By Greg Hammond, J.D.
The federal district court in Harrisburg, Pennsylvania, erred in finding that the FTC too narrowly defined the geographic market in its challenge to the proposed merger between Penn State Hershey Medical Center and Pinnacle Health System, the U.S. Court of Appeals in Philadelphia has ruled. Because the FTC demonstrated that the proposed transaction would be presumptively anticompetitive and the hospitals failed to rebut that presumption, the district court’s order was reversed and remanded, and the lower court was directed to enter the preliminary injunction (FTC v. Penn State Hershey Medical Center, September 27, 2016, Fisher, D.).
The FTC filed its administrative complaint in December 2015, alleging that the proposed transaction would violate Section 5 of the FTC Act and Section 7 of the Clayton Act by eliminating price competition, increasing the merged entity’s bargaining leverage, and eliminating vital quality competition in the Harrisburg area. The district court denied the FTC’s request for a preliminary injunction, finding that the FTC failed to meet its burden to properly define the relevant geographic market. Consequently, in the district court’s view, there was no way to determine whether the proposed merger was likely to be anticompetitive and the FTC could not show a likelihood of success on the merits. The FTC timely appealed.
Relevant geographic market. The FTC contended that the relevant geographic market was the "Harrisburg area," or the four counties encompassing and immediately surrounding Harrisburg, Pennsylvania: Dauphin, Cumberland, Lebanon, and Perry counties. The district court’s analysis, which found that the geographic market was insufficiently pleaded, erred in three ways, according to the appellate court. First, by relying almost exclusively on the number of patients that enter the proposed market, the lower court’s analysis more closely aligned with a discredited economic theory, not the hypothetical monopolist test. Second, the lower court focused on the likely response of patients to a price increase, completely neglecting any mention of the likely response of insurers. Third, the district court grounded its reasoning, in part, on the private agreements between the hospitals and two insurers, even though these types of private contracts were not relevant to the hypothetical monopolist test.
Market properly defined. The appellate court next concluded that the FTC met its burden to properly define the relevant geographic market. The FTC presented extensive evidence demonstrating that insurers would have no choice but to accept a price increase from a combined Hershey/Pinnacle in lieu of excluding the hospitals from their networks, the court determined. In particular, two of Central Pennsylvania’s largest insurers testified that they could not successfully market a network to employers without including at least one of the hospitals. Insurers also testified that they considered the Harrisburg area a distinct market and did not consider hospitals in other areas, such as York or Lancaster counties, to be suitable alternatives. The FTC’s evidence consequently showed that the increase in the hospitals’ bargaining leverage as a result of the merger would allow the post-merger combined Hershey/Pinnacle to profitably impose a significant non-transitory increase in price or "SSNIP" on payors.
Anticompetitive effects. The merger was deemed presumptively anticompetitive, according to the appellate court, because the FTC put forth undisputed evidence that the post-merger HHI would be 5,984—more than twice that of a highly concentrated market—and alleged that the post-merger combined Hershey/Pinnacle would control 76 percent of the market in Harrisburg.
Efficiencies. To rebut the FTC’s prima facie case, the hospitals set forth two efficiencies-based defenses, including that the merger would produce procompetitive effects, such as relieving Hershey’s capacity constraints and allowing Hershey to avoid construction of an expensive bed tower that would save $277 million—savings which could be passed on to patients—and the merger would enhance their efforts to engage in risk-based contracting.
The court rejected the efficiencies defense argument, finding that the claimed efficiencies were insufficient to rebut the presumption of anticompetitiveness. First, the evidence was ambiguous at best that Hershey needed to construct a 100-bed tower to alleviate its capacity constraints. Rather, the hospitals’ efficiencies analysis demonstrated that Hershey needed only 13 additional beds in order to operate at 85 percent capacity—a hospital’s optimal occupancy rate. Second, Hershey’s ability to forego building the 100-bed tower was a reduction in output, according to the appellate court, but the Merger Guidelines expressly indicate that the FTC will not consider efficiencies that "arise from anticompetitive reductions in output or service."
With regard to the hospitals’ argument that the merger would enhance their efforts to engage in risk-based contracting, the appellate court concluded that it was not clear from the record how this would be so beyond the mere assertion that it would save the hospitals money and that such savings would be passed on to consumers. An efficiencies analysis requires more than speculative assurances that a benefit enjoyed by the hospitals would also be enjoyed by the public, the appellate court stated. Further, it was unclear how the ability to engage in risk-based contracting would counteract any of the anticompetitive effects of the merger. The supposed benefit was also not merger specific.
Anticompetitive effects. The hospitals also argued that because of repositioning by other hospitals in the area, the merger would not have anticompetitive effects. Although the appellate court agreed that recent affiliations and acquisitions in the Harrisburg area could assuage some of the concerns that the proposed combination would have anticompetitive effects, the court did not believe that repositioning by these hospitals would have the ability to constrain post-merger prices, as evidenced by extensive testimony by insurers that there would be no network without Hershey and Pinnacle. The appellate court consequently concluded that the hospitals have not rebutted the FTC’s prima facie case that the merger would likely be anticompetitive. The FTC therefore carried its burden to demonstrate that it is likely to succeed on the merits.
Weighing the equities. Lastly, the appellate court concluded that the equities favored granting the injunction. None of the private equities, or those equities that may have public benefit, on the hospitals’ side of the ledger were sufficient to overcome the public’s strong interest in effective enforcement of the antitrust laws, according to the court. Moreover, even accepting the hospitals’ assertion that they would abandon the merger following issuance of the injunction, the result—that the public would be denied the procompetitive advantages of the merger—would be the hospitals’ doing.
The case is No. 16-2365.
Attorneys: Michele Arington for the FTC. Bruce Beemer, Office of Attorney General of Pennsylvania, for Commonwealth of Pennsylvania. William D. Coglianese (Jones Day) and James P. Deangelo (McNees Wallace & Nurick LLC) for Penn State Hershey Medical Center and Pinnacle Health System.
Companies: Penn State Hershey Medical Center; Pinnacle Health System
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