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I just posted a new ICLE white paper, co-authored with former ICLE Associate Director, Ben Sperry:

When Past Is Not Prologue: The Weakness of the Economic Evidence Against Health Insurance Mergers.

Yesterday the hearing in the DOJ’s challenge to stop the Aetna-Humana merger got underway, and last week phase 1 of the Cigna-Anthem merger trial came to a close.

The DOJ’s challenge in both cases is fundamentally rooted in a timeworn structural analysis: More consolidation in the market (where “the market” is a hotly-contested issue, of course) means less competition and higher premiums for consumers.

Following the traditional structural playbook, the DOJ argues that the Aetna-Humana merger (to pick one) would result in presumptively anticompetitive levels of concentration, and that neither new entry not divestiture would suffice to introduce sufficient competition. It does not (in its pretrial brief, at least) consider other market dynamics (including especially the complex and evolving regulatory environment) that would constrain the firm’s ability to charge supracompetitive prices.

Aetna & Humana, for their part, contend that things are a bit more complicated than the government suggests, that the government defines the relevant market incorrectly, and that

the evidence will show that there is no correlation between the number of [Medicare Advantage organizations] in a county (or their shares) and Medicare Advantage pricing—a fundamental fact that the Government’s theories of harm cannot overcome.

The trial will, of course, feature expert economic evidence from both sides. But until we see that evidence, or read the inevitable papers derived from it, we are stuck evaluating the basic outlines of the economic arguments based on the existing literature.

A host of antitrust commentators, politicians, and other interested parties have determined that the literature condemns the mergers, based largely on a small set of papers purporting to demonstrate that an increase of premiums, without corresponding benefit, inexorably follows health insurance “consolidation.” In fact, virtually all of these critics base their claims on a 2012 case study of a 1999 merger (between Aetna and Prudential) by economists Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan, Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry, as well as associated testimony by Prof. Dafny, along with a small number of other papers by her (and a couple others).

Our paper challenges these claims. As we summarize:

This white paper counsels extreme caution in the use of past statistical studies of the purported effects of health insurance company mergers to infer that today’s proposed mergers—between Aetna/Humana and Anthem/Cigna—will likely have similar effects. Focusing on one influential study—Paying a Premium on Your Premium…—as a jumping off point, we highlight some of the many reasons that past is not prologue.

In short: extrapolated, long-term, cumulative, average effects drawn from 17-year-old data may grab headlines, but they really don’t tell us much of anything about the likely effects of a particular merger today, or about the effects of increased concentration in any particular product or geographic market.

While our analysis doesn’t necessarily undermine the paper’s limited, historical conclusions, it does counsel extreme caution for inferring the study’s applicability to today’s proposed mergers.

By way of reference, Dafny, et al. found average premium price increases from the 1999 Aetna/Prudential merger of only 0.25 percent per year for two years following the merger in the geographic markets they studied. “Health Insurance Mergers May Lead to 0.25 Percent Price Increases!” isn’t quite as compelling a claim as what critics have been saying, but it’s arguably more accurate (and more relevant) than the 7 percent price increase purportedly based on the paper that merger critics like to throw around.

Moreover, different markets and a changed regulatory environment alone aren’t the only things suggesting that past is not prologue. When we delve into the paper more closely we find even more significant limitations on the paper’s support for the claims made in its name, and its relevance to the current proposed mergers.

The full paper is available here.

On November 9, pharmaceutical stocks soared as Donald Trump’s election victory eased concerns about government intervention in drug pricing. Shares of Pfizer rose 8.5%, Allergan PLC was up 8%, and biotech Celgene jumped 10.4%. Drug distributors also gained, with McKesson up 6.4% and Express Scripts climbing 3.4%. Throughout the campaign, Clinton had vowed to take on the pharmaceutical industry and proposed various reforms to reign in drug prices, from levying fines on drug companies that imposed unjustified price increases to capping patients’ annual expenditures on drugs. Pharmaceutical stocks had generally underperformed this year as the market, like much of America, awaited a Clinton victory.

In contrast, Trump generally had less to say on the subject of drug pricing, hence the market’s favorable response to his unexpected victory. Yet, as the end of the first post-election month draws near, we are still uncertain whether Trump is friend or foe to the pharmaceutical industry. Trump’s only proposal that directly impacts the industry would allow the government to negotiate the prices of Medicare Part D drugs with drug makers. Although this proposal would likely have little impact on prices because existing Part D plans already negotiate prices with drug makers, there is a risk that this “negotiation” could ultimately lead to price controls imposed on the industry. And as I have previously discussed, price controls—whether direct or indirect—are a bad idea for prescription drugs: they lead to higher initial launch prices for drugs, increased drug prices for consumers with private insurance coverage, drug shortages in certain markets, and reduced incentives for innovation.

Several of Trump’s other health proposals have mixed implications for the industry. For example, a repeal or overhaul of the Affordable Care Act could eliminate the current tax on drug makers and loosen requirements for Medicaid drug rebates and Medicare part D discounts. On the other hand, if repealing the ACA reduces the number of people insured, spending on pharmaceuticals would fall. Similarly, if Trump renegotiates international trade deals, pharmaceutical firms could benefit from stronger markets or longer patent exclusivity rights, or they could suffer if foreign countries abandon trade agreements altogether or retaliate with disadvantageous terms.

Yet, with drug spending up 8.5 percent last year and recent pricing scandals launched by 500+ percentage increases in individual drugs (i.e., Martin Shkreli, Valeant Pharmaceuticals, Mylan), the current debate over drug pricing is unlikely to fade. Even a Republican-led Congress and White House is likely to heed the public outcry and do something about drug prices.

Drug makers would be wise to stave off any government-imposed price restrictions by voluntarily limiting price increases on important drugs. Major pharmaceutical company Allergan has recently done just this by issuing a “social contract with patients” that made several drug pricing commitments to its customers. Among other assurances, Allergan has promised to limit price increases to single-digit percentage increases and no longer engage in the common industry tactic of dramatically increasing prices for branded drugs nearing patent expiry. Last year throughout the pharmaceutical industry, the prices of the most commonly-used brand drugs increased by over 16 percent and, in the last two years before patent expiry, drug makers increased the list prices of drugs by an average of 35 percent. Thus, Allergan’s commitment will produce significant savings over the life of a product, creating hundreds of millions of dollars in savings to health plans, patients, and the health care system.

If Allergan can make this commitment for its entire drug inventory—over 80+ drugs—why haven’t other companies done the same? Similar commitments by other drug makers might be enough to prevent lawmakers from turning to market-distorting reforms, such as price controls, that could end up doing more harm than good for consumers, the pharmaceutical industry, and long-term innovation.

As regulatory review of the merger between Aetna and Humana hits the homestretch, merger critics have become increasingly vocal in their opposition to the deal. This is particularly true of a subset of healthcare providers concerned about losing bargaining power over insurers.

Fortunately for consumers, the merger appears to be well on its way to approval. California recently became the 16th of 20 state insurance commissions that will eventually review the merger to approve it. The U.S. Department of Justice is currently reviewing the merger and may issue its determination as early as July.

Only Missouri has issued a preliminary opinion that the merger might lead to competitive harm. But Missouri is almost certain to remain an outlier, and its analysis simply doesn’t hold up to scrutiny.

The Missouri opinion echoed the Missouri Hospital Association’s (MHA) concerns about the effect of the merger on Medicare Advantage (MA) plans. It’s important to remember, however, that hospital associations like the MHA are not consumer advocacy groups. They are trade organizations whose primary function is to protect the interests of their member hospitals.

In fact, the American Hospital Association (AHA) has mounted continuous opposition to the deal. This is itself a good indication that the merger will benefit consumers, in part by reducing hospital reimbursement costs under MA plans.

