District Court Denies Preliminary Injunction in FTC Challenge to Merger of Pennsylvania Hospitals

by Locke Lord LLP
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On May 9, 2016, Federal District Court Judge John E. Jones III denied a motion by the U.S. Federal Trade Commission (FTC) for a preliminary injunction blocking the consummation of a merger between the Penn State Medical Center and the PinnacleHealth System pending an administrative trial at the FTC, citing the FTC’s allegation of a relevant geographic market that was “unrealistically narrow.”

The case is notable for several reasons. First, this was the first loss for the Commission in a challenged hospital merger case in many years. Second, the District Court appears to have relied upon the now- discredited Elzinga Hogarty (EH) test for relevant geographic markets. Third, the District Court misconstrued the SSNIP test for market definitions. Finally, the district court gave significant weight to merging hospitals’ deal efficiencies, including the Affordable Care Act.

Over the decade running from the early 1990s to the mid-2000s the FTC (and the Department of Justice) lost a series of challenges to hospital mergers, many of which relied on the EH test. These losses caused the Commission to review its analytical approach and to adopt an effects driven analysis to geographic market definitions. This change in approach led to nearly a decade’s worth of FTC victories in challenging hospital mergers-- until Judge Jones’ decision in Penn State Hershey.

So how did this decision come to be?
The two hospitals are located in the Harrisburg, Pennsylvania Metropolitan Statistical Area (MSA), which includes Dauphin, Cumberland and Perry Counties. In its Complaint for Preliminary Injunction, the FTC utilized the test from the 2010 U.S. Department of Justice and Federal Trade Commission Horizontal Merger Guidelines (Merger Guidelines) for determining the relevant geographic market which is the effects driven analysis. The Guidelines’ test looks to the area in which a hypothetical monopolist could “…profitably negotiate a small but significant non-transitory increase in price.” Using the Guidelines test the FTC adopted the MSA, plus Lebanon County, as the relevant geographic market (Harrisburg Area). For its support, the FTC relied upon “[e]vidence from multiple sources” showing that the “overwhelming percentage of commercially insured residents of the Harrisburg Area” seek “general acute care” medical services from the hospitals in the Harrisburg Area. The FTC also alleged that hospitals outside of the Harrisburg Area drew “very few” of their patients from the Harrisburg Area. In addition the FTC claimed that health insurers offering healthcare networks in the Harrisburg Area do not consider hospitals located outside of the Harrisburg Area “to be viable substitutes for Harrisburg Area hospitals” and if they omitted Harrisburg Area hospitals from their plans they would be very difficult to market to Harrisburg Area residents and employers.

In its opinion the District Court notes, but does not use, the geographic market test from the Merger Guidelines. Instead the Court relies upon an Eighth Circuit decision in a non-merger case, Little Rock Cardiology Clinic, v. Baptist Health and Baptist Medical System HMO, Inc., 591 F.3d 591, 599 (8th Cir. 2009) which requires plaintiffs to show the relative in-flow and out-flow of patients into and out from the area served by the conspiring hospital to justify a proposed geographic market definition. This type of flow analysis was developed by Professors Elzinga and Hogarty  as part of their studies of the beer and coal industries in the 1970s. However the EH test has since been subjected to more current economic analysis which has exposed its inherent weaknesses. Indeed Professor Elzinga himself has disavowed the test. See In re Evanston Northwestern Healthcare Corp., No. 9315 (F.T.C. Feb. 11, 2005) (testimony of Professor Kenneth Elzinga)1. Some economic analyses have demonstrated that in certain economic situations the EH test could produce unduly broad geographic market definitions. See, e.g., Capps and others, “Antitrust Policy and Hospital Mergers: Recommendations for a New Approach,” Antitrust Bulletin 47, 2 (Winter 2002). But the District Court chose not to give credence to this reversal and used the EH in-flow test to examine the relative number of patients traveling to the merging hospitals from outside the Harrisburg Area (43.5% for the Hershey hospital) and found that this data “… strongly indicate that the FTC has created a geographic market that is too narrow.” As noted above, the District Court cited to Little Rock Cardiology Clinic PA v. Baptist Health, a decision that requires absolute adherence to the EH test regardless of its now-discredited economic bases.

In support of its conclusion that the geographic market should be significantly broader than the Harrisburg Area, the District Court found that a hypothetical monopolist’s efforts at a 10% price increase in this broader area would be unsuccessful due to (1) the larger number of hospitals in the market and (2) because the merging hospitals had previously committed to five year caps with the two leading health insurers in central Pennsylvania on any price increases by the merged hospitals.

This part of the Court’s analysis is problematic for two reasons. First, there is no consideration of the economic realities of the other hospitals and the SSNIP test is part of a hypothetical (not actual) evaluation of market participant reactions. Second, FTC Chair Edith Ramirez cautioned in a May 12, 2016 speech that such temporary price restrictions are inadequate because they leave “payers and ultimately consumers vulnerable when they expire” and that “structural remedies are the best way to preserve competition.”

The Court went on to review deal efficiencies after it had already determined that the FTC had not demonstrated a likelihood of success on the merits. In this case the District Court looked at Hershey Hospital’s capacity constraints and the repositioning of post-merger competitors as bases for not enjoining the merger. More notably, however the Court observed that its 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.” None of these latter points had ever before been considered as antitrust efficiencies flowing from the consummation of a hospital merger. 

On May 10, 2016, the FTC filed with the District Court its Motion for Injunction Pending Appeal, and on May 12th the Court granted the FTC a two week extension of a previously stipulated-to temporary restraining order to pursue its appeal with the Third Circuit. With other hospital merger challenges pending, the FTC must believe that it needs the support of the Third Circuit to offset the Eighth Circuit’s dogged support of the EH test.

1Kenneth Elzinga and Anthony Swisher, “Limits of the Elzinga-Hogarty test in Hospital Mergers: The Evanston Case,” International Journal of the Economics of Business 18 n. 1 (2011), http//www.tandfonline.com/doi/full/10.1080/13571516.2011.542963.

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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