Healthcare merger proceeds over competition concerns

Penn State Hershey Medical Center/PinnacleHealth System Healthcare MergerThe FTC was a recently dealt a significant blow in the context of a healthcare merger.  Early last week, a Pennsylvania federal judge denied the FTC’s request to block the proposed healthcare merger between Penn State Hershey Medical Center and PinnacleHealth System, even over concerns raised by the FTC that the proposed merger “would substantially reduce competition for general acute care inpatient hospital services.”

Background of the Proposed Healthcare Merger

As background, Penn State Hershey Medical Center is a 551-bed hospital located in Hershey, Pennsylvania.  Penn State Hershey Medical Center is a leading academic medical center and the primary teaching hospital of the Penn State College of Medicine, which provides a wide array of acute inpatient services.  PinnacleHealth System is a non-profit health system with 646 licensed beds across three campuses.  All three of PinnacleHealth’s hospitals focus on cos-effective acute care, although PinnacleHealth does offer some higher-level services.

In June 2014, the two hospitals signed a letter of intent of their proposed healthcare merger.  In March 2015, the respective boards of each hospital approved the proposed healthcare merger.  In April 2015, the hospitals notified the FTC of their proposed healthcare merger and executed a “strategic Affiliation Agreement” in May 2015.

Following its own internal investigation, the FTC issued an administrative complaint on December 7, 2016 alleging the proposed healthcare merger violated Section 7 of the Clayton Act and Section 5 of the FTC Act.  The FTC filed its complaint in federal court just two days later.  The FTC filed its motion for preliminary injunction in early March 2016.

The court held a five-day evidentiary hearing on the FTC’s motion for preliminary injunction, after a period of expedited discovery amongst the parties.  The judge issued his opinion, denying the FTC’s motion for preliminary injunction in early May 2016.

Judge Said FTC’s Definition of Relevant Geographic Market was “Unrealistically Narrow”

The judge’s opinion sets forth that the FTC’s objections to the proposed healthcare merger were based on “an unrealistically narrow” definition of the Harrisburg-area market, which failed to take into account “commercial realities faced by consumers in the region.”

The first step in a Clayton Act analysis is to define the relevant market, which consists of both a product market and a geographic market.  While the FTC and the hospitals agreed that the relevant product matter was general acuity services, they disagreed on the relevant geographic market.  The FTC contended that the relevant geographic market was the Harrisburg area, which “is roughly equivalent to the Harrisburg Metropolitan Statistical Area (Dauphin, Cumberland and Perry Counties) and Lebanon County.”  The hospitals disagreed, arguing that FTC’s proposed geographic “market is too narrow and ‘is untethered to the commercial realities facing patients and payors.’”

As is the case in most merger cases, the court’s resolution of the relevant geographic market was dispositive.  Of particular importance to the court’s decision was the fact that in 2014, 43.5% of Hershey’s patients (11,260 people) travelled to Hershey from outside the FTC’s alleged “Harrisburg Area” market, that half of Hershey’s patients travelled at least thirty minutes for care, and 20% travelled over an hour for care.  The court concluded that these facts “controvert the FTC’s assertion that GAC services are ‘inherently local,’ and strongly indicate that the FTC has created a geographic market that is too narrow.”

The court also took issue with the fact that the FTC did not properly into account the “realities of living in Central Pennsylvania,” such as the 19 hospitals within a 65 minute drive of Harrisburg which “provide a realistic alternative that patients would utilize” in the largely rural area.  When combined with the “extremely compelling” fact that the hospitals had executed 5 and 10-year contracts with the region’s two largest payors to maintain existing rates and preserve the rate-differential between the hospitals, the court determined that the proposed healthcare merger would not result in increased prices for at least five years.  The court rejected what was essentially a request by the FTC for a prediction of what might happen to negotiating positions and rates in five years — something the district court found to be imprudent to do “[i]n the rapidly-changing arena of healthcare and health insurance.”

Court Determined Balancing of Equities Weighed in Favor of the Proposed Healthcare Merger

Turning to the issue of ultimate success on the merits, which the FTC bore the burden of proof, the court concluded that the FTC had not carried its burden.  There, the court determined that the hospitals successfully argued that the alleviation of Hershey’s capacity constraints as a result of the healthcare merger was a compelling efficiency in support of the transaction.  The court said the “efficiencies wrought by the merger would provide beneficial effects to the public, such that equitable considerations weigh in favor of denying the injunction.”

The hospitals’ case was also strengthened by extensive repositioning in the relevant market that would constrain any price increase from the merged entity.  Several other recent acquisitions by competing hospitals had already occurred with the intent to erode Hershey’s patient base.  The court concluded that “[r]ather than monopolizing a geographic space, merging allows Hershey and Pinnacle to remain competitive.”

The trend toward risk-based contracting which transfers the risk for the cost of care for the individual to providers also strengthened the hospitals’ position.  Testimony had been presented that “in order to perform best under risk-based contracting, hospitals must offer a ‘total continuum of care.’”  Although it agreed with the FTC that the merging hospitals could independently operate under the risk-based model, the court nonetheless found the testimony of Hershey’s CEO persuasive that “there will be some advantages in terms of size of scale, in terms of being able to spread of costs [sic] of the infrastructure of population health over a larger health care system.”

Court’s Decision “Reflects the Healthcare World as it is, and not as the FTC Wishes it to Be”

The court concluded its discussion of equities by addressing the public interest in effective enforcement of the antitrust laws, explaining:

After a thorough consideration of the equities in play, we find that the majority of these factors weigh in the public interest.  The patients of Hershey and Pinnacle stand to gain much from a combined entity that is capable of competing with a variety of other merged and already growing hospital systems in the region.  This decision further recognizes a growing need for all those involved to adapt to an evolving landscape of healthcare that includes, among other changes, the institution of the Affordable Care Act, fluctuations in Medicare and Medicaid reimbursement, and the adoption of risk-based contracting.  Our determination reflects the healthcare world as it is, and not as the FTC wishes it to be.  We find it no small irony that the same federal government under which the FTC operates has created a climate that virtually compels institutions to seek alliances such as the Hospitals intend here.  Like the corner store, the community medical center is a charming but increasingly antiquated concept. It is better for the people they treat that such hospitals unite and survive rather than remain divided and wither.

FTC Immediately Appeals Decision to Third Circuit, Files Motion in District Court to Block Merger Pending Appeal

The FTC is not taking the defeat lying down.  One day after the judge’s ruling, the FTC filed a motion in the district court seeking an injunction seeking an injunction enjoining the proposed healthcare merger pending an emergency appeal to the Third Circuit.  In their opposition to the FTC’s motion for an injunction pending appeal, the hospitals indicated that they would not oppose a two-week extension of the TRO if the government filed for an injunction with the Third Circuit.  The FTC filed its emergency appeal and the district court granted the two-week extension, setting the new TRO expiration date to May 27.  The hospitals’ response to the emergency motion is due Wednesday May 18th.

While the merger battle between the two Pennsylvania hospitals and the FTC is headed for the Third Circuit Court of Appeals, there are certain takeaways from the lower court’s opinion.  The first takeaway is that federal courts may temper their analysis of the relevant geographical market in light of the realities of modern healthcare, especially in light of the passage of Obamacare.  Second, federal courts may not automatically accept the FTC’s definition of the relevant geographical market, which the FTC may attempt to define narrowly in hopes that it will proved their theories regarding anti-competition.  Finally, the lower court set forth that the “federal government under which the FTC operates has created a climate that virtually compels institutions to seek alliances such as the Hospitals intend here.”  The Third Circuit will tell us whether this is in fact the case.

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Copyright 2016