More generally, critics have argued that history proves that health insurance mergers lead to higher premiums, without any countervailing benefits. Merger opponents place great stock in a study by economist Leemore Dafny and co-authors that purports to show that insurance mergers have historically led to seven percent higher premiums.

But that study, which looked at a pre-Affordable Care Act (ACA) deal and assessed its effects only on premiums for traditional employer-provided plans, has little relevance today.

The Dafny study first performed a straightforward statistical analysis of overall changes in concentration (that is, the number of insurers in a given market) and price, and concluded that “there is no significant association between concentration levels and premium growth.” Critics never mention this finding.

The study’s secondary, more speculative, analysis took the observed effects of a single merger — the 1999 merger between Prudential and Aetna — and extrapolated for all changes in concentration (i.e., the number of insurers in a given market) and price over an eight-year period. It concluded that, on average, seven percent of the cumulative increase in premium prices between 1998 and 2006 was the result of a reduction in the number of insurers.

But what critics fail to mention is that when the authors looked at the actual consequences of the 1999 Prudential/Aetna merger, they found effects lasting only two years — and an average price increase of only one half of one percent. And these negligible effects were restricted to premiums paid under plans purchased by large employers, a critical limitation of the studies’ relevance to today’s proposed mergers.

Moreover, as the study notes in passing, over the same eight-year period, average premium prices increased in total by 54 percent. Yet the study offers no insights into what was driving the vast bulk of premium price increases — or whether those factors are still present today.  

Few sectors of the economy have changed more radically in the past few decades than healthcare has. While extrapolated effects drawn from 17-year-old data may grab headlines, they really don’t tell us much of anything about the likely effects of a particular merger today.

Indeed, the ACA and current trends in healthcare policy have dramatically altered the way health insurance markets work. Among other things, the advent of new technologies and the move to “value-based” care are redefining the relationship between insurers and healthcare providers. Nowhere is this more evident than in the Medicare and Medicare Advantage market at the heart of the Aetna/Humana merger.

In an effort to stop the merger on antitrust grounds, critics claim that Medicare and MA are distinct products, in distinct markets. But it is simply incorrect to claim that Medicare Advantage and traditional Medicare aren’t “genuine alternatives.”

In fact, as the Office of Insurance Regulation in Florida — a bellwether state for healthcare policy — concluded in approving the merger: “Medicare Advantage, the private market product, competes directly with Traditional Medicare.”

Consumers who search for plans at Medicare.gov are presented with a direct comparison between traditional Medicare and available MA plans. And the evidence suggests that they regularly switch between the two. Today, almost a third of eligible Medicare recipients choose MA plans, and the majority of current MA enrollees switched to MA from traditional Medicare.

True, Medicare and MA plans are not identical. But for antitrust purposes, substitutes need not be perfect to exert pricing discipline on each other. Take HMOs and PPOs, for example. No one disputes that they are substitutes, and that prices for one constrain prices for the other. But as anyone who has considered switching between an HMO and a PPO knows, price is not the only variable that influences consumers’ decisions.

The same is true for MA and traditional Medicare. For many consumers, Medicare’s standard benefits, more-expensive supplemental benefits, plus a wider range of provider options present a viable alternative to MA’s lower-cost expanded benefits and narrower, managed provider network.

The move away from a traditional fee-for-service model changes how insurers do business. It requires larger investments in technology, better tracking of preventive care and health outcomes, and more-holistic supervision of patient care by insurers. Arguably, all of this may be accomplished most efficiently by larger insurers with more resources and a greater ability to work with larger, more integrated providers.

This is exactly why many hospitals, which continue to profit from traditional, fee-for-service systems, are opposed to a merger that promises to expand these value-based plans. Significantly, healthcare providers like Encompass Medical Group, which have done the most to transition their services to the value-based care model, have offered letters of support for the merger.

Regardless of their rhetoric — whether about market definition or historic precedent — the most vocal merger critics are opposed to the deal for a very simple reason: They stand to lose money if the merger is approved. That may be a good reason for some hospitals to wish the merger would go away, but it is a terrible reason to actually stop it.

[This post was first published on June 27, 2016 in The Hill as “Don’t believe the critics, Aetna-Humana merger a good deal for consumers“]

In an effort to control drug spending, several states are considering initiatives that will impose new price controls on prescription drugs. Ballot measures under consideration in California and Ohio will require drug companies to sell drugs under various state programs at a mandated discount. And legislators in Massachusetts and Pennsylvania have drafted bills that would create new government commissions to regulate the price of drugs. These state initiatives have followed proposals by presidential nominees to enact new price controls to address the high costs of pharmaceuticals.

As I explain in a new study, further price controls are a bad idea for several reasons.

First, as I discussed in a previous post, several government programs, such as Medicaid, the 340B Program, the Department of Defense and Veterans Affairs drug programs, and spending in the coverage gap of Medicare Part D, already impose price controls. Under these programs, required rebates are typically calculated as set percentages off of a drug company’s average drug price. But this approach gives drug companies an incentive to raise prices; a required percentage rebate off of a higher average price can serve to offset the mandated price control.

Second, over 40 percent of drugs sold in the U.S. are sold under government programs that mandate price controls. With such a large share of their drugs sold at significant discounts, drug companies have the incentive to charge even higher prices to other non-covered patients to offset the discounts. Indeed, numerous studies and government analyses have concluded that required discounts under Medicaid and Medicare have resulted in increased prices for other consumers as manufacturers seek to offset revenue lost under price controls.

Third, evidence suggests that price controls contribute to significant drug shortages: at a below-market price, the demand for drugs exceeds the amount of drugs that manufacturers are willing or able to sell.

Fourth, price controls hinder innovation in the pharmaceutical industry. Brand drug companies incur an average of $2.6 billion in costs to bring each new drug to market with FDA approval. They must offset these significant costs with revenues earned during the patent period; within 3 months after patent expiry, generic competitors will have already captured over 70 percent of the brand drugs’ market share and significantly eroded their profits. But price controls imposed on drugs under patent increase the risk that drug companies will not earn the profits they need to offset their development costs (only 20% of marketed brand drugs ever earn enough sales to cover their development cost). The result will be less R&D spending and less innovation. Indeed, a substantial body of empirical literature establishes that pharmaceutical firms’ profitability is linked to their research and development efforts and innovation.

Instead of imposing price controls, the government should increase drug competition in order to reduce drug spending without these negative consequences. Increased drug competition will expand product offerings, giving consumers more choice in the drugs they take. It will also lower prices and spur innovation as suppliers compete to attain or protect valuable market share from rivals.

First, the FDA should reduce the backlog of generic drugs awaiting approval. The single most important factor in controlling drug spending in recent decades has been the dramatic increase in generic drug usage; generic drugs have saved consumers $1.68 trillion over the past decade. But the degree to which generics reduce drug prices depends on the number of generic competitors in the market; the more competitors, the more price competition and downward pressure on prices. Unfortunately, a backlog of generic drug approvals at the FDA has restricted generic competition in many important market segments. There are currently over 3,500 generic applications pending approval; fast-tracking these FDA approvals will provide consumers with many new lower-priced drug options.

Second, regulators should expedite the approval and acceptance of biosimilars—the generic counterparts to high-priced biologic drugs. Biologic drugs are different from traditional medications because they are based on living organisms and, as a result, are far more complex and expensive to develop. By 2013, spending on biologic drugs comprised a quarter of all drug spending in the U.S., and their share of drug spending is expected increase significantly over the next decade. Unfortunately, the average cost of a biologic drug is 22 times greater than a traditional drug, making them prohibitively expensive for many consumers.

