Statement of the American Hospital Association
submitted to the Federal Trade Commission

March 25, 1996

On behalf of our 5,000 institutional members, the American Hospital Association (AHA) is pleased to submit suggestions for refining the Federal Trade Commission's analysis of efficiencies. As AHA's members participate in the restructuring of health care delivery, antitrust will continue to be an issue of fundamental importance.

Introduction

This is a critical time for hospitals and health care providers. Until the early 1970s, hospitals operated in an environment that encouraged the construction and expansion of hospital facilities and services. More recently, prospective fee schedules and capitated payments have put cost containment pressures on hospitals which, along with technological advances and changing clinical protocols, have reduced utilization of inpatient services and facilities and resulted in substantial excess capacity. In addition, proposed reductions in government reimbursement programs will, if enacted, affect the financial viability of many hospitals throughout the nation.

In short, hospitals that were encouraged to build capacity are now faced with increasing pressures to eliminate excess capacity and become more efficient. In this rapidly changing environment, hospitals are looking for ways to compete more effectively in the marketplace or, in some cases, to survive. Frequently, hospitals are finding that a merger with another hospital is the best way to achieve these goals.

Because hospital markets tend to be highly concentrated, in a large percentage of hospital markets, any merger between two hospitals is likely to be presumptively illegal under the Merger Guidelines. Historically, the enforcement agencies have been skeptical when merging parties advance efficiency justifications to rebut this presumption. Given the level of excess capacity that is characteristic of inpatient hospital services in many areas, and the increasing pressure on hospitals to operate efficiently, such hostility is unwarranted. The enforcement agencies should not, as they have done in the past, discount efficiencies as speculative, unsupported, or unlikely to be passed onto consumers.

Changes in Health Care Reimbursement and Delivery

Direct federal involvement in private hospital investment began during the Great Depression. After World War II, these efforts intensified with the establishment of the Hill-Burton Program, which subsidized the development of hospital facilities and services. By 1978, the program had used $4.4 billion in federal money to leverage another $9.1 billion from state and local governments. These funds were used to build 500,000 beds, nearly half the hospital beds in use in 1985.

Even more significant than the federal government's capital contributions to hospital construction has been the impact of the federal health care financing programs, Medicare and Medicaid. Prior to the implementation of Medicare and Medicaid in 1965, the federal government financed about 15 percent of hospital spending. Today, with federal financing of care for the elderly and disabled, total government spending accounts for more than 50 percent of community hospitals' net revenues, with Medicare alone accounting for 36 percent of such revenues. As the largest source of income for most hospitals, Medicare has had a profound effect on hospital organization and financial viability.

Initially, Medicare and Medicaid paid hospitals based on costs, giving hospitals an incentive to spend more, rather than less. Indeed, the "spend a dollar, get a dollar" incentive of cost reimbursement encouraged hospitals to expand services and invest in capital resources, particularly because Medicare and Medicaid increased hospital utilization by expanding access for the poor and the elderly. Also, because insurance insulated most patients from health care prices, hospitals competed on the basis of services, amenities, and quality. This competition further fueled investment in hospital facilities and equipment.

During the 1960s and 1970s, in an attempt to contain unnecessary duplication of hospital services, the federal government implemented a number of health planning programs whose purpose was to allocate health care resources and control capital. The federal government's health planning efforts began in 1966 with the Comprehensive Health Program (CHP). CHP focused on local determination of health priorities, and was concerned more with "planning" in its pure sense than regulation of health care spending. As health care costs escalated, the regulatory aspect of CHP was strengthened by the Social Security Amendments of 1972. In 1973, a proposal to combine the Hill-Burton program and CHP into a single, stronger program resulted in the National Health Planning and Resource Development Act (NHPRDA).

Ultimately, there was widespread dissatisfaction with the proscriptive approach of the NHPRDA, and federal health planning was largely abandoned in favor of a new reimbursement system adopted in the Social Security Amendments of 1983. These amendments implemented the prospective payment system (PPS), which, for most hospitals, replaced cost-based reimbursement with a set of fixed prices established by the federal government. If a hospital's costs exceed Medicare's fixed payment, the hospital must absorb the financial loss. If its costs are less than the payment, it retains the difference.

