Legal fight over IDN mergers leaves future of health system consolidation in limbo

The Federal Trade Commission is now 0-for-2 in health system merger challenges this year, and may soon be 0-for-3 pending a case in West Virginia.  News outlets have proclaimed that this week’s decision by a U.S. district judge to allow the merger of Chicago’s Advocate Health Care and NorthShore University HealthSystem over FTC objections could prompt a new wave of hospital consolidation.

But before health system CEOs break out the champagne and call their crosstown rivals to create monopolies, let’s wait to see what health systems actually emerge in Chicago’s North Side, the Capital Region of Pennsylvania, and West Virginia.

The clear frustration of hospital executives and other observers is that Obamacare encourages larger, more integrated healthcare delivery. “We find it no small irony that the same federal government under which the FTC operates has created a climate that virtually compels institutions to seek alliances such as the Hospitals intend here.” That’s the opinion of the U.S. District Court for the Middle District of Pennsylvania, which denied the FTC’s preliminary injunction on the merger between PinnacleHealth and Penn State Hershey Medical Center in May.

This opinion goes on to compare the community medical center to a corner store— “a charming but increasingly antiquated concept.” But neither PinnacleHealth nor Penn State Hershey (nor Advocate nor NorthShore) are “community medical centers.” They each have significant market share and leverage within their service areas.

The FTC’s rationale is more nuanced than corner stores versus Wal-Mart. Think Costco versus Sam’s Club, where you buy an annual membership (a.k.a. health insurance) to one integrated delivery network or the other.

The agency is trying to determine the tipping point between a health system being large enough to create efficiencies, but not so large to demand exorbitant rate increases from payers. That tipping point appears to be if an insurer can create a viable insurance product that excludes the merged health system from its provider network. Can an insurer sell a viable product on Chicago’s Northside if Advocate/NorthShore is not in the provider network? Will anyone in Harrisburg buy insurance that directs them to hospitals 30 miles away in York? If the answer is “no,” then these merged health systems, with their associated physician groups, have insurers in a vise.

With the three merger challenges, the FTC has demonstrated its intent to stop any merger that would allow a single integrated delivery network to dominate a defined market or sub-market, preferring that local customers have access to at least two viable IDNs.

Obamacare has baked-in mechanisms (e.g., price transparency through the health insurance exchanges and inducements for value-based contracting through ACOs) that rely on market forces to lower costs and increase quality. But as with most industries, the fullest cost/quality potential is realized if there is intense competition between near-equivalent organizations.

Most healthcare markets are gravitating toward a dynamic where between two and four IDNs split the region, more or less evenly, in part because of fear of FTC retribution. Instead of creating a mammoth health system with Advocate, NorthShore could have been part of a counterbalance to Advocate by merging with some combination of Northwestern Memorial HealthCare, Rush System for Health, and Presence Health, which are all nearby health systems that Advocate/NorthShore contend the FTC left out of its market share calculations.

PinnacleHealth and Penn State Hershey sought to allay regulators’ fears by signing long-term contracts with their region’s major carriers, Highmark and Capital Blue Cross. While these five- and 10-year contracts, respectively, helped convince Judge John E. Jones III to deny the FTC’s preliminary injection in May 2016, these contracts appear to simply assure that the proposed Penn State Health will lock horns with Highmark in about five years.

What might save the Advocate/NorthShore merger is the promise to create a new insurance product, possibly available on the 2017 exchange with a premium 10 percent less expensive than other plans. If this is a precursor to the integration of payer and provider, Advocate/NorthShore has financial incentive to keeps costs (and therefore premiums) low.

An exemplar of the integrated payer/provider model is UPMC Health in Pittsburgh, which for the past two years has posted some of the lowest premiums for Silver plans not only in western Pennsylvania but in the nation. But UPMC has worked on its insurance product since the 1990s, and as its rival Highmark can attest, integrating payer with provider is a complicated, money-sapping process.

Advocate could rely on its experience with Blue Cross and Blue Shield of Illinois; the two introduced a narrow-network HMO exchange plan for 2016.

But BCBS Illinois has opposed the merger. That could be because Advocate/NorthShore would have something beyond negotiating leverage; the combined entity could conceivably not need to work with private insurers at all.

If all three FTC challenges are overturned and the mergers go through, there could indeed be a wave of health system mergers, with market-leading IDNs scooping up desirable hospitals within their regions. These mega-systems would work closely with an insurer or launch their own health plans, starting a negative feedback cycle where rival hospitals and insurers struggle to attract customers.

If the mergers are stopped, expect 40- to 50-percent market share to be a de facto cap for IDNs within a region. Large IDNs will instead affiliate with IDNs in nearby markets, forming regional clinically integrated alliances, none of which have a dominant market share within a specific market. Whole states and regions will divide into two or three competing alliances, with lower-premium insurance products directing to one or the other.

Of course, it is not necessarily the role of a district judge to look at national healthcare dynamics. The FTC, and higher courts, have the burden of broader implications of their decisions. Keep in mind that the Affordable Care Act survived legal challenges that won favor in lower court rulings. Both NFIB v. Sebelius (which challenged the individual mandate) and King v. Burwell (which challenged phrasing in the law concerning subsidies) were ultimately won by the government after lower court rulings gave hope to opponents of the ACA.

Mark Cherry is a principal analyst at DRG and a Hospitals and IDNs expert. Follow him on Twitter at @MarkCherryDRG.