Better vs. Cheaper? – Court Says Cost Trumps Quality in Health Care – Orders Undoing of Physician Group Tie-up

by Proskauer Rose LLP

The health care industry is in the midst of a revolution caused by demographic changes, advancements in medical understanding and, of course, Obamacare. As health care providers scramble to adjust to this brave new world, the potential benefits of consolidation are never far from their minds. Last month, however, the District Court of Idaho sent a strong signal that those contemplating such a move must proceed with caution. Parties no longer may rely solely on claims of improved patient care and greater efficiency to justify consolidation; they also must show that the transaction will not adversely impact competition. The case is particularly notable because it did not involve a hospital merger; it was simply an attempt by a regional health system to expand its network by acquiring an independent physician group in a locale it was underserving.

The story begins in 2012 when St. Luke's Health System acquired the Saltzer Medical Group for $16 million. While St. Luke's is a relatively large system and does business throughout Idaho, in the critical market alleged – Nampa City – St. Luke's was but a pinprick. It has no hospital in the city, and employed only nine primary care physicians to serve its Nampa City emergency outpatient clinic. Saltzer, by contrast, was a large physician group operating throughout the region, offering both primary care and specialty services. It had 16 primary care physicians serving Nampa, Idaho. After the transaction was consummated – it was too small to trigger pre-closing regulatory approval – the FTC opened an investigation and ultimately challenged it.

In ordering divestiture, the District Court acknowledged the pro-competitive benefits of the transaction. "The Acquisition," the court said, "was intended by St. Luke's and Saltzer primarily to improve patient outcomes." The court was "convinced" that the acquisition "would have that effect." Still, that was not enough to save the transaction.

The District Court apparently was moved by St. Luke's high market share – over 80% of primary care physicians – in Nampa City. But the court's methodology for defining the market – and therefore the associated market shares – leads to an incredibly narrow market. Nampa City is part of the Boise-Nampa Metropolitan Area. There are at least three relatively large cities in that region, including the largest, Boise, located 20 miles away, and Meridian, located just 14 miles away.

If this were a hospital-to-hospital merger, the proximity of these competing facilities likely would have been sufficient to include them in the same market. Not so here, where the focus of the analysis was the consolidation among primary care physicians. In excluding Boise physicians from the market, the District Court noted that health plans needed to "offer a network" of primary care services close to where their enrollees lived. It further noted that 68% of Nampa residents get their primary care in Nampa, and only 15% travel to Boise, which likely reflects patients who are "getting their physician services near where they work." Because Boise would be inconvenient for patients who live and work in Nampa, Boise doctors were not, the court concluded, good substitutes.

The logic for excluding Boise may make some sense. But there are also many primary care physicians located just beyond Nampa city limits in the remaining parts of Canyon County, where Nampa is located (Boise and Meridian are in adjacent counties). The court offered no reason or analysis for excluding the remaining parts of Canyon County. Nor did it explain why physicians living in Canyon County would be unwilling to open offices in Nampa City if the existing Nampa physicians tried to exert undue pricing leverage over health plans.

In any event, having defined the market so narrowly, the outcome of the case was written on the wall. From a pure market share perspective, St. Luke's and Saltzer would have a combined market share of 80% of primary care services in Nampa City. (The market share plummeted if all of Canyon County were included). Following the FTC's merger guidelines, the court held that the market was "highly concentrated" and therefore "presumptively anticompetitive."

Under the FTC's guidelines, high concentration is problematic because it limits options health plans have when contracting with physicians. Were that the story the FTC presented, and the court found, the argument would make sense. But the court went in a different direction.

The court found that the affiliation with St. Luke's would enable Saltzer to obtain higher reimbursement rates – not because of the elimination of competition between St. Luke's primary care physicians and Saltzer's primary care physicians – but because it is a large health system, with hospitals in other parts of Idaho (notably, not Nampa), and could therefore pressure health plans to increase reimbursement rates. Put simply, it reflects the "big is bad" mentality that the U.S. Supreme Court has eschewed in antitrust jurisprudence since the 1980s.