Because payments are fixed, hospitals have incentives to ensure that hospital stays are not extended unnecessarily and that patients who do not require hospitalization are treated on an outpatient basis. In some hospital markets, managed care organizations have reinforced the trend toward fewer and shorter hospital admissions. These trends will accelerate as federal and state governments encourage the movement of Medicare and Medicaid beneficiaries into managed care. At the same time, changes in clinical practice and medical technology have allowed more diagnostic and therapeutic services to be provided in an outpatient setting. The result has been a dramatic change in the way health care is delivered.

From 1983 to 1993, hospital admissions declined 14.9% and average length of stay decreased 7.1 percent. Declining inpatient utilization has been accompanied by a shift to outpatient treatment. Between 1983 and 1993, outpatient visits grew from 210,000,000 to 366,885,000, nearly 75 percent, while the number of outpatient surgeries soared 167.8 percent.

The new emphasis on outpatient care has left many hospitals with excess inpatient capacity. Average hospital occupancy rates declined from 75.9 percent in 1980 to 63.5 percent in 1991. During 1983 to 1993, daily patient census declined 21 percent. As a result, hospitals are now supporting a costly and underutilized infrastructure that was largely created by previous build-and-spend incentives. Significant excess capacity is now common in many hospital markets, and industry experts expect it to get worse. For example, last year a health care consulting group determined that Washington, DC, which has 5.36 beds per 1,000 population, needs only 2.47 beds per 1,000 population under current market conditions and would need only 1.51 beds per 1,000 population if the market were 100 percent managed care. A recent study by the AmHS Institute concluded that, based on hospital occupancy of 67 percent and assuming HMO use rates, there are 447,545 excess hospital beds in the country. Even if total patient days were 50 percent higher than HMO use rates, there would still be 207,000 excess beds.

Hospitals are searching for ways to reduce excess capacity, operate more efficiently, and realign the services they provide to their communities. Frequently , this involves mergers or other joint activity between competitors. Such consolidations can reduce overall health care costs by eliminating duplicate services and reducing the number of unused beds.

Critics have charged that cooperative activity is not necessary in order to reduce unnecessary duplication of services and excess capacity. They argue that unilateral activity by hospitals, such as closure, downsizing, or specialization, could achieve the same results. For a number of reasons, however, hospitals find it difficult or impossible to take such measures. Distressed hospitals are reluctant to close, even if they are experiencing severe financial troubles. Despite declining demand for inpatient services, the number of community hospital closures has decreased every year since peaking at 85 in 1988. Last year, only 17 community hospitals closed. Nonprofit hospitals, in particular, view closure as a failure to fulfill their mission, and are likely to call on philanthropic and other support to meet obligations. Hospital trustees, who are frequently community leaders, are reluctant to close hospitals for a number of reasons. First and foremost, they do not wish to hinder their community's access to health care services. If no other hospitals are nearby, not only do inpatient services become unavailable, but physicians are less willing to practice in areas where there is no hospital to which they can admit patients. Trustees also face other community pressures to keep hospitals open. In many communities, hospitals are some of the largest employers, and hospital closure would be detrimental to the local economy.

Hospitals are also reluctant to specialize. Although attractive in theory, specialization requires a hospital to give up a segment of its business in the hope that it will gain new business in the services it retains. However, unless other hospitals in the market are likely to specialize in complementary ways, in response, (that is, give up the services in which the first hospital is specializing), the risk to the specializing hospital is significant. The risk to hospitals is accentuated by the fact that employers and managed care buyers in many markets appear to place a premium on "one-stop shopping"--the ability to obtain substantially all (or at least all the basic) hospital services from each contracting hospital. Specialization, therefore, can place hospitals at a distinct competitive disadvantage. While it may, in the short-term, cut costs and reduce the amount of excess capacity, it does not appear to be a viable long-term solution.

CONSIDERATION OF EFFICIENCIES IN HOSPITAL MERGERS

Standard of Proof

In the past, merging hospitals have been held to a strict "clear and convincing evidence" standard in proving efficiencies. Unlike the 1984 Department of Justice Merger Guidelines, the 1992 Merger Guidelines do not require that these efficiencies be demonstrated with "clear and convincing evidence." Some federal enforcement officials, however, have suggested that the clear and convincing standard is still valid.

Such a strict standard suggests that the efficiencies defense is disfavored. There is no evidence, however, that Congress ever intended the Clayton Act to disfavor efficiencies. Moreover, such a view would not serve the underlying purpose of the antitrust laws. Even the Federal Trade Commission Statement Concerning Horizontal Mergers required only "substantial evidence."

