Evanston Northwestern Healthcare Corporation Must Divest Highland Park Hospital - Administrative Law Judge Rules for FTC.

The federal antitrust enforcement program against hospital mergers has been notable for the fact that the government lost more than a half dozen merger cases in the courts over the last decade. The Federal Trade Commission (FTC) has responded to this adverse precedent by embarking on a retrospective analysis of hospital mergers, and targeted one consummated merger as an apparent test case to demonstrate the anticompetitive effects such mergers produce and create new jurisprudence that would reinvigorate the hospital merger enforcement program. Last week, the first major step toward implementing that strategy occurred in a preliminary decision in the consummated merger case.

In January 2000, Evanston Hospital ("Evanston") and Glenbrook Hospital ( "Glenbrook") merged with Highland Park Hospital ("Highland Park") to form the Evanston Northwestern Healthcare Corporation ("ENH"). Over four years later, on February 10, 2004, Complaint Counsel for the FTC filed a Complaint challenging the merger under Section 7 of the Clayton Act, 15 U.S.C. s. 18, asserting that the merger has substantially lessened competition.

On October 20, 2005, the Administrative Law Judge (ALJ) ruled that ENH had lessened competition and that it would be required to divest Highland Park. Highland Park has announced it will appeal to the FTC and, if necessary, the courts. The case is far from over, and any "lessons" derived are preliminary.

Background

In its complaint, the FTC alleged that the merger of ENH and Highland Park had substantially lessened competition in the market for general acute care inpatient services sold to managed care organizations in an area along Lake Michigan in Chicago's Northshore area. In case the evidence was so strong that the precise definition of product and geographic markets was not needed, the FTC also alleged that the merger of ENH and Highland Park had substantially lessened competition without alleging a relevant product or geographic market.1

Trial commenced on February 10, 2005 and continued for eight weeks. Closing arguments were heard on July 7, 2005. The deadline for filing the Initial Decision within one year of the Complaint was extended several times, with the ALJ finally filing the Initial Decision on October 20, 2005.

The Decision

Most merger challenges occur preclosing, and as the ALJ acknowledged, this case presented a rare opportunity to examine the actual effects of a merger. As in any case analyzing the effect of a merger under Section 7 of the Clayton Act, the ALJ first determined the relevant product market and geographic market. Then, the ALJ analyzed whether anticompetitive effects were probable. The ALJ was able to use market concentration statistics and, unique in this case, post-acquisition evidence. Finally, ENH's procompetitive justifications and affirmative defense were assessed.

The Markets

The ALJ found that the relevant product market in this case was general acute care inpatient services sold to managed care organizations, including primary, secondary, and tertiary inpatient services. The product market did not include specialty hospitals that did not provide the full range of hospital services. The ALJ also noted that outpatient services did not substitute for inpatient services.

In many of the previous government merger cases, the case foundered because the government failed to prove its alleged relevant geographic market. Here again, the ALJ rejected the FTC's staff proffered market, but went on to define a market himself. The ALJ found that the relevant geographic market was the area encompassing the following seven hospitals in Chicago's Northshore area: Evanston, Glenbrook, Highland Park, Lake Forest, Advocate Lutheran General, Rush North Shore, and St. Francis. Since Evanston, Glenbrook, and Highland Park are part of ENH, the relevant geographic market thus included only four other competing hospitals.

A key question was which hospitals managed care organizations need to have in their hospital networks in order to establish viable, competitive networks, and the ALJ noted the importance of local hospitals in this analysis. Thus, the ALJ did not examine any data concerning where patients actually received acute care inpatient services because he felt this data did not address the question of which hospitals patients wanted in their managed care organizations' hospital networks. In fact, the FTC Staff offered Professor Kenneth Elzinga as an expert to opine that patient flow data and the Elzinga-Hogarty Test are not relevant to the geographic market analysis.

Instead, the ALJ weighed whether managed care organizations described facilities as competitors to Evanston and Highland Park, and several other hospitals that ENH had characterized as competitors in the geographic market were excluded as a result of testimony by managed care organizations. The ALJ also examined how far consumers were willing to travel, and the ALJ thus looked to the driving time from Evanston and Highland Park to other facilities to determine if they were in the relevant geographic market.

Using the relevant markets as a framework, the ALJ looked to the market shares of the seven hospitals in the geographic market and determined that a concentrated market was made even more so by the merger of Evanston, Glenbrook, and Highland Park. For instance, ENH increased its market share from 35 to 40% from 1999 to 2002 while the market shares of its four competitors fell in that same time period. Thus, the FTC had demonstrated sufficient market concentration to predict probable higher prices as a result of the merger.