The court did, of course, rely on market share figures in a variety of forms to conclude that St. Luke's and Saltzer were not just competitors, but each other's closest competitor in negotiating physician contracts with health plans. But the court did not cite documentary evidence, or even testimony, showing that any health plan had considered forgoing contracting with one in favor of the other based on price or other considerations. The court simply said that, because Saltzer had so many physicians, if a health plan chose not to contract with St. Luke's, many patients would end up at Saltzer. And if a health plan chose not to contract with Saltzer, about a third would be diverted to St. Luke's. But such "diversion ratios," as they are called, are really nothing more than market share statistics presented under a different rubric. They do not establish that St. Luke's small presence in Nampa actually exerted a competitive constraint on Saltzer, or vice versa.

Perhaps recognizing this, the court sought to go beyond market shares. But this is where its logic broke down. It cited documents suggesting that the acquisition would result in higher prices. But the driving force behind those predictions was not the elimination of competition between St. Luke's nine physicians and the Saltzer medical group. The driving force was, as reflected in the documents and testimony, the negotiating power that St. Luke's as a large health system in Idaho would obtain. Saltzer's documents, for example, noted that there would be an opportunity to negotiate higher reimbursement rates because of the "clout of the entire [St. Luke's] network." The largest payor, Blue Cross, agreed, stating that St. Luke's is already "the dominant provider in a number of markets, and the transaction extends their reach to the Nampa market." For example, one of the ways in which Saltzer might obtain higher reimbursement rates post-acquisition would be for physicians to use higher "hospital-based rates" for in-office services since Saltzer would be affiliated with a hospital. But this reflects the fact it would be part of a network of hospitals – it has nothing to do with the alleged elimination of competition with St. Luke's eight employed Nampa City physicians.

In any event, having found that being part of a network could lead to higher prices, the court concluded that the FTC had made a prima facie case. The burden then switched to St. Luke's to justify its acquisition. It first argued that, if it tried to raise prices above competitive levels, health plans could then contract with other primary care physicians, some of whom might relocate. The court rejected this. But having defined the market so narrowly – as confined to the city limits of Nampa – the court (somewhat inconsistently) never addressed whether Canyon County physicians – who live and work nearby – could be persuaded to open a new office in Nampa City proper. All the court did say was that it would be "difficult to recruit family doctors to Canyon County" from afar. But this would seem irrelevant, as the court did not find that St. Luke's had a dominant share of Canyon County, versus Nampa city.

The court also found persuasive that a competing hospital, St. Alphonsus, was not able to recruit any primary care physicians in the last two years. But, factually, there was no finding that it had tried. And legally, the relevant question is whether entry would occur in the face of higher reimbursements, and hence salaries. Looking at past entry in a competitive market may have a bearing on that question, but it is hardly dispositive.

Finally, the court rejected St. Luke's various efficiency defenses. The acquisition, the court noted, was designed to facilitate a paradigm shift in the way care is provided – from a fee-for-service basis to a "value based" system. The primary difference between the two modes is that in a fee-for-service system, physicians are paid for whatever work they do, even if it is unnecessary. In a value based system, also called capitation, health care providers are paid on a per patient basis, and have an incentive to provide only services that improve patient care. While the court noted the salutary benefits of capitation, it felt that there were ways short of acquisition to accomplish these goals. As such, the court held that the desire to improve care and efficiency could not overcome the potential for anticompetitive effects.

Ultimately, St. Luke's is instructive for a number of reasons.

  • It reaffirms, once again, that in health care markets, the FTC will not by shy in investigating and challenging small transactions – ones that are too small to require pre-closing notification under the Hart-Scott-Rodino Act.

  • It shows that the FTC, and the courts, will scrutinize carefully not just hospital mergers, but health systems' acquisitions of physician groups as well.

  • It suggests that geographic market definition – often a critical, if not dispositive issue – may be different, and narrower, for physician group acquisitions than for hospital mergers.

  • It reaffirms the persuasive power of documents that suggest price increases resulting from the acquisition.

  • It shows that courts may be concerned about the power of large health systems expanding into underserved territories, and the clout that the entire network may have.

  • It shows that even relatively small overlaps between an existing health system seeking to expand its network into new areas and dominant existing providers could spark challenge.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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