Fortunately, Congress has recognized the need for cheaper, “generic” substitutes for biologic drugs—or biosimilars. As part of the Affordable Care Act, Congress created a biosimilars approval pathway that would enable these cheaper biologic drugs to obtain FDA approval and reach patients more quickly. Nevertheless, the FDA has approved only one biosimilar for use in the U.S. despite several pending biosimilar applications. The agency has also yet to provide any meaningful guidance as to what standards it will employ in determining whether a biosimilar is interchangeable with a biologic. Burdensome requirements for interchangeability increase the difficulty and cost of biosimilar approval and limit the ease of biosimilar substitution at pharmacies.

Expediting the approval of biosimilars will increase competition in the market for biologic drugs, reducing prices and allowing more patients access to these life-saving and life-enhancing treatments. Estimates suggest that a biosimilar approval pathway at the FDA will save U.S. consumers between $44 billion and $250 billion over the next decade.

The recent surge in drug spending must be addressed to ensure that patients can continue to afford life-saving and life-enhancing medications. However, proposals calling for new price controls are the wrong approach. While superficially appealing, price controls may have unintended consequences—less innovation, drug shortages, and higher prices for some consumers—that could harm consumers rather than helping them. In contrast, promoting competition will lower pharmaceutical prices and drug spending without these deleterious effects.

 

 

 

Politicians have recently called for price controls to address the high costs of pharmaceuticals. Price controls are government-mandated limits on prices, or government-required discounts on prices. On the campaign trail, Hillary Clinton has called for price controls for lower-income Medicare patients while Donald Trump has recently joined Clinton, Bernie Sanders, and President Obama in calling for more government intervention in the Medicare Part D program. Before embarking upon additional price controls for the drug industry, policymakers and presidential candidates would do well to understand the impacts and problems arising from existing controls.

Unbeknownst to many, a vast array of price controls are already in place in the pharmaceutical market. Over 40 percent of outpatient drug spending is spent in public programs that use price controls. In order to sell drugs to consumers covered by these public programs, manufacturers must agree to offer certain rebates or discounts on drug prices. The calculations are generally based on the Average Manufacturer Price (AMP–the average price wholesalers pay manufacturers for drugs that are sold to retail pharmacies) or the Best Price (the lowest price the manufacturer offers the drug to any purchaser including all rebates and discounts). The most significant public programs using some form of price control are described below.

  1. Medicaid

The Medicaid program provides health insurance for low-income and medically needy individuals. The legally-required rebate depends on the specific category of drug; for example, brand manufacturers are required to sell drugs for the lesser of 23.1% off AMP or the best price offered to any purchaser.

The Affordable Care Act significantly expanded Medicaid eligibility so that in 2014, the program covered approximately 64.9 million individuals, or 20 percent of the U.S. population. State Medicaid data indicates that manufacturers paid an enormous sum — in excess of $16.7 billion — in Medicaid rebates in 2012.

  1. 340B Program

The “340B Program”, created by Congress in 1992, requires drug manufacturers to provide outpatient drugs at significantly reduced prices to 340B-eligible entities—entities that serve a high proportion of low-income or uninsured patients. Like Medicaid, the 340B discount must be at least 23.1 percent off AMP. However, the statutory formula calculates different discounts for different products and is estimated to produce discounts that average 45 percent off average prices. Surprisingly, the formulas can even result in a negative 340B selling price for a drug, in which case manufacturers are instructed to set the drug price at a penny.

The Affordable Care Act broadened the definition of qualified buyers to include many additional types of hospitals. As a result, both the number of 340B-eligible hospitals and the money spent on 340B drugs tripled between 2005 and 2014. By 2014, there were over 14,000 hospitals and affiliated sites in the 340B program, representing about one-third of all U.S. hospitals.

The 340B program has a glaring flaw that punishes the pharmaceutical industry without any offsetting benefits for low-income patients. The 340B statute does NOT require that providers only dispense 340B drugs to needy patients. In what amounts to merely shifting profits from pharmaceutical companies to other health care providers, providers may also sell drugs purchased at the steep 340B discount to non-qualified patients and pocket the difference between the 340B discounted price and the reimbursement of the non-qualified patients’ private insurance companies. About half of the 340B entities generate significant revenues from private insurer reimbursements that exceed 340B prices.

  1. Departments of Defense and Veterans Affairs Drug Programs

In order to sell drugs through the Medicaid program, drug manufacturers must also provide drugs to four government agencies—the VA, Department of Defense, Public Health Service and Coast Guard—at statutorily-imposed discounts. The required discounted price is the lesser of 24% off AMP or the lowest price manufacturers charge their most-favored nonfederal customers under comparable terms. Because of additional contracts that generate pricing concessions from specific vendors, studies indicate that VA and DOD pricing for brand pharmaceuticals was approximately 41-42% of the average wholesale price.

  1. Medicare Part D

An optional Medicare prescription drug benefit (Medicare Part D) was enacted in 2005 to offer coverage to many of the nation’s retirees and disabled persons. Unlike Medicaid and the 340B program, there is no statutory rebate level on prescription drugs covered under the program. Instead, private Medicare Part D plans, acting on behalf of the Medicare program, negotiate prices with pharmaceutical manufacturers and may obtain price concessions in the form of rebates. Manufacturers are willing to offer significant rebates and discounts in order to provide drugs to the millions of covered participants. The rebates often amount to as much as a 20-30 percent discount on brand medicines. CMS reported that manufacturers paid in excess of $10.3 billion in Part D rebates in 2012.

The Medicare Part D program does include direct price controls on drugs sold in the coverage gap. The coverage gap (or “donut hole”) is a spending level in which enrollees are responsible for a larger share of their total drug costs. For 2016, the coverage gap begins when the individual and the plan have spent $3,310 on covered drugs and ends when $7,515 has been spent. Medicare Part D requires brand drug manufacturers to offer 50 percent discounts on drugs sold during the coverage gap. These required discounts will cost drug manufacturers approximately $41 billion between 2012-2021.

While existing price controls do produce lower prices for some consumers, they may also result in increased prices for others, and in the long-term may drive up prices for all.  Many of the required rebates under Medicaid, the 340B program, and VA and DOD programs are based on drugs’ AMP.  Calculating rebates from average drug prices gives manufactures an incentive to charge higher prices to wholesalers and pharmacies in order to offset discounts. Moreover, with at least 40% of drugs sold under price controls, and some programs even requiring drugs to be sold for a penny, manufacturers are forced to sell many drugs at significant discounts.  This creates incentives to charge higher prices to other non-covered patients to offset the discounts.  Further price controls will only amplify these incentives and create inefficient market imbalances.

 

Last week concluded round 3 of Congressional hearings on mergers in the healthcare provider and health insurance markets. Much like the previous rounds, the hearing saw predictable representatives, of predictable constituencies, saying predictable things.

The pattern is pretty clear: The American Hospital Association (AHA) makes the case that mergers in the provider market are good for consumers, while mergers in the health insurance market are bad. A scholar or two decries all consolidation in both markets. Another interested group, like maybe the American Medical Association (AMA), also criticizes the mergers. And it’s usually left to a representative of the insurance industry, typically one or more of the merging parties themselves, or perhaps a scholar from a free market think tank, to defend the merger.

Lurking behind the public and politicized airings of these mergers, and especially the pending Anthem/Cigna and Aetna/Humana health insurance mergers, is the Affordable Care Act (ACA). Unfortunately, the partisan politics surrounding the ACA, particularly during this election season, may be trumping the sensible economic analysis of the competitive effects of these mergers.

In particular, the partisan assessments of the ACA’s effect on the marketplace have greatly colored the Congressional (mis-)understandings of the competitive consequences of the mergers.  

