Untangling Competitive Relationships in Health Care Mergers

In recent years, participants all along the health care industry’s value chain have increasingly pursued both horizontal and vertical consolidation. As a result, merger reviews and antitrust litigation have been on the rise.

Analysis Group has analyzed the complex, interrelated economics and competition impacts in health care markets for many important merger reviews.

• Managing Principal Kris Comeaux was part of the Analysis Group team working with St. Alphonsus in its challenge to the acquisition of the Saltzer Medical Group by a competing hospital, St. Luke’s. The Federal Trade Commission (FTC) filed its own challenge to the acquisition, which ultimately resulted in a ruling requiring St. Luke’s to unwind the already consummated merger. The case became a frequently cited precedent in the analysis of health care industry mergers.
• Following the St. Luke’s decision, Vice President David Toniatti was an instrumental member of the Analysis Group team working with the FTC in its challenges to the proposed mergers of Penn State Hershey Medical Center and PinnacleHealth System and Sanford-Mid Dakota in 2016 and 2017. In other insurance and hospital merger reviews, Dr. Toniatti also has worked with merging parties appearing before the US Department of Justice (DOJ) and the FTC.
• Vice President Jonathan Borck and Dr. Toniatti provided research and analytical support for an expert report prepared for the California Department of Managed Health Care (DMHC) in their review of Centene’s and Magellan’s proposed merger in that state in 2021.
• A team from Analysis Group led by Principal Mark J. Lewis and Vice President Emily Cotton supported affiliated expert Professor Catherine Tucker, who testified on behalf of UnitedHealth Group (a multinational managed health care and insurance company) in its successful defense to the DOJ’s challenge of its acquisition of claims processing company Change Healthcare.

Ms. Comeaux spoke with Dr. Toniatti and Dr. Borck about the current state of competition analysis in health care merger reviews, following the St. Luke’s decision.

Ms. Comeaux: The FTC had gone through a long stretch when it didn’t bring any successful challenges to hospital mergers, but that began to change in the early 2010s with a number of successful litigations, including St. Luke’s. How have the precedents set in these cases impacted competition analyses in your work on mergers?

Dr. Toniatti: Part of the reason the FTC started to find success in the courts, including the St. Luke’s case, is because it was able to leverage recent economic research that provided a framework for modeling interactions of the different parties in the health care industry. The model commonly used when evaluating mergers of hospitals or other health care providers is what economists call a two-stage model of competition. In the first stage, insurers negotiate with providers to create networks for their plans. In the second stage, patients choose which hospital or provider to go to for care. The factors driving competition in each stage are different but related.

Dr. Borck: To add a bit more color to Dave’s comments about the two-stage model, proponents favor it because it tries to mirror the realities of how demand for health care services is met in the US. Providers negotiate rates with insurers to develop plans that are attractive to subscribers, while patients choose which hospitals or doctors to go to for a wide variety of reasons, only some of which may be related to cost. Those reasons can include the distance that a patient would have to travel for a specific service, the relationship between a physician and the patient, the reputations of competing hospitals and practices, and the patient’s loyalty to their primary care provider.

Ms. Comeaux: Can you talk more about the role of key tools, such as diversion analyses and willingness-to-pay analyses, in reviews of hospital mergers?

Dr. Borck: Diversion analysis continues to be a common screening tool that the FTC and DOJ use in hospital mergers, as well as in reviews in other industries. In health care, the idea is that diversion analysis predicts where a patient might go if they do not go to their preferred provider. It’s most directly relevant to the second stage of competition that deals with patient decisions.

But diversion ratios can be indirectly relevant to the first stage of competition when evaluating how a proposed transaction could affect a provider’s bargaining leverage with an insurer. In this first stage, what is relevant is the extent to which an insurer views merging providers as substitutes for each other in their networks. While there are limitations, diversions can sometimes provide some insight into how patients rank providers, which can affect the leverage a particular provider may or may not have in negotiating rates.

Dr. Toniatti: I would offer a similar answer for the willingness-to-pay, or WTP, analysis. This is also a common screening tool that the agencies use. The purpose of the WTP analysis is to estimate how much a patient values having a particular provider in an insurer’s network. An assumption is that when two providers merge, they will negotiate jointly with an insurer. The question then is whether the value of including both providers in an insurer’s network post-merger is greater to a patient than the combined value that each provider offers separately pre-merger.

Much of this work originated with Professor David Dranove, along with other economists. Professor Dranove, as you know, testified in the St. Luke’s matter, and we have worked with him often in other matters, including the DOJ’s challenge to the proposed Anthem/Cigna merger.

Ms. Comeaux: How have these analyses evolved or been refined in the decade since St. Luke’s?

Dr. Toniatti: As with any economic model, some simplifying assumptions are necessary. One assumption of this two-stage model is that providers are assumed to be substitutes to insurers. On several projects with my colleagues Dov Rothman and Chris Ody, we’ve leveraged more recent economic research to better understand how insurers compete with one another.