Because the merging parties have access to the relevant information showing efficiencies, they generally should have the burden of proof. Rather than being held to a strict standard of clear and convincing evidence, however, they should be held to a standard of substantial evidence. To the extent that the agencies have asserted that the parties do not have an incentive to provide information about the costs of implementation, they may require an assessment of these costs, including any obstacles to the merger. Indeed, failure to show the costs of implementation has been the principal reason efficiencies were not recognized in several recent cases. As hospitals grapple with declining demand, excess capacity, and a delivery system that is undergoing substantial restructuring, it is imperative that the agencies abandon their "dismissive" attitude toward efficiencies. Indeed, given the history of this industry, a showing that there is significant excess capacity in the market and that the proposed merger or affiliation will result in specific identifiable efficiencies should be sufficient evidence to evaluate those efficiencies in assessing the overall competitive effect of the merger.

Extent of the Efficiencies

As stated in the Merger Guidelines, "expected net efficiencies must be greater the more significant are the competitive risks" created by the merger. This means that, as a general rule, the agencies use a "sliding scale" to determine if net efficiencies justify a particular merger. In other words, for mergers in concentrated markets which substantially increase concentration, the amount of the net efficiencies would have to be significant to justify the transaction. On the other hand, for mergers in which there is only a slight increase in concentration, the net efficiencies would not need to be as significant.

While the balancing of anticompetitive effects, on the one hand, and efficiencies, on the other hand, will not necessarily be a mathematical computation, an understanding of the magnitude of the expected efficiencies is necessary for the efficiencies to have any meaning or be given any weight. Thus, while the balancing should be a qualitative analysis, it cannot be conducted without some mathematical computation.

The difficulties in establishing net efficiencies and in weighing them against likely anticompetitive effects have led Chairman Pitofsky to propose that, in moderately concentrated markets where the Herfindahl-Hirschman Index was below 1800 and the merged firms' post-acquisition market share was less than 35 percent, efficiencies should be an absolute defense. While this approach has some merit in that mergers in the moderately concentrated category generally tend to present less anticompetitive risk, Chairman Pitofsky's suggestion of barring the efficiencies defense where the acquiring firm has a market share of 35 percent or more and the acquired firm "has any significant market position (even 2 or 3 percent)," would unnecessarily deprive many merging hospitals with an opportunity to establish that significant efficiencies would offset an anticompetitive effect.

Least Restrictive Means

The 1992 Merger Guidelines require that efficiencies be "merger-specific." If "equivalent or comparable savings can reasonably be achieved by the parties through other means," the efficiencies are likely to be rejected or discounted by the agencies. In many cases this enables the agencies to second guess the business decisions of hospitals to merge rather than to combine in ways short of a merger. In some cases mergers may be preferable to other substitutes where, for example, there is likely to be an anticompetitive "spillover" effect or where the merger is more likely to assure such efficiencies which may only be theoretically possible under other relationships. In any event, in most cases a merger which results in substantial efficiencies is preferable to no efficiencies if the merger is not allowed to go forward. In addition, the Guidelines apparently require the parties to prove a negative--that there are absolutely no less restrictive alternatives that will achieve the same level of efficiencies. Although other means of achieving efficiencies (by joint venture, contractual arrangements, internal expansion, etc.) may theoretically be available, their practical feasibility may be difficult to assess because of a lack of information. While there may be documents to show that alternatives have been considered by the parties and why the parties believe the merger would be a better means of achieving the claimed efficiencies, in many cases such documentation does not exist. Moreover, there may be disagreements even within a hospital about the best way to achieve efficiencies.

If the agencies adopt a strict interpretation of the 1992 Merger Guidelines' "merger-specific" test, it may be nearly impossible for private parties to make such a showing--the evidence simply won't exist. While there might be a basis for requiring a substantial evidence test with respect to efficiencies, it is not desirable to maintain the same evidentiary standard in proving that an efficiency is merger-specific. Instead of requiring the merging parties to demonstrate that every possible alternative was considered and rejected as less effective, the parties should have to show only that the decision to merge was made for valid business reasons.