Witness testimony and questions from members of Congress at the hearings suggest that there is widespread agreement that the ACA is encouraging increased consolidation in healthcare provider markets, for example, but there is nothing approaching unanimity of opinion in Congress or among interested parties regarding what, if anything, to do about it. Congressional Democrats, for their part, have insisted that stepped up vigilance, particularly of health insurance mergers, is required to ensure that continued competition in health insurance markets isn’t undermined, and that the realization of the ACA’s objectives in the provider market aren’t undermined by insurance companies engaging in anticompetitive conduct. Meanwhile, Congressional Republicans have generally been inclined to imply (or outright state) that increased concentration is bad, so that they can blame increasing concentration and any lack of competition on the increased regulatory costs or other effects of the ACA. Both sides appear to be missing the greater complexities of the story, however.

While the ACA may be creating certain impediments in the health insurance market, it’s also creating some opportunities for increased health insurance competition, and implementing provisions that should serve to hold down prices. Furthermore, even if the ACA is encouraging more concentration, those increases in concentration can’t be assumed to be anticompetitive. Mergers may very well be the best way for insurers to provide benefits to consumers in a post-ACA world — that is, the world we live in. The ACA may have plenty of negative outcomes, and there may be reasons to attack the ACA itself, but there is no reason to assume that any increased concentration it may bring about is a bad thing.

Asking the right questions about the ACA

We don’t need more self-serving and/or politicized testimony We need instead to apply an economic framework to the competition issues arising from these mergers in order to understand their actual, likely effects on the health insurance marketplace we have. This framework has to answer questions like:

  • How do we understand the effects of the ACA on the marketplace?
    • In what ways does the ACA require us to alter our understanding of the competitive environment in which health insurance and healthcare are offered?
    • Does the ACA promote concentration in health insurance markets?
    • If so, is that a bad thing?
  • Do efficiencies arise from increased integration in the healthcare provider market?
  • Do efficiencies arise from increased integration in the health insurance market?
  • How do state regulatory regimes affect the understanding of what markets are at issue, and what competitive effects are likely, for antitrust analysis?
  • What are the potential competitive effects of increased concentration in the health care markets?
  • Does increased health insurance market concentration exacerbate or counteract those effects?

Beginning with this post, at least a few of us here at TOTM will take on some of these issues, as part of a blog series aimed at better understanding the antitrust law and economics of the pending health insurance mergers.

Today, we will focus on the ambiguous competitive implications of the ACA. Although not a comprehensive analysis, in this post we will discuss some key insights into how the ACA’s regulations and subsidies should inform our assessment of the competitiveness of the healthcare industry as a whole, and the antitrust review of health insurance mergers in particular.

The ambiguous effects of the ACA

It’s an understatement to say that the ACA is an issue of great political controversy. While many Democrats argue that it has been nothing but a boon to consumers, Republicans usually have nothing good to say about the law’s effects. But both sides miss important but ambiguous effects of the law on the healthcare industry. And because they miss (or disregard) this ambiguity for political reasons, they risk seriously misunderstanding the legal and economic implications of the ACA for healthcare industry mergers.

To begin with, there are substantial negative effects, of course. Requiring insurance companies to accept patients with pre-existing conditions reduces the ability of insurance companies to manage risk. This has led to upward pricing pressure for premiums. While the mandate to buy insurance was supposed to help bring more young, healthy people into the risk pool, so far the projected signups haven’t been realized.

The ACA’s redefinition of what is an acceptable insurance policy has also caused many consumers to lose the policy of their choice. And the ACA’s many regulations, such as the Minimum Loss Ratio requiring insurance companies to spend 80% of premiums on healthcare, have squeezed the profit margins of many insurance companies, leading, in some cases, to exit from the marketplace altogether and, in others, to a reduction of new marketplace entry or competition in other submarkets.

On the other hand, there may be benefits from the ACA. While many insurers participated in private exchanges even before the ACA-mandated health insurance exchanges, the increased consumer education from the government’s efforts may have helped enrollment even in private exchanges, and may also have helped to keep premiums from increasing as much as they would have otherwise. At the same time, the increased subsidies for individuals have helped lower-income people afford those premiums. Some have even argued that increased participation in the on-demand economy can be linked to the ability of individuals to buy health insurance directly. On top of that, there has been some entry into certain health insurance submarkets due to lower barriers to entry (because there is less need for agents to sell in a new market with the online exchanges). And the changes in how Medicare pays, with a greater focus on outcomes rather than services provided, has led to the adoption of value-based pricing from both health care providers and health insurance companies.

Further, some of the ACA’s effects have  decidedly ambiguous consequences for healthcare and health insurance markets. On the one hand, for example, the ACA’s compensation rules have encouraged consolidation among healthcare providers, as noted. One reason for this is that the government gives higher payments for Medicare services delivered by a hospital versus an independent doctor. Similarly, increased regulatory burdens have led to higher compliance costs and more consolidation as providers attempt to economize on those costs. All of this has happened perhaps to the detriment of doctors (and/or patients) who wanted to remain independent from hospitals and larger health network systems, and, as a result, has generally raised costs for payors like insurers and governments.

But much of this consolidation has also arguably led to increased efficiency and greater benefits for consumers. For instance, the integration of healthcare networks leads to increased sharing of health information and better analytics, better care for patients, reduced overhead costs, and other efficiencies. Ultimately these should translate into higher quality care for patients. And to the extent that they do, they should also translate into lower costs for insurers and lower premiums — provided health insurers are not prevented from obtaining sufficient bargaining power to impose pricing discipline on healthcare providers.

In other words, both the AHA and AMA could be right as to different aspects of the ACA’s effects.

Understanding mergers within the regulatory environment

But what they can’t say is that increased consolidation per se is clearly problematic, nor that, even if it is correlated with sub-optimal outcomes, it is consolidation causing those outcomes, rather than something else (like the ACA) that is causing both the sub-optimal outcomes as well as consolidation.

In fact, it may well be the case that increased consolidation improves overall outcomes in healthcare provider and health insurance markets relative to what would happen under the ACA absent consolidation. For Congressional Democrats and others interested in bolstering the ACA and offering the best possible outcomes for consumers, reflexively challenging health insurance mergers because consolidation is “bad,” may be undermining both of these objectives.

Meanwhile, and for the same reasons, Congressional Republicans who decry Obamacare should be careful that they do not likewise condemn mergers under what amounts to a “big is bad” theory that is inconsistent with the rigorous law and economics approach that they otherwise generally support. To the extent that the true target is not health insurance industry consolidation, but rather underlying regulatory changes that have encouraged that consolidation, scoring political points by impugning mergers threatens both health insurance consumers in the short run, as well as consumers throughout the economy in the long run (by undermining the well-established economic critiques of a reflexive “big is bad” response).

It is simply not clear that ACA-induced health insurance mergers are likely to be anticompetitive. In fact, because the ACA builds on state regulation of insurance providers, requiring greater transparency and regulatory review of pricing and coverage terms, it seems unlikely that health insurers would be free to engage in anticompetitive price increases or reduced coverage that could harm consumers.

On the contrary, the managerial and transactional efficiencies from the proposed mergers, combined with greater bargaining power against now-larger providers are likely to lead to both better quality care and cost savings passed-on to consumers. Increased entry, at least in part due to the ACA in most of the markets in which the merging companies will compete, along with integrated health networks themselves entering and threatening entry into insurance markets, will almost certainly lead to more consumer cost savings. In the current regulatory environment created by the ACA, in other words, insurance mergers have considerable upside potential, with little downside risk.

Conclusion

In sum, regardless of what one thinks about the ACA and its likely effects on consumers, it is not clear that health insurance mergers, especially in a post-ACA world, will be harmful.

Rather, assessing the likely competitive effects of health insurance mergers entails consideration of many complicated (and, unfortunately, politicized) issues. In future blog posts we will discuss (among other things): the proper treatment of efficiencies arising from health insurance mergers, the appropriate geographic and product markets for health insurance merger reviews, the role of state regulations in assessing likely competitive effects, and the strengths and weaknesses of arguments for potential competitive harms arising from the mergers.

