District Court Blocks FTC and PA AG Challenge to Hershey-Pinnacle Merger

Overview

On May 9, 2016, the US District Court for the Middle District of Pennsylvania denied the motion by the Federal Trade Commission (FTC) and Pennsylvania Office of Attorney General (together, the agencies) for a preliminary injunction to enjoin the merger of Penn State Hershey Medical Center (Hershey) and PinnacleHealth System (Pinnacle). The decision ends a string of victories by the FTC in recent health care merger litigation. The key issue in the case, and ultimately dispositive, was geographic market definition. Focusing on the “commercial realities faced by consumers in the region,” US District Judge John E. Jones III found the FTC’s proposed geographic market unrealistically narrow and said other hospitals within the region provided reasonable alternatives for patients. Long-term agreements with two commercial health insurers also were significant to the court’s analysis. Judge Jones found these agreements, which locked in rate structures and differentials for at least five years, “extremely compelling” evidence.

Although the decision is a setback for the FTC—and the Pennsylvania Attorney General, which has been among the most active state attorneys general offices in health care antitrust enforcement in recent years (see, e.g., Pennsylvania v. Geisinger Health Sys. Found., No. 1:13-cv-02647-YK (M.D. Pa. Oct. 25, 2013); Pennsylvania v. Geisinger Health Sys. Found., No. 4:12-cv-01081-CCC (M.D. Pa. June 7, 2012))—the matter is not yet resolved. On May 11, 2016, the FTC and Pennsylvania Attorney General moved for a temporary stay pending a planned appeal to the US Court of Appeals for the Third Circuit, and on May 12, 2016, they filed an emergency motion for an injunction with the Third Circuit. On May 12, 2016, the district court did not grant the temporary stay, but instead ordered a two-week extension of the temporary restraining order. Accordingly, the FTC and Pennsylvania Attorney General have until May 27, 2016, to persuade the Third Circuit to grant the injunction.

The Hershey-Pinnacle case is one of three hospital mergers the FTC has challenged since last fall. The hospital parties opposed the agency’s definition of the relevant geographic market in each case. Courts have not had occasion to address hospital geographic market definition during the recent wave of hospital mergers and FTC challenges to several of them. Hospitals and health systems pursuing mergers with a competitor should monitor these developing cases closely for new guidance from the courts.

Background

On December 9, 2015, the FTC and Pennsylvania Attorney General brought an action before the Middle District of Pennsylvania to temporarily restrain and preliminarily enjoin the parties’ from consummating the proposed merger pending a full administrative proceeding before the FTC on the merits of the case.

The agencies alleged that the proposed merger of Hershey and Pinnacle would result in a substantial lessening of competition for general acute care (GAC) inpatient hospital services offered in a four-county area around Harrisburg, Pennsylvania, (the Harrisburg Area). They contended that the proper relevant geographic market is one in which “consumers can practicably find alternative providers of the service,” and emphasized that health care consumers generally prefer to seek care relatively close to their home or workplace. In support of their alleged four-county geographic market, the FTC and Pennsylvania Attorney General further asserted that: (1) a large percentage of the patients in the four-county area seek GAC services within these four counties; (2) hospitals located outside the four counties do not draw many patients from within the four county area; and (3) health plans could not effectively market a network to employers and patients in the Harrisburg Area that did not include a hospital in these four counties. Within the Harrisburg Area, a combined Hershey and Pinnacle would have created the area’s largest general acute care system with a 64 percent market share.

After a five-day evidentiary hearing, the court denied the motion for a preliminary injunction.

The Court’s Analysis

Geographic Market

In the two previous hospital merger challenges that were litigated, the relevant geographic market was uncontested. Not so here. The defendants countered that the alleged Harrisburg Area market was far too narrowly drawn. The court found that the resolution of this threshold issue was dispositive to the case.

The agencies’ proposed geographic market reflected the FTC’s core view, expressed repeatedly in numerous recent merger challenges, that markets for GAC inpatient services are inherently local because patients prefer to seek care close to their home. In support of their proposed market, the FTC and Pennsylvania Attorney General argued that “very few” patients who live in the Harrisburg Area travel to hospitals outside of the four counties, and commercial health plans would not be able to successfully market a network that excluded Hershey or Pinnacle to employers and consumers in the Harrisburg Area. The availability of competing hospitals reasonably near the merging parties, with which commercial health plans can contract to form a marketable provider network in that area, is central to the FTC’s method for defining the relevant geographic market.