Plans for Implementing the Proposed Efficiencies

In the past, the agencies have required the merging parties to have a clear vision of the efficiencies that can realistically be accomplished through the merger, how to go about achieving them in practice, and how to overcome potential obstacles. They have required the parties to demonstrate in detail a commitment to follow through on any particular course of post-merger action to achieve those efficiencies. In this context, they have suggested that the community, including the medical staff, be advised of the hospital's post-merger plans. In some cases, the hospitals have even agreed with state regulators to achieve these efficiencies or be penalized. The agencies have indicated that the best evidence of the extent of achievable efficiencies is usually contained in internal plans and cost studies that precede the decision to merge. By the same token, the agencies have tended to review economic consultants' reports prepared after the decision to merge very critically on the ground that efficiencies can be ascribed to any transaction. However, this natural skepticism should not stand in the way of credible economic assessments since many hospitals do not document every step of the decision making process. While a detailed plan of implementation is desirable, many hospitals are reluctant to develop or communicate the specific plans prior to approval of their transaction. As a practical matter, many consultants assist hospitals through several stages of business planning. The first stage typically involves identification of areas of efficiencies so that the parties can determine whether the transaction makes sense from a business point of view. While this is a necessary step, it is rarely sufficient to establish that net efficiencies will be achieved.

A second step that is often undertaken is the identification and quantification of savings from specific administrative functions, support services, and clinical consolidations, together with an estimation of the costs of implementation. In some cases alternative plans are presented to show ranges of possible efficiencies. While this study is not sufficient to implement these efficiencies, it is usually a good faith undertaking to assist in the business planning of the hospitals and to estimate the net efficiencies likely to result from the transaction.

The third phase that may be undertaken by the hospitals, usually after approval of their transaction, is a detailed plan of implementation which takes into account all of the issues required for consolidation-- including space considerations, differences in employment practices and benefits, standardized protocols and procedures, and the like. Included within this plan of implementation are detailed recommendations regarding termination of employees, consolidation of services and, in some cases, closures of departments or facilities. While adoption of such a plan of implementation usually assures that such steps are taken, it is unrealistic to expect the merging hospitals to undertake this type of analysis and create this type of turmoil prior to approval by the agencies. Even when such a plan is devised, confidentiality concerns may prevent the disclosure of the plan to physicians and hospital personnel, even high-ranking executives. Disclosure to the public may also be problematic, and should not be required. A community, usually with little notice, cannot be expected to support uniformly a plan that will result in significant changes detrimental to at least some within that community. For this reason, efficiencies which are tied to a plan of implementation but which have not been presented in full to the merging hospitals or to the community at large should not be given less weight unless it can be shown that the parties do not intend to adopt such plan or that there are significant obstacles to implementation.

In addition, while the phases of an efficiency plan may be integrated and accelerated, there are also antitrust risks associated with the sharing of information and the allocation of services prior to approval of the transaction and its closing. Therefore, the parties must balance between identifying and committing themselves to particular efficiencies that may facilitate antitrust approval and the desire to obtain approval before undertaking the difficult tasks of fully advising the community and implementing the efficiencies. Moreover, because of antitrust concerns about premerger exchange of information, the parties should not be criticized for the inadequacy of company documents detailing the implementation of efficiencies.

Benefits to the Consumer

The agencies have indicated that, in order to justify a proposed transaction, the parties must pass on their net efficiencies to the consumer. However, this requirement has been interpreted narrowly by the agencies to require a reduction in rates. In several cases involving the state antitrust agencies, such rate reductions requirements have actually been set forth in consent judgments or decrees. Chairman Pitofsky has criticized the requirement that efficiencies must eventually lead to lower prices as a "killer qualification" because "it is difficult to see how any defender of a merger can demonstrate with certainty that the benefits of the merger will be passed along to consumers." It is more reasonable, however, to show that such a benefit is as probable as the merger's likely anticompetitive effect. Chairman Pitofsky argues that even when future cost savings can be satisfactorily established, their likely effect on future prices cannot be reasonably predicted. Thus, the lower price requirement can vitiate the defense. Similarly, Commissioner Varney believes that where a merger does not impose a severe threat to competition, efficiencies should be presumed to flow to the consumers.

The agencies have failed to consider sufficiently the non-price benefits that may inure to consumers as a result of a merger. "[M]ergers represent a significant mechanism for converting acute, inpatient capacity to other functions...[and] may offer an expeditious approach to structural change." Net savings can be used to offer new services or enhance existing services needed by the community. Assets previously tied up in unnecessary or duplicative resources can be converted to uses that better meet community needs. For example, closure of inpatient beds may result in the opportunity to add rehabilitation or long-term care, passing savings on to consumers not in the form of rate reduction, but in the form of new services. Also, because larger facilities tend to offer a wider array of services, mergers that increase the size of a facility are likely to expand the services available to the community.