Earlier this week the International Center for Law & Economics, along with a group of prominent professors and scholars of law and economics, filed an amicus brief with the Ninth Circuit seeking rehearing en banc of the court’s FTC, et al. v. St Luke’s case.

ICLE, joined by the Medicaid Defense Fund, also filed an amicus brief with the Ninth Circuit panel that originally heard the case.

The case involves the purchase by St. Luke’s Hospital of the Saltzer Medical Group, a multi-specialty physician group in Nampa, Idaho. The FTC and the State of Idaho sought to permanently enjoin the transaction under the Clayton Act, arguing that

[T]he combination of St. Luke’s and Saltzer would give it the market power to demand higher rates for health care services provided by primary care physicians (PCPs) in Nampa, Idaho and surrounding areas, ultimately leading to higher costs for health care consumers.

The district court agreed and its decision was affirmed by the Ninth Circuit panel.

Unfortunately, in affirming the district court’s decision, the Ninth Circuit made several errors in its treatment of the efficiencies offered by St. Luke’s in defense of the merger. Most importantly:

  • The court refused to recognize St. Luke’s proffered quality efficiencies, stating that “[i]t is not enough to show that the merger would allow St. Luke’s to better serve patients.”
  • The panel also applied the “less restrictive alternative” analysis in such a way that any theoretically possible alternative to a merger would discount those claimed efficiencies.
  • Finally, the Ninth Circuit panel imposed a much higher burden of proof for St. Luke’s to prove efficiencies than it did for the FTC to make out its prima facie case.

As we note in our brief:

If permitted to stand, the Panel’s decision will signal to market participants that the efficiencies defense is essentially unavailable in the Ninth Circuit, especially if those efficiencies go towards improving quality. Companies contemplating a merger designed to make each party more efficient will be unable to rely on an efficiencies defense and will therefore abandon transactions that promote consumer welfare lest they fall victim to the sort of reasoning employed by the panel in this case.

The following excerpts from the brief elaborate on the errors committed by the court and highlight their significance, particularly in the health care context:

The Panel implied that only price effects can be cognizable efficiencies, noting that the District Court “did not find that the merger would increase competition or decrease prices.” But price divorced from product characteristics is an irrelevant concept. The relevant concept is quality-adjusted price, and a showing that a merger would result in higher product quality at the same price would certainly establish cognizable efficiencies.

* * *

By placing the ultimate burden of proving efficiencies on the defendants and by applying a narrow, impractical view of merger specificity, the Panel has wrongfully denied application of known procompetitive efficiencies. In fact, under the Panel’s ruling, it will be nearly impossible for merging parties to disprove all alternatives when the burden is on the merging party to address any and every untested, theoretical less-restrictive structural alternative.

* * *

Significantly, the Panel failed to consider the proffered significant advantages that health care acquisitions may have over contractual alternatives or how these advantages impact the feasibility of contracting as a less restrictive alternative. In a complex integration of assets, “the costs of contracting will generally increase more than the costs of vertical integration.” (Benjamin Klein, Robert G. Crawford, and Armen A. Alchian, Vertical Integration, Appropriable Rents, and the Competitive Contracting Process, 21 J. L. & ECON. 297, 298 (1978)). In health care in particular, complexity is a given. Health care is characterized by dramatically imperfect information, and myriad specialized and differentiated products whose attributes are often difficult to measure. Realigning incentives through contract is imperfect and often unsuccessful. Moreover, the health care market is one of the most fickle, plagued by constantly changing market conditions arising from technological evolution, ever-changing regulations, and heterogeneous (and shifting) consumer demand. Such uncertainty frequently creates too many contingencies for parties to address in either writing or enforcing contracts, making acquisition a more appropriate substitute.

* * *

Sound antitrust policy and law do not permit the theoretical to triumph over the practical. One can always envision ways that firms could function to achieve potential efficiencies…. But this approach would harm consumers and fail to further the aims of the antitrust laws.

* * *

The Panel’s approach to efficiencies in this case demonstrates a problematic asymmetry in merger analysis. As FTC Commissioner Wright has cautioned:

Merger analysis is by its nature a predictive enterprise. Thinking rigorously about probabilistic assessment of competitive harms is an appropriate approach from an economic perspective. However, there is some reason for concern that the approach applied to efficiencies is deterministic in practice. In other words, there is a potentially dangerous asymmetry from a consumer welfare perspective of an approach that embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other. (Dissenting Statement of Commissioner Joshua D. Wright at 5, In the Matter of Ardagh Group S.A., and Saint-Gobain Containers, Inc., and Compagnie de Saint-Gobain)

* * *

In this case, the Panel effectively presumed competitive harm and then imposed unduly high evidentiary burdens on the merging parties to demonstrate actual procompetitive effects. The differential treatment and evidentiary burdens placed on St. Luke’s to prove competitive benefits is “unjustified and counterproductive.” (Daniel A. Crane, Rethinking Merger Efficiencies, 110 MICH. L. REV. 347, 390 (2011)). Such asymmetry between the government’s and St. Luke’s burdens is “inconsistent with a merger policy designed to promote consumer welfare.” (Dissenting Statement of Commissioner Joshua D. Wright at 7, In the Matter of Ardagh Group S.A., and Saint-Gobain Containers, Inc., and Compagnie de Saint-Gobain).

* * *

In reaching its decision, the Panel dismissed these very sorts of procompetitive and quality-enhancing efficiencies associated with the merger that were recognized by the district court. Instead, the Panel simply decided that it would not consider the “laudable goal” of improving health care as a procompetitive efficiency in the St. Luke’s case – or in any other health care provider merger moving forward. The Panel stated that “[i]t is not enough to show that the merger would allow St. Luke’s to better serve patients.” Such a broad, blanket conclusion can serve only to harm consumers.

* * *

By creating a barrier to considering quality-enhancing efficiencies associated with better care, the approach taken by the Panel will deter future provider realignment and create a “chilling” effect on vital provider integration and collaboration. If the Panel’s decision is upheld, providers will be considerably less likely to engage in realignment aimed at improving care and lowering long-term costs. As a result, both patients and payors will suffer in the form of higher costs and lower quality of care. This can’t be – and isn’t – the outcome to which appropriate antitrust law and policy aspires.

The scholars joining ICLE on the brief are:

  • George Bittlingmayer, Wagnon Distinguished Professor of Finance and Otto Distinguished Professor of Austrian Economics, University of Kansas
  • Henry Butler, George Mason University Foundation Professor of Law and Executive Director of the Law & Economics Center, George Mason University
  • Daniel A. Crane, Associate Dean for Faculty and Research and Professor of Law, University of Michigan
  • Harold Demsetz, UCLA Emeritus Chair Professor of Business Economics, University of California, Los Angeles
  • Bernard Ganglmair, Assistant Professor, University of Texas at Dallas
  • Gus Hurwitz, Assistant Professor of Law, University of Nebraska-Lincoln
  • Keith Hylton, William Fairfield Warren Distinguished Professor of Law, Boston University
  • Thom Lambert, Wall Chair in Corporate Law and Governance, University of Missouri
  • John Lopatka, A. Robert Noll Distinguished Professor of Law, Pennsylvania State University
  • Geoffrey Manne, Founder and Executive Director of the International Center for Law and Economics and Senior Fellow at TechFreedom
  • Stephen Margolis, Alumni Distinguished Undergraduate Professor, North Carolina State University
  • Fred McChesney, de la Cruz-Mentschikoff Endowed Chair in Law and Economics, University of Miami
  • Tom Morgan, Oppenheim Professor Emeritus of Antitrust and Trade Regulation Law, George Washington University
  • David Olson, Associate Professor of Law, Boston College
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics, Emory University
  • D. Daniel Sokol, Professor of Law, University of Florida
  • Mike Sykuta, Associate Professor and Director of the Contracting and Organizations Research Institute, University of Missouri

The amicus brief is available here.

