Antitrust and nonprofit hospital mergers: a return to basics.

• Author: Richman, Barak D.

Courts reviewing proposed mergers of nonprofit hospitals have too often abandoned the bedrock principles of antitrust law, failing to pay heed to the most elemental hallmarks of socially beneficial competition. This Article suggests that courts' misapplication of antitrust law in these cases reflects a failure to understand the structural details of the American health care market. After reviewing recent cases in which courts have rejected challenges to proposed mergers between nonprofit hospitals, it documents how courts have engaged in a faulty analysis that ultimately protects nonprofit hospitals from the rigors of standard antitrust scrutiny. It then identifies the core principles of antitrust law--preventing supracompetitive prices, optimizing output, and maximizing allocative efficiency--that have been absent from, if not violated by, the rulings in these merger cases.

INTRODUCTION I. THE SETTING: COURTS' PROTECTION OF NONPROFITS II. A RETURN TO PRINCIPLES: UNDERSTANDING INSURANCE, MORAL HAZARD, AND CROSS-SUBSIDIES A. The Effects on Prices: Market Power Plus U.S.-Style Health Insurance B. The Effects on Output: The Antitrust of Overconsumption C. The Effects of Cost-Shifting: The Antitrust of Cross-Subsidies CONCLUSION INTRODUCTION

In recent years, courts reviewing proposed mergers of nonprofit hospitals have abandoned the bedrock principles of antitrust law. The hallmarks of socially beneficial competition--maximizing allocative efficiency and total surplus--are absent from their analysis. Not surprisingly, this trend has yielded a string of cases in which antitrust enforcers have lost challenges to proposed mergers that courts likely would have prohibited had they occurred in other industries. (1) This string of losses has troubled antitrust policymakers, (2) and has led some observers to wonder whether the core principles of competition law are being forsaken in favor of political expedience and favorable predispositions toward the health care sector. (3) One knowledgeable commentator has suggested that "the role of antitrust law in monitoring the health care industry faces an increasingly uncertain, and perhaps diminishing, future." (4)

The futility of Federal Trade Commission (FTC) and Department of Justice (DOJ) challenges in federal courts has caught the attention of many scholars and has prompted a search for explanations. Some have concluded that, as a general matter, courts do not want competition in the health care sector and prefer instead to entrust benevolent monopolists to act in the community's best interests. They thus delegate health care allocations to paternalistic hospitals rather than empower consumers to motivate the competitive process. (5) Alarmed by judicial declarations such as "[i]n the real world, hospitals are in the business of saving lives, and managed care organizations are in the business of saving dollars," (6) commentators in this camp conclude that the hospital merger cases amount to a carve-out of antitrust enforcement and "present some of the most serious and successful challenges to traditional economic presumptions that can be found anywhere in contemporary antitrust law." (7)

Other scholars attribute the losing streak to the complexity of hospital merger cases and the subsequent likelihood that judges will make mistakes in various steps of the legal analysis. (8) Determining the relevant geographic and product markets, for example, requires significant technical sophistication and commonly leads to judicial error. (9) Courts have also tended to underestimate a merged facility's market power. (10) In addition, recent decisions suggest that many courts fail to understand the nature of nonprice competition, such that a concern about escalating health care costs leads to the view that duplicative investments in technologies are socially wasteful, instead of a reflection of robust competition on quality. (11)

However, although some judges may be hostile toward competition in the health care industry, and even if the requisite antitrust analysis in these cases is difficult, the inability of courts to properly apply antitrust law in these cases reflects a more fundamental, and arguably more troubling, problem: a failure to understand how the structure of the American health care sector shapes market competition.

The most important features of the U.S. health care system include the financing of care through insurance, a tax system that subsidizes health insurance, a legal and regulatory system that tends to require all "medically necessary" care, and a reliance on private nonprofit institutions to provide care to the indigent, technological innovation, and other public goods. These features are critical in understanding the market for health care, and they accordingly shape a proper antitrust analysis. However, because courts have not adequately recognized the economic significance of these structural features, they have misunderstood the dangers of market power in the health care sector and have thus inappropriately relaxed the standards of antitrust law.

This Article attempts to refocus hospital merger review on the foundations of antitrust law. It begins with a review of recent cases in which the FTC and DOJ unsuccessfully challenged proposed mergers between nonprofit hospitals, documenting how courts have engaged in a faulty analysis that ultimately protects nonprofit hospitals from the rigors of standard antitrust scrutiny. The Article then identifies bedrock principles of antitrust law--preventing supracompetitive prices, optimizing output, and maximizing allocative efficiency--that have been absent from, if not violated by, the rulings in these merger cases.

1. THE SETTING: COURTS' PROTECTION OF NONPROFITS

   There is little dispute that when courts are asked to evaluate the potential benefits and harms of nonprofit market power, they are addressing issues of substantial policy importance. Rising health care costs are a matter of national alarm, and increasing attention has been paid to the growing market power accumulated by health care providers. Recent studies suggest that market power pervades the health care sector and is responsible for a torrent of supracompetitive--and even supramonopoly--prices. (12) Moreover, much of the recent rise in health care costs is directly attributable to increases in supply-side market power that are products of hospital consolidations and the growth of provider collaborations. (13) Antitrust agencies, which are empowered by the Clayton Act to investigate and challenge in federal court mergers that would lead to anticompetitive consequences, (14) appropriately identified growing hospital market power as an enforcement priority. As the merger wave of the 1990s spread to hospitals, federal and state antitrust policymakers mustered a number of ambitious challenges to proposed mergers of nonprofit hospitals. (15)

   However laudable these enforcement efforts were, antitrust enforcement agencies have found little success, losing each of the seven suits initiated since 1994 to challenge proposed hospital mergers. (16) Antitrust scholars have already spilled significant ink criticizing the judicial reasoning and outcomes in those cases. (17) However, retracