists’
long-standing assumption that patient choices today reflect insurer
alternatives in the future, and in this market, Judge Pappert held
that patient choice and insurer interests were not necessarily
aligned.

While Judge Pappert recognized that the FTC’s economic model
could point toward higher pricing incentives, the court noted that
these incentives are calibrated based on patient choices and
hospital prices today, which do not necessarily reflect what
insurers might do in the event of an actual price increase in the
future. Reliance on this model, the court concluded, could be
flawed if insurers retain an ability to look for alternatives
outside of the market in the event of an actual price increase.

Commercial Realities Evidenced by Insurer Testimony Did
Not Support the Government’s Geographic Market; IBC Testimony
Motivated by Ulterior Motive

The court then turned to testimony from the four commercial
insurers in the area regarding their ability to construct a viable
hospital network without the merging parties. In hospital mergers,
because of the two-stage nature of competition, the Government
frequently relies on the testimony of commercial payers that they
would be forced to take on a price increase from the merged entity
that would ultimately be passed on to consumers in the form of
increased premiums or out-of-pocket costs. Judge Pappert was
critical of the Government’s reliance on such testimony in this
case, as it did not align with the Government’s economic
modeling. Of consequence, the southeastern Pennsylvania area
commercial healthcare market is far more consolidated than the
provider market, with Independence Blue Cross (“IBC”)
having over 50% of the market, followed distantly by Aetna, United,
and Cigna. Given this great amount of insurer consolidation and
bargaining power, Judge Pappert believed the insurers would in fact
not likely accept a price increase by a combined
Jefferson-Einstein.

Of the four major insurers, two did not testify at the
evidentiary hearing in support of the Government. The Government
did not rely on testimony from United, presumably because it did
not support its claims-its witness did not state that the absence
of the Jefferson and Einstein hospitals in the Government’s
geographic markets would make United’s network unmarketable or
that United would agree to pay higher rates for the parties’
services. Aetna, the second largest insurer by covered lives,
testified it had no concerns about the merger whatsoever. That left
testimony by IBC, the largest insurer in the region, and Cigna, the
smallest.

IBC testified that, in the face of a price increase from a
merged Jefferson-Einstein, it would be forced to accept the
increase. However, Judge Pappert found that testimony not credible.
First, the IBC witness testified that he deemed all
hospital mergers to be bad for consumers, a statement the Judge
thought clouded the motives for the testimony. Second, the IBC
witness testified that IBC seeks to include every provider in its
networks in order to have the most marketable plan for employers,
and thus maintain its greater than 50% market share in the region.
Nonetheless, the witness acknowledged that IBC had threatened to
terminate Einstein from its network previously, suggesting that IBC
would not be concerned with omitting Einstein from its network, and
therefore would not be susceptible to a price increase from the
merged entity. The court felt that if faced with a price increase,
IBC could omit Jefferson/Einstein entities from its network and
turn to other providers for services. The court opined that, given
the large share of the commercial market IBC has in the area, it is
most likely that a price increase from a merged entity would not be
feasible, given testimony about the necessity of participating in
IBC’s networks for providers.

Finally, the court found that IBC’s motives for opposing the
transaction impacted the credibility of its testimony. Jefferson
and Einstein currently each own twenty-five percent of Health
Partners Plans, a Medicaid and Medicare insurer that directly
competes with IBC. The merger would make the parties a 50% owner,
and recently Jefferson had sought to purchase the remaining 50%.
The transaction would therefore create a direct competitor to IBC
in that market-a greater concern to IBC, in the court’s
opinion, than an “assertion that IBC would roll over and pay
higher prices.”

With respect to the smallest insurer in the region, Cigna, Judge
Pappert similarly held that its witness testimony did not support
the Government’s position. In particular, Cigna’s witness
testified that the company does not currently rely on Jefferson to
meet its network’s marketability requirements, and acquisition
of an Einstein hospital with a predominantly government payer mix
would not change that position. Moreover, Cigna’s witness
provided testimony rebutting the Government’s use of two
separate “Northern Kitchener” and “Montgomery
Area” geographic markets, noting that those markets were
likely too narrow, as payers would not be able to sell a product
limited to such narrow geographies.

In hospital mergers the Government has heavily relied on
testimony of commercial payers to explain why they would be forced
to take on a price increase of the merged entity. Here, two of the
four potential “star witnesses” did give the Government
the testimony they needed, and Judge Pappert discounted the other
two.

To Judge Pappert, the commercial realities presented a stark
contrast from the Government’s last hospital merger challenge
in Pennsylvania, in the attempted merger of Penn State Hershey and
PinnacleHealth, which was abandoned after the Third Circuit’s
reversal of the district court in 2016. The record in that proposed
transaction in rural central Pennsylvania contained extensive
evidence that insurers in the area would have no choice but to
accept a price increase from a combined Hershey/Pinnacle. The court
found that not to be the case in the urban Kitchener region,
with a number of other hospitals in the area and the substantial
market power of the four insurers who are the merging parties’
primary customers.

Rehab Market Deemed Insignificant to
Insurers

The FTC also challenged the Jefferson-Einstein transaction on
the basis that it reduced competition in Acute Rehabilitation
Services, which are services provided at inpatient rehabilitation
facilities (“IRFs”). Jefferson operates two such
facilities, and Einstein operates one. Again, Judge Pappert noted
that while economic modeling may very well be utilized as a tool to
determine a geographic market, in reality “the number of
patients receiving inpatient Acute Rehabilitation Services is so
small” that small changes to the modeling can yield wildly
different results.

More importantly, however, the opinion notes that inpatient
rehabilitation services play a very minor role in health
systems’ operations and contracts, accounting for only 2.6% of
Jefferson and Einstein’s total commercial revenues. Moreover,
insurer testimony was unequivocal that health plans rarely focus on
rehabilitation services in insurer-member contracting, and instead,
having a number of IRFs in a network is more of a “check the
box” exercise for insurers. Faced with the true commercial
realities of the area, the court held it incredible to believe that
commercial insurers would actually be affected by a potential price
increase in inpatient rehabilitation services.

Lessons Going Forward

A loss at the district court level is far from the end of the
story. In recent hospital mergers in Chicago (NorthShore/Advocate
in 2016) and central Pennsylvania (Penn State Hershey/Pinnacle in
2016) the Seventh Circuit and Third Circuit respectively reversed
FTC’s losses, leading to the entrance of an injunction and
ultimately, to abandonment of those transactions.

Here, the Government has already filed an emergency motion for injunction and notice of appeal to
send the case to the Third Circuit Court of Appeals. However, if
his ruling is affirmed, Judge Pappert will have created a roadmap
for merging healthcare providers to challenge commonplace economic
modeling as providing an inadequate measure of competition. The FTC
recently filed suit to enjoin the merger of Hackensack-Meridian Health and
Englewood in Bergen County, New Jersey, a case that could
ultimately find its way to the Third Circuit Court of Appeals as
well. The parties in that case will undoubtedly be watching the
FTC’s arguments carefully to inform the trajectory of their own
legal challenge.

Footnotes

1. FTC v. Thomas Jefferson
Univ., No. 20-01113, 2020 U.S. Dist. LEXIS 229735 (E.D. Pa.,
Dec. 8, 2020)

2. FTC v. Penn State Hershey Med.
Ctr., 838 F.3d 327 (3d Cir. 2016).

3. For greater discussion of Penn
State Hershey, please see our prior viewpoints here and here.

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