There is always a temptation for antitrust agencies and plaintiffs to center a case around so-called “hot” documents — typically company documents with a snippet or sound-bites extracted, some times out of context. Some practitioners argue that “[h]ot document can be crucial to the outcome of any antitrust matter.” Although “hot” documents can help catch the interest of the public, a busy judge or an unsophisticated jury, they often can lead to misleading results. But more times than not, antitrust cases are resolved on economics and what John Adams called “hard facts,” not snippets from emails or other corporate documents. Antitrust case books are littered with cases that initially looked promising based on some supposed hot documents, but ultimately failed because the foundations of a sound antitrust case were missing.

As discussed below this is especially true for a recent case brought by the FTC, FTC v. St. Luke’s, currently pending before the Ninth Circuit Court of Appeals, in which the FTC at each pleading stage has consistently relied on “hot” documents to make its case.

The crafting and prosecution of civil antitrust cases by federal regulators is a delicate balancing act. Regulators must adhere to well-defined principles of antitrust enforcement, and on the other hand appeal to the interests of a busy judge. The simple way of doing this is using snippets of documents to attempt to show the defendants knew they were violating the law.

After all, if federal regulators merely had to properly define geographic and relevant product markets, show a coherent model of anticompetitive harm, and demonstrate that any anticipated harm would outweigh any procompetitive benefits, where is the fun in that? The reality is that antitrust cases typically rely on economic analysis, not snippets of hot documents. Antitrust regulators routinely include internal company documents in their cases to supplement the dry mechanical nature of antitrust analysis. However, in isolation, these documents can create competitive concerns when they simply do not exist.

With this in mind, it is vital that antitrust regulators do not build an entire case around what seem to be inflammatory documents. Quotes from executives, internal memoranda about competitors, and customer presentations are the icing on the cake after a proper antitrust analysis. As the International Center for Law and Economics’ Geoff Manne once explained,

[t]he problem is that these documents are easily misunderstood, and thus, while the economic significance of such documents is often quite limited, their persuasive value is quite substantial.

Herein lies the problem illustrated by the Federal Trade Commission’s use of provocative documents in its suit against the vertical acquisition of Saltzer Medical Group, an independent physician group comprised of 41 doctors, by St. Luke’s Health System. The FTC seeks to stop the acquisition involving these two Idaho based health care providers, a $16 million transaction, and a number comparatively small to other health care mergers investigated by the antitrust agencies. The transaction would give St. Luke’s a total of 24 primary care physicians operating in and around Nampa, Idaho.

In St. Luke’s the FTC used “hot” documents in each stage of its pleadings, from its complaint through its merits brief on appeal. Some of the statements pulled from executives’ emails, notes and memoranda seem inflammatory suggesting St. Luke’s intended to increase prices and to control market share all in order to further its strength relative to payer contracting. These statements however have little grounding in the reality of health care competition.

The reliance by the FTC on these so-called hot documents is problematic for several reasons. First, the selective quoting of internal documents paints the intention of the merger solely to increase profit for St. Luke’s at the expense of payers, when the reality is that the merger is premised on the integration of health care services and the move from the traditional fee-for-service model to a patient-centric model. St Luke’s intention of incorporating primary care into its system is in-line with the goals of the Affordable Care Act to promote over all well-being through integration. The District Court in this case recognized that the purpose of the merger was “primarily to improve patient outcomes.” And, in fact, underserved and uninsured patients are already benefitting from the transaction.

Second, the selective quoting suggested a narrow geographic market, and therefore an artificially high level of concentration in Nampa, Idaho. The suggestion contradicts reality, that nearly one-third of Nampa residents seek primary care physician services outside of Nampa. The geographic market advanced by the FTC is not a proper market, regardless of whether selected documents appear to support it. Without a properly defined geographic market, it is impossible to determine market share and therefore prove a violation of the Clayton Antitrust Act.

The DOJ Antitrust Division and the FTC have acknowledged that markets can not properly be defined solely on spicy documents. Writing in their 2006 commentary on the Horizontal Merger Guidelines, the agencies noted that

[t]he Agencies are careful, however, not to assume that a ‘market’ identified for business purposes is the same as a relevant market defined in the context of a merger analysis. … It is unremarkable that ‘markets’ in common business usage do not always coincide with ‘markets’ in an antitrust context, inasmuch as the terms are used for different purposes.

Third, even if St. Luke’s had the intention of increasing prices, just because one wants to do something such as raise prices above a competitive level or scale back research and development expenses — even if it genuinely believes it is able — does not mean that it can. Merger analysis is not a question of mens rea (or subjective intent). Rather, the analysis must show that such behavior will be likely as a result of diminished competition. Regulators must not look at evidence of this subjective intent and then conclude that the behavior must be possible and that a merger is therefore likely to substantially lessen competition. This would be the tail wagging the dog. Instead, regulators must first determine whether, as a matter of economic principle, a merger is likely to have a particular effect. Then, once the analytical tests have been run, documents can support these theories. But without sound support for the underlying theories, documents (however condemning) cannot bring the case across the goal line.

Certainly, documents suggesting intent to raise prices should bring an antitrust plaintiff across the goal line? Not so, as Seventh Circuit Judge Frank Easterbrook has explained:

Almost all evidence bearing on “intent” tends to show both greed and desire to succeed and glee at a rival’s predicament. … [B]ut drive to succeed lies at the core of a rivalrous economy. Firms need not like their competitors; they need not cheer them on to success; a desire to extinguish one’s rivals is entirely consistent with, often is the motive behind competition.

As Harvard Law Professor Phil Areeda observed, relying on documents describing intent is inherently risky because

(1) the businessperson often uses a colorful and combative vocabulary far removed from the lawyer’s linguistic niceties, and (2) juries and judges may fail to distinguish a lawful competitive intent from a predatory state of mind. (7 Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law § 1506 (2d ed. 2003).)

So-called “hot” documents may help guide merger analysis, but served up as a main course make a paltry meal. Merger cases rise or fall on hard facts and economics, and next week we will see if the Ninth Circuit recognizes this as both St. Luke’s and the FTC argue their cases.

A century ago Congress enacted the Clayton Act, which prohibits acquisitions that may substantially lessen competition. For years, the antitrust enforcement Agencies looked at only one part of the ledger – the potential for price increases. Agencies didn’t take into account the potential efficiencies in cost savings, better products, services, and innovation. One of the major reforms of the Clinton Administration was to fully incorporate efficiencies in merger analysis, helping to develop sound enforcement standards for the 21st Century.

But the current approach of the Federal Trade Commission (“FTC”), especially in hospital mergers, appears to be taking a major step backwards by failing to fully consider efficiencies and arguing for legal thresholds inconsistent with sound competition policy. The FTC’s approach used primarily in hospital mergers seems uniquely misguided since there is a tremendous need for smart hospital consolidation to help bend the cost curve and improve healthcare delivery.

The FTC’s backwards analysis of efficiencies is juxtaposed in two recent hospital-physician alliances.

As I discussed in my last post, no one would doubt the need for greater integration between hospitals and physicians – the debate during the enactment of the Affordable Care Act (“ACA”) detailed how the current siloed approach to healthcare is the worst of all worlds, leading to escalating costs and inferior care. In FTC v. St. Luke’s Health System, Ltd., the FTC challenged Boise-based St. Luke’s acquisition of a physician practice in neighboring Nampa, Idaho.

In the case, St. Luke’s presented a compelling case for efficiencies.