Evidence of Price Increases

Because this was a consummated merger, the FTC staff was also able to rely on other evidence to establish that ENH achieved higher prices as a result of the merger. Documents from both Evanston and Highland Park described one of the main benefits of a potential merger as ending competition between the two hospitals, and the ALJ saw this as evidence that the primary motivation for the merger was to gain market power that could then be used to gain better leverage in negotiations with managed care organizations.

In addition, EHN began to use this market power by increasing prices to managed care organizations before the merger was even completed. ENH decided that all three hospitals would operate under one contract and demanded the same rate regardless of the level or complexity of services provided at each hospital. In determining the rate, ENH chose the higher of Evanston or Highland Park's rate and added a "premium" on top of that, resulting in at least an $18 million savings for ENH. ENH also implemented "discount off charges" arrangements which allowed it to set its own prices with the managed care organizations. Moreover, ENH combined the Highland Park and Evanston chargemasters and adopted the higher rate for each item resulting in a $5 million savings in just nine months. Then, once this consolidation was completed, ENH raised its chargemaster rates four times from 2002 to 2003.

The testimony of managed care organizations confirmed that ENH used its new market power to gain better leverage in contract negotiations. Before the merger, managed care organizations obtained competitive pricing from Evanston and Highland Park because they could choose between the two. After the merger, managed care organizations were only able to obtain higher pricing from ENH, a fact that ENH celebrated in its internal documents.

Importantly, ENH's prices also rose relative to the prices of other hospitals, and the increase was not the result of market changes that would have affected all hospitals equally. The FTC's expert compared price increases implemented by ENH post-merger to price increases implemented by other hospitals in her control groups and found that, across all managed care plans, ENH's price increases exceeded the control groups by 11 to 18%, i.e., if other hospitals raised their prices by 10%, ENH raised its prices by 21 to 28%. Even under ENH's expert's calculations, ENH's post-merger price increases were 9 to 10% higher than price increases by hospitals in his control groups. The ALJ concluded that these relative price changes, not relative prices, were the appropriate methodology to test for market power.

ENH's Justifications for Higher Prices Rejected

ENH argued that the price increases were the result of its "learning about demand" for its services and that the price increases could be accounted for by post-merger "quality of care improvements" to Highland Park. The ALJ rejected both arguments.

ENH argued that some of Highland Parks' contract rates were below market and that the post-merger price increases brought its prices up to the level charged by other hospitals. Although some price increase may have been justifiable based on outdated contracts, the level to which the prices were raised was well in excess of the reasonable increase anticipated by managed care organizations. Nor were the price increases justified based on Evanston or Highland Park's status as teaching hospitals. Moreover, ENH's expert did not present viable evidence to support its theory. In fact, the ALJ found that the price increases ENH was able to command after the merger were the result of a newly created market condition, namely the elimination of Highland Park as a price-restraining competitor.

ENH also contended that the quality improvements at Highland Park justified ENH's increased prices and outweighed any anticompetitive effects of the merger. Under merger jurisprudence, it has been unclear whether quality should be considered a procompetitive justification, an affirmative defense, or an efficiency. The ALJ decided to analyze it as a procompetitive justification under the competitive effects analysis of the merger. However on the facts, while noting that there had been significant improvements to Highland Park, the ALJ pointed out that there was no quantifiable evidence that the improvements at Highland Park enhanced competition and thus benefited consumer welfare. In addition, there was no way to determine whether the improvements at Highland Park were due specifically to the merger or to nationwide efforts to improve patient care. Finally, two of the improvements made to Highland Park's organization were found to be merger-specific, but these were not enough to overcome the anticompetitive impact of the post-merger price increases.

ENH's Affirmative Defenses Also Rejected

ENH asserted several affirmative defenses. First, ENH argued that its non profit status and commitment to the community should be taken into account. ENH also argued that other hospitals could reposition themselves to compete with ENH as a result of the merger, and that hospitals could and did expand their service offerings and capacity in response to the merger. In addition, ENH argued that Highland Park's status as a failing firm should be taken into account. Finally, ENH asserted that Evanston and Highland Park were already a single entity because they were part of a common network and that they were not capable of conspiring with each other under Copperweld. The ALJ rejected them all, holding that the only viable explanation for ENH's higher prices was that the merger enhanced ENH's market power by eliminating a competitor.

Divestiture Required

Because the FTC had proved that the challenged merger has substantially lessened competition, and ENH did not have any viable procompetitive justifications or affirmative defenses, the ALJ determined that the appropriate remedy for the violation was full divestiture of Highland Park. The ALJ said this was the most effective remedy to restore competition to that which would have existed without the merger and which is necessary and in the public interest to eliminate the ill effects of the acquisition.

We will continue to follow this case, and will report on any future developments.

Footnotes

1 An additional part of the Complaint, which alleged claims against ENH Medical Group, Inc., an associated physician practice, was resolved by a consent decree approved and ordered by the FTC on May 17, 2005.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

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