In our research, we’ve found that it’s perhaps less widely recognized that the different hospitals can also be seen as complements, rather than substitutes, by insurers. When hospitals are considered substitutes by insurers, then including one hospital in an insurer’s network makes it less valuable to the insurer to include the other hospital. It’s possible in some settings that an insurer might only need one or the other hospital, not both.

 

But when two hospitals are complements, an insurer may find that including one hospital in the network makes it more valuable to include the other hospital as well, because, for example, including the first hospital increases how many additional members the insurer can attract by adding the second hospital. This can be the case when two hospitals offer key services that are difficult or impossible to replace with services from other hospitals.

If complementary hospitals merge, then the combined entity actually can have less bargaining leverage with an insurer than each hospital had independently. The economic intuition is similar to what’s observed in patent negotiations or other areas where there are complementary inputs to a product.

In patent litigation, for example, if a manufacturer needs multiple patents for a product, each patent holder can “hold up” the manufacturer because the full value of the product depends on each patent. This “hold up” problem is reduced if the patent holders negotiate collectively with the manufacturer.

The logic is the same when hospitals negotiate collectively with an insurer. Hospitals can often be complements in some ways and substitutes in other ways.

Ms. Comeaux: That’s interesting, particularly when thinking about how the lines between classical vertical and horizontal effects may become blurred in health care markets. For example, in many respects St. Luke’s was a more classical vertical merger—a hospital acquiring a downstream physician group, which typically would refer patients to a hospital for complementary services outside the scope of the particular practice. But St. Luke’s also involved horizontal concerns about head-to-head competition in the provision of primary care services, which were offered both by the hospital and by the physicians in the private practice.

It seems increasingly common that there are both vertical and horizontal components to health care mergers. How do you think about the complexity that arises in these cases?

Dr. Borck: The approach can vary depending on the particular setting. Any large health care system or hospital is organized into and operates multiple lines of business, all of which may have different operating characteristics, different markets, and different payment structures.

Many hospitals employ physician groups and therefore compete horizontally with private practices in the same geographic area. But as you point out in the St. Luke’s example, the hospitals also rely on referrals from those same private practices. As health care providers expand to serve multiple markets and provide a wide range of services to consumers, these competitive concerns proliferate, and our analyses may find that a merger both increases competition in one product or geographic market, and at the same time lessens competition in another.

The Centene/Magellan merger gives us examples of the complex interplay between customer and competitor relationships. On the one hand, there were what I might call “classical” horizontal effects about head-to-head competition for services that both companies provide. But at the same time, there were vertical effects because Magellan provides other services to Centene and also to Centene’s competitors.

 

Dr. Toniatti: That’s right. For the vertical story, we needed to consider in particular how Magellan providing behavioral-specific services affected Centene’s profits. A potential concern is that Magellan might have an incentive to charge higher prices to Centene’s competitors because that would benefit Centene, or as an extreme case, we considered whether Magellan would have an incentive to foreclose these competitors entirely.

At the same time, Centene and Magellan may have different incentives in their relationship with each other. Centene could have an incentive to set lower premiums if it effectively received behavioral-specific services “at cost.” This is the type of “elimination of double marginalization” effect that could lead to pro-competitive benefits from a merger.

Dr. Borck: A separate vertical question that is increasingly common is whether one of the parties—in this case, Magellan—might obtain competitively sensitive data from the other party—that is, Centene—who were customers of that party. So, all those different kinds of relationships and effects had to be examined within the context of how the combined entity would be allowed to operate.

Dr. Toniatti: How an upstream party might use competitively sensitive data to disadvantage or foreclose downstream rivals was certainly a key focus on the recent United/Change trial, which several of our colleagues worked on. We see in the court’s opinion an acknowledgement that, in theory, an upstream firm might have incentive to harm downstream rivals—and a more general recognition that a firm has an incentive to maximize its enterprise-wide profits.

But whether maximizing enterprise-wide profits means that a firm will actually try to harm its downstream rivals is a separate question and depends on the facts of the case. In the United/Change transaction, the court concluded that United’s testimony—particularly testimony about its corporate culture, its firewall policies, and its track record of protecting confidential data from rivals—established that United would have an incentive to preserve its multi-payer business model.

Ms. Comeaux: What do you see as the key takeaways from your work on these and other cases?

Dr. Borck: In the end, I think we can expect the relationships between health care organizations will only continue to grow more complex, and so the economic and market analyses required to understand competitive impacts will also need to be more sophisticated. It’s vitally important to be able to untangle this complex web of relationships when examining competitive effects.

Dr. Toniatti: That rings especially true given the pressure from Washington to increase scrutiny of large mergers. For example, back in January [of 2022], President Biden issued an Executive Order on actions to be taken to promote greater competition in specific industries, including health care. But today’s competition issues in health care are often not simple textbook cases of mergers of direct competitors (purely horizontal), or the acquisition of an upstream supplier by a downstream producer (purely vertical). We need to think about how these dynamics may strengthen or reduce competition. ■