As noted by the St. Luke’s court, one of the leading factors in rising healthcare costs is the use of the ineffective fee-for-service system. In their attempt to control costs and abandon fee-for-service payment, the merging parties effectively demonstrated to the court that the combined entity would offer a high level of coordinated and patient-centered care. Therefore, along with integrating electronic records and increasing access for under-privileged patients, the merged entity can also successfully manage population health and offer risk-based payment initiatives to all employed physicians. Indeed, the transaction consummated several months ago has already shown significant cost savings and consumer benefits especially for underserved patients. The court recognized

[t]he Acquisition was intended by St. Luke’s and Saltzer primarily to improve patient outcomes. The Court believes that it would have that effect if left intact.

(Appellants’ Reply Brief at 22, FTC v. St. Luke’s Health Sys., No 14-35173 (9th Cir. Sept. 2, 2014).)

But the court gave no weight to the efficiencies primarily because the FTC set forward the wrong legal roadmap.

Under the FTC’s current roadmap for efficiencies, the FTC may prove antitrust harm via predication and presumption while defendants are required to decisively prove countervailing procompetitive efficiencies. Such asymmetric burdens of proof greatly favor the FTC and eliminate a court’s ability to properly analyze the procompetitive nature of efficiencies against the supposed antitrust harm.

Moreover, the FTC basically claims that any efficiencies can only be considered “merger-specific” if the parties are able to demonstrate there are no less anticompetitive means to achieve them. It is not enough that they result directly from the merger.

In the case of St. Luke’s, the court determined the defendants’ efficiencies would “improve the quality of medical care” in Nampa, Idaho, but were not merger-specific. The court relied on the FTC’s experts to find that efficiencies such as “elimination of fee-for-service reimbursement” and the movement “to risk-based reimbursement” were not merger-specific, because other entities had potentially achieved similar efficiencies within different provider “structures.” The FTC and their experts did not indicate the success of these other models nor dispute that St. Luke’s would achieve their stated efficiencies. Instead, the mere possibility of potential, alternative structures was enough to overcome merger efficiencies purposed to “move the focus of health care back to the patient.” (The case is currently on appeal and hopefully the Ninth Circuit can correct the lower court’s error).

In contrast to the St. Luke’s case is the recent FTC advisory letter to the Norman Physician Hospital Organization (“Norman PHO”). The Norman PHO proposed a competitive collaboration serving to integrate care between the Norman Physician Association’s 280 physicians and Norman Regional Health System, the largest health system in Norman, Oklahoma. In its analysis of the Norman PHO, the FTC found that the groups could not “quantify… the likely overall efficiency benefits of its proposed program” nor “provide direct evidence of actual efficiencies or competitive effects.” Furthermore, such an arrangement had the potential to “exercise market power.” Nonetheless, the FTC permitted the collaboration. Its decision was instead decided on the basis of Norman PHO’s non-exclusive physician contracting provisions.

It seems difficult if not impossible to reconcile the FTC’s approaches in Boise and Norman. In Norman the FTC relied on only theoretical efficiencies to permit an alliance with significant market power. The FTC was more than willing to accept Norman PHO’s “potential to… generate significant efficiencies.” Such an even-handed approach concerning efficiencies was not applied in analyzing efficiencies in St. Luke’s merger.

The starting point for understanding the FTC’s misguided analysis of efficiencies in St. Luke’s and other merger cases stems from the 2010 Horizontal Merger Guidelines (“Guidelines”).

A recent dissent by FTC Commissioner Joshua Wright outlines the problem – there are asymmetric burdens placed on the plaintiff and defendant. Using the Guidelines, FTC’s merger analysis

embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.

Relying on the structural presumption established in United States v. Philadelphia Nat’l Bank, the FTC need only illustrate that a merger will substantially lessen competition, typically demonstrated through a showing of undue concentration in a relevant market, not actual anticompetitive effects. If this low burden is met, the burden is then shifted to the defendants to rebut the presumption of competitive harm.

As part of their defense, defendants must then prove that any proposed efficiencies are cognizable, meaning “merger-specific,” and have been “verified and do not arise from anticompetitive reductions in output or service.” Furthermore, merging parties must demonstrate “by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved…, how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific.”

As stated in a recent speech by FTC Commissioner Joshua Wright,

the critical lesson of the modern economic approach to mergers is that post-merger changes in pricing incentives and competitive effects are what matter.

The FTC’s merger policy “has long been dominated by a focus on only one side of the ledger—anticompetitive effects.” In other words the defendants must demonstrate efficiencies with certainty, while the government can condemn a merger based on a prediction. This asymmetric enforcement policy favors the FTC while requiring defendants meet stringent, unyielding standards.

As the ICLE amicus brief in St. Luke’s discusses, not satisfied with the asymmetric advantage, the plaintiffs in St. Luke’s attempt to “guild the lily” by claiming that efficiencies can only be considered in cases where there is a presumption of competitive harm, perhaps based solely on “first order” evidence, such as increased market shares. Of course, nothing in the law, Guidelines, or sound competition policy limits the defense in that fashion.

The court should consider efficiencies regardless of the level of economic harm. The question is whether the efficiencies will outweigh that harm. As Geoff recently pointed out:

There is no economic basis for demanding more proof of claimed efficiencies than of claimed anticompetitive harms. And the Guidelines since 1997 were (ostensibly) drafted in part precisely to ensure that efficiencies were appropriately considered by the agencies (and the courts) in their enforcement decisions.

With presumptions that strongly benefit the FTC, it is clear that efficiencies are often overlooked or ignored. From 1997-2007, FTC’s Bureau of Competition staff deliberated on a total of 342 efficiencies claims. Of the 342 efficiency claims, only 29 were accepted by FTC staff whereas 109 were rejected and 204 received “no decision.” The most common concerns among FTC staff were that stated efficiencies were not verifiable or were not merger specific.

Both “concerns” come directly from the Guidelines requiring plaintiffs provide significant and oftentimes impossible foresight and information to overcome evidentiary burdens. As former FTC Chairman Tim Muris observed

too often, the [FTC] found no cognizable efficiencies when anticompetitive effects were determined to be likely and seemed to recognize efficiency only when no adverse effects were predicted.

Thus, in situations in which the FTC believes the dominant issue is market concentration, plaintiffs’ attempts to demonstrate procompetitive reasoning are outright dismissed.

The FTC’s efficiency arguments are also not grounded in legal precedent. Courts have recognized that asymmetric burdens are inconsistent with the intent of the Act. As then D.C. Circuit Judge Clarence Thomas observed,

[i]mposing a heavy burden of production on a defendant would be particularly anomalous where … it is easy to establish a prima facie case.

Courts have recognized that efficiencies can be “speculative” or be “based on a prediction backed by sound business judgment.” And in Sherman Act cases the law places the burden on the plaintiff to demonstrate that there are less restrictive alternatives to a potentially illegal restraint – unlike the requirement applied by the FTC that the defendant prove there are no less restrictive alternatives to a merger to achieve efficiencies.

The FTC and the courts should deem worthy efficiencies wherein there is a reasonable likelihood that procompetitive effects will take place post-merger. Furthermore, the courts should not look at efficiencies inside a vacuum. In healthcare, policies and laws, such as the effects of the ACA, must be taken into account. The ACA promotes coordination among providers and incentivizes entities that can move away from fee-for-service payment. In the past, courts relying on the role of health policy in merger analysis have found that efficiencies leading to integrated medicine and “better medical care” are relevant.

In St. Luke’s the court observed that “the existing law seemed to hinder innovation and resist creative solutions” and that “flexibility and experimentation” are “two virtues that are not emphasized in the antitrust law.” Undoubtedly, the current approach to efficiencies makes it near impossible for providers to demonstrate efficiencies.