In addition, the proposed affiliation or merger may enable the parties to continue to support significant charity care, but not enable them also to pass on rate reductions to the consumer. In 1993, hospitals provided $16 billion in uncompensated care, up from $6.1 billion just ten years earlier. During the same period, unsponsored care rose from $4.8 billion to $12.9 billion. Proposed cuts in federal health care spending will require hospitals to assume an even greater charity care burden.

Benefits may also be passed on to consumers in the form of higher quality. A number of studies have suggested that higher volume is associated with better outcomes. A 1983 study conducted by the Prospective Payment Assessment Commission found that hospitals performing fewer than 50 coronary artery bypass graft procedures had a 30-day post-admission mortality nearly 60 percent higher than hospitals performing 170 or more such procedures. The same study found that costs for the low-volume hospitals were 22 percent higher than at the high-volume hospitals. Another, more recent, study concluded that the size of hospitals is correlated positively with several different measures of hospital quality.

While the agencies may have a legitimate concern that after the proposed affiliation, none of the net savings will be passed on in any form, this is a question of the parties' intent. The agencies may consider this issue by direct evidence of the parties' intent or by assessing whether there is sufficient competition or sufficient payor market power to force the savings to be passed on to consumers. As a general rule, competition from similarly situated competitors will increase the likelihood that the savings will be passed on. Any efficiencies attained through a merger may be imitated by the merging parties' rivals within a reasonable period of time, which makes it more likely that the cost savings will translate to lower prices. This argument is particularly persuasive in the hospital industry where a strong, competing hospital or a powerful managed care payor may force efficiencies resulting from the merger to be passed on to the consumer. Thus, unless there is evidence of projected rate increases attributable to the merger or insufficient competition to force the savings on to the consumer, there is a significant likelihood that the savings will benefit the consumer either in the form of rate reduction, rate freezes, enhanced services or increased charity care.

The merging parties should not be required to prove that consumer benefits will occur immediately upon merging. The agencies have indicated that efficiencies may prevail even if there is some time lag between the realization of a merger's anticompetitive effects and the attainment of efficiencies. It should be sufficient that the parties intend to realize the efficiencies within a reasonable time after the merger.

Conclusion

Based on the above analysis, the American Hospital Association believes that the federal antitrust agencies should modify their policies and practices with respect to efficiency analysis as follows:

1. The agencies should recognize that most hospitals have the incentive to operate more efficiently in order to compete or, in some cases, to survive in a rapidly changing environment characterized by overcapacity and declining demand.
2. Because only the merging parties are aware of the efficiencies that the merger may achieve, they generally should have the burden of showing by substantial evidence that the net efficiencies offset any anticompetitive effects. The parties should not be held to a stricter standard of clear and convincing evidence.
3. The extent of the efficiencies necessary to justify a transaction should depend on the extent of the anticompetitive effect. In moderately concentrated markets where the post-acquisition market share is less than 35 percent, efficiencies should be an absolute defense. Parties should never be precluded from establishing efficiencies, regardless of market share.
4. To show that the efficiencies are merger specific, the parties should only be required to demonstrate that the decision to merge was made for valid business reasons after consideration of other options.
5. The merging parties should be required to identify with specificity the likely savings and the likely costs of implementation. The agencies should not required the parties to show detailed plans of implementation. Similarly, the agencies should not require the merging parties to disclose their plans to the public and/or hospital personnel.
6. It should be presumed that net savings will be passed on to consumers. If the agencies attempt to rebut this presumption, the merging parties may prove that consumers will benefit by introducing evidence establishing a clear plan of implementation, vigorous competition of similarly efficient competitors, or the power of managed care plans or other purchasers in the market. The parties should also be able to that the benefit to consumers may come in the form of rate reductions (or freezes), access to new or enhanced services, improved quality, or increased charity care.

These comments contain our recommendations for a few changes to the Commission's existing enforcement procedures. These changes could be implemented at the regulatory level without additional legislative authority. Our comments are limited to the agency's analysis of efficiencies. Additional modifications to antitrust enforcement will be necessary as hospitals and other health care providers prepare to deliver health care in a new environment, and we would be happy to provide the agencies with our suggestions for such modifications.