The court concluded that the agencies’ proposed geographic market was too small and unreasonably excluded important competitors to the merging parties. Instead of focusing, as the agencies do, on patient preferences for local care or on the location of hospitals to which commercial health plans turn for their provider networks, the court emphasized the substantial in-migration of patients from outside the Harrisburg Area. The court noted that 43.5 percent of Hershey’s patients (comprising over half of Hershey’s revenues) traveled to Hershey from outside the FTC’s and Pennsylvania Attorney General’s proposed geographic market. The court also noted that central Pennsylvania is highly rural, which obliges many residents to drive significant distances for goods and services. Applying this observation to hospital services, the court noted that half of Hershey’s patients drive at least 30 minutes for care, and that 20 percent of Hershey’s inpatients traveled more than an hour for their admission to Hershey. The court also highlighted that 19 hospitals are within a 65-minute drive of Hershey. Against this background, the court found the FTC’s and Pennsylvania Attorney General’s proposed market “unrealistically narrow” and divorced from the “commercial realities faced by consumers in the region.” Accordingly, the court held that the FTC and Pennsylvania Attorney General failed to demonstrate a likelihood of ultimate success on the merits.

Payor Contracts

Recently, Hershey and Pinnacle entered into five-year and 10-year agreements with Highmark and Capital Blue Cross—respectively—that require the hospitals to maintain existing rate structures for fee-for-service contracts and preserve the existing rate-differential between Hershey and Pinnacle. The court found these agreements with two of Pennsylvania’s largest commercial health plans to be “extremely compelling” evidence for the competition analysis. The FTC and Pennsylvania Attorney General argued that the court needed to consider what would happen to rates once these agreements expired, but the judge said that doing so would be “imprudent” in light of the “rapidly-changing arena of healthcare and health insurance.”

In light of the hospitals’ agreements with Highmark and Capital Blue Cross, the court found that it could not predict that the merger would allow Hershey and Pinnacle to impose an anticompetitive price increase. In doing so, the court implicitly rejected several FTC and Pennsylvania Attorney General arguments relating to these agreements, including that they: (1) were “strong evidence” that the health plans believed the merger would be anticompetitive; (2) would not prevent the merged entity from allocating more risk to the health plans and less risk to the merged entity in future risk-sharing agreements; and (3) would do nothing to address the anticompetitive effects of the merger on non-price competition between the hospitals, including expansion of services, quality of care, and the purchase and implementation of new technologies and equipment.

Equities

Having found the FTC and Pennsylvania Attorney General unlikely to prevail on the merits as a result of their failure to define a relevant geographic market, the court was not required to weigh the equities. Nevertheless, it did so and evaluated evidence presented by Hershey and Pinnacle that the merger would result in procompetitive efficiencies. The court found that the merger would alleviate some of Hershey’s capacity constraints by allowing Hershey—the more expensive, higher-acuity facility—to transfer patients immediately to Pinnacle’s less expensive, lower-acuity facilities, thereby permitting Hershey to forego the expense of constructing a new bed tower and shift patients to Pinnacle’s lower-cost setting of care.

Other Factors

The decision identified other factors in support of denying the motion for a preliminary injunction as well. The court found that the merging parties were already facing enhanced competition, by virtue of “extensive repositioning” by other hospital systems looking to “erode” the parties’ patient base, and that these hospital systems will competitively constrain Hershey and Pinnacle post-merger. The court also found that the merger would add scale and thereby create advantages related to risk-based contracting of the type encouraged by the Affordable Care Act (ACA), even though the judge agreed with the agencies’ contention that Hershey and Pinnacle already are “independently capable” of entering into risk-based contracts. This portion of the court’s opinion is dicta, but it is notable that a court has now recognized and credited a defense to an antitrust challenge to a healthcare merger based on provisions in the ACA.

Key Implications

Few courts have had occasion to address disputes over hospital geographic market definition during the recent wave of hospital mergers and FTC challenges. In light of this opinion, should it stand on appeal, hospital defendants in future cases will likely use patient flow volumes into and/or out of the government’s proposed market (although the Hershey court did not mention outflows) to argue for a market broader than that alleged by the government. A larger geographic market containing additional hospitals provides defendants greater opportunity to argue that competition will constrain them from raising prices after the merger.

Although this court seemed to diverge from recent case law by crediting risk-based contracting efficiencies, it is important to note that the court weighed the efficiencies only after finding that the FTC and Pennsylvania Attorney General could not establish a prima facie case. Accordingly, it is not clear that similar efficiency claims based analogous evidence, if presented in a hospital merger case with a different posture in terms of the court’s assessment of the government’s prima facie case, would be sufficient to overcome that merger’s potential adverse competitive effects.

The court observed that a tension exists between the antitrust laws and the Affordable Care Act, stating: “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.” FTC officials have repeatedly rejected this point of view, stating that the goals of the antitrust laws and the ACA are aligned. The extent to which this argument finds traction in the Third Circuit and in other courts remains to be seen.