As Commissioner Wright has observed, these asymmetric evidentiary burdens

do not make economic sense and are inconsistent with a merger policy designed to promote consumer welfare.

In the context of St. Luke’s and other healthcare provider mergers, appropriate efficiency analysis is a keystone of determining a merger’s total effects. Dismissal of efficiencies on the basis of a rigid, incorrect legal procedural structure is not aligned with current economic thinking or a sound approach to incorporate competition analysis into the drive for healthcare reform. It is time for the FTC to set efficiency analysis in the right direction.

There is a consensus in America that we need to control health care costs and improve the delivery of health care. After a long debate on health care reform and careful scrutiny of health care markets, there seems to be agreement that the unintegrated, “siloed approach” to health care is inefficient, costly, and contrary to the goal of improving care. But some antitrust enforcers — most notably the FTC — are standing in the way.

Enlightened health care providers are responding to this consensus by entering into transactions that will lead to greater clinical and financial integration, facilitating a movement from volume-based to value-based delivery of care. Any many aspects of the Affordable Care Act encourage this path to integration. Yet when the market seeks to address these critical concerns about our health care system, the FTC and some state Attorneys General take positions diametrically opposed to sound national health care policy as adopted by Congress and implemented by the Department of Health and Human Services.

To be sure, not all state antitrust enforcers stand in the way of health care reform. For example, many states including New York, Pennsylvania and Massachusetts, seem to be willing to permit hospital mergers even in concentrated markets with an agreement for continued regulation. At the same time, however, the FTC has been aggressively challenging integration, taking the stance that hospital mergers will raise prices by giving those hospitals greater leverage in negotiations.

The distance between HHS and the FTC in DC is about 6 blocks, but in healthcare policy they seem to be are miles apart.

The FTC’s skepticism about integration is an old story. As I have discussed previously, during the last decade the agency challenged more than 30 physician collaborations even though those cases lacked any evidence that the collaborations led to higher prices. And, when physicians asked for advice on collaborations, it took the Commission on average more than 436 days to respond to those requests (about as long as it took Congress to debate and enact the Affordable Care Act).

The FTC is on a recent winning streak in challenging hospital mergers. But those were primarily simple cases with direct competition between hospitals in the same market with very high levels of concentration. The courts did not struggle long in these cases, because the competitive harm appeared straightforward.

Far more controversial is when a hospital acquires a physician practice. This type of vertical integration seems precisely what the advocates for health care reform are crying out for. The lack of integration between physicians and hospitals is a core to the problems in health care delivery. But the antitrust law is entirely solicitous of these types of vertical mergers. There has not been a vertical merger successfully challenged in the courts since 1980 – the days of reruns of the TV show Dr. Kildare. And even the supposedly pro-enforcement Obama Administration has not gone to court to challenge a vertical merger, and the Obama FTC has not even secured a merger consent under a vertical theory.

The case in which the FTC has decided to “bet the house” is its challenge to St. Luke’s Health System’s acquisition of Saltzer Medical Group in Nampa, Idaho.

St. Luke’s operates the largest hospital in Boise, and Saltzer is the largest physician practice in Nampa, roughly 20-miles away. But rather than recognizing that this was a vertical affiliation designed to integrate care and to promote a transition to a system in which the provider takes the risk of overutilization, the FTC characterized the transaction as purely horizontal – no different from the merger of two hospitals. In that manner, the FTC sought to paint concentration levels it designed to assure victory.

But back to the reasons why integration is essential. It is undisputed that provider integration is the key to improving American health care. Americans pay substantially more than any other industrialized nation for health care services, 17.2 percent of gross domestic product. Furthermore, these higher costs are not associated with better overall care or greater access for patients. As noted during the debate on the Affordable Care Act, the American health care system’s higher costs and lower quality and access are mostly associated with the usage of a fee-for-service system that pays for each individual medical service, and the “siloed approach” to medicine in which providers work autonomously and do not coordinate to improve patient outcomes.

In order to lower health care costs and improve care, many providers have sought to transform health care into a value-based, patient-centered approach. To institute such a health care initiative, medical staff, physicians, and hospitals must clinically integrate and align their financial incentives. Integrated providers utilize financial risk, share electronic records and data, and implement quality measures in order to provide the best patient care.

The most effective means of ensuring full-scale integration is through a tight affiliation, most often achieved through a merger. Unlike contractual arrangements that are costly, time-sensitive, and complicated by an outdated health care regulatory structure, integrated affiliations ensure that entities can effectively combine and promote structural change throughout the newly formed organization.

For nearly five weeks of trial in Boise St. Luke’s and the FTC fought these conflicting visions of integration and health care policy. Ultimately, the court decided the supposed Nampa primary care physician market posited by the FTC would become far more concentrated, and the merger would substantially lessen competition for “Adult Primary Care Services” by raising prices in Nampa. As such, the district court ordered an immediate divestiture.

Rarely, however, has an antitrust court expressed such anguish at its decision. The district court readily “applauded [St. Luke’s] for its efforts to improve the delivery of healthcare.” It acknowledged the positive impact the merger would have on health care within the region. The court further noted that Saltzer had attempted to coordinate with other providers via loose affiliations but had failed to reap any benefits. Due to Saltzer’s lack of integration, Saltzer physicians had limited “the number of Medicaid or uninsured patients they could accept.”

According to the district court, the combination of St. Luke’s and Saltzer would “improve the quality of medical care.” Along with utilizing the same electronic medical records system and giving the Saltzer physicians access to sophisticated quality metrics designed to improve their practices, the parties would improve care by abandoning fee-for-service payment for all employed physicians and institute population health management reimbursing the physicians via risk-based payment initiatives.

As noted by the district court, these stated efficiencies would improve patient outcomes “if left intact.” Along with improving coordination and quality of care, the merger, as noted by an amicus brief submitted by the International Center for Law & Economics and the Medicaid Defense Fund to the Ninth Circuit, has also already expanded access to Medicaid and uninsured patients by ensuring previously constrained Saltzer physicians can offer services to the most needy.

The court ultimately was not persuaded by the demonstrated procompetitive benefits. Instead, the district court relied on the FTC’s misguided arguments and determined that the stated efficiencies were not “merger-specific,” because such efficiencies could potentially be achieved via other organizational structures. The district court did not analyze the potential success of substitute structures in achieving the stated efficiencies; instead, it relied on the mere existence of alternative provider structures. As a result, as ICLE and the Medicaid Defense Fund point out:

By placing the ultimate burden of proving efficiencies on the Appellants and applying a narrow, impractical view of merger specificity, the court has wrongfully denied application of known procompetitive efficiencies. In fact, under the court’s ruling, it will be nearly impossible for merging parties to disprove all alternatives when the burden is on the merging party to oppose untested, theoretical less restrictive structural alternatives.

Notably, the district court’s divestiture order has been stayed by the Ninth Circuit. The appeal on the merits is expected to be heard some time this autumn. Along with reviewing the relevant geographic market and usage of divestiture as a remedy, the Ninth Circuit will also analyze the lower court’s analysis of the merger’s procompetitive efficiencies. For now, the stay order is a limited victory for underserved patients and the merging defendants. While such a ruling is not determinative of the Ninth Circuit’s decision on the merits, it does demonstrate that the merging parties have at least a reasonable possibility of success.

As one might imagine, the Ninth Circuit decision is of great importance to the antitrust and health care reform community. If the district court’s ruling is upheld, it could provide a deterrent to health care providers from further integrating via mergers, a precedent antithetical to the very goals of health care reform. However, if the Ninth Circuit finds the merger does not substantially lessen competition, then precompetitive vertical integration is less likely to be derailed by misapplication of the antitrust laws. The importance and impact of such a decision on American patients cannot be understated.