Hospital mergers and antitrust: some economic and legal issues

American Journal of Economics and Sociology, The,  July, 1995  by Sarah E. Whitesell,  William E. Whitesell

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I

Introduction

The hospital industry has changed remarkably in the last decade and a half as the federal government has accelerated a reversal of a health care policy that encouraged the expansion of the hospital industry. Costs of hospital care have increased about two-thirds faster than the C.P.I. during most of the period; and hospitals have merged, in part, to increase efficiency. Health planning and cooperation among providers have in turn led to clashes with policy initiatives in antitrust enforcement. The conflict between health care policy and antitrust enforcement has been played out in a series of federal challenges to hospital mergers. These antitrust actions raise questions about the applicability of traditional legal-economic antitrust analysis to the hospital market, some of which are addressed in this paper.(1)

This paper considers changes in the hospital market(2) that have led to the spate of hospital mergers in recent years and then considers the peculiar nature of the hospital market in light of the traditional competitive paradigm. The analysis suggests that current antitrust laws are flexible enough to take account of the peculiarities of the hospital market, briefly notes the antitrust laws relevant to hospital mergers, and discusses their appropriate application in the hospital merger arena. The concluding recommendation is that proposed reforms in health care delivery systems maintain traditional skepticism regarding benevolent behavior by monopolists.

II

Growth and Change in the Hospital Market

The flurry of activity in the hospital merger area over the past decade results from a variety of changes, including changes in the market for delivering hospital services per se. The changes in hospital markets reflect changes in national health care policy, efficiency pressures from state agencies and insurance carriers, a desire by hospitals to increase their relative strength in bargaining with the insurance industry, and similar factors.

The federal government has been a major factor in the hospital market for almost sixty years. For example, federal capital assistance programs have, since their beginning around the time of the Great Depression, provided hospitals with billions of dollars in federal money, leveraging federal dollars to encourage state and local governments to make similar investments in health care facilities and services.(3) Medicare and Medicaid, implemented in 1965 to increase access to health care, dramatically increased the federal government's health care financing, including the government's share of hospital spending.(4) The government provided cost-based reimbursement to hospitals for Medicare and Medicaid patients and encouraged hospitals to expand services and make capital expenditures.(5)

Generous cost-based third party payment systems increased demand for medical services and thereby encouraged the for-profit sector of the hospital market, particularly in large health care delivery corporations They grew explosively in the seventies and early eighties. Investor-owned hospitals, including multihospital systems grew largely through mergers, gaining power from their ability to raise capital to restructure their firms to respond to changing market conditions. Multihospital systems and hospital management chains also benefited from economies of scale relevant to purchasing, management, and compliance with regulatory requirements; and they gained market power in bargaining with the insurance industry.(6) Additional expansion came when non-profit hospitals contracted for management by investor-owned companies.

The dramatic increase in hospital construction and use was followed by concerns regarding overuse of hospital facilities, over-investment in hospital facilities, and rising costs.(7) Government began to reverse its policies.(8) This has been apparent in Social Security amendments as well as changes in the Medicare and Medicaid programs. Further, by obtaining waivers from federal requirements under federal Medicaid rules, many states have developed cost containment strategies for their own Medicaid programs. In an effort to avoid shifting of Medicare and Medicaid reimbursement shortfalls, insurers have similarly tightened their reimbursement policies.(9)

Thus, changing national health policy helped to pave the way for expansion and then for restructuring the hospital market. As the cost of hospital care has continued to climb, several trends have characterized the industry since 1983 and have contributed to a significant number of hospital mergers. Such trends include (1) changes in medical practice and the shift to outpatient facilities, (2) attempts by some hospitals to compete for doctor loyalty and patronage by installing relatively more sophisticated medical equipment, and (3) rising costs and decreasing government reimbursements, not to mention (4) the desire of hospitals to increase their bargaining power in dealing with the insurance industry. All these have been factors affecting the desire of hospitals to merge, thereby setting the stage for potential conflicts with traditional antitrust philosophy.(10) One may speculate about specific reasons why these changes may have prompted individual hospitals to consider merger alternatives administrators might earlier have rejected. However, it is reasonable to suppose that hospital administrators have begun to recognize that the changes just noted have obvious implications for profitability, an item that may have been of less pressing concern before changes began to erode patient volumes and revenues generally. This would help to explain why both nonprofit and profit-oriented hospitals seem increasingly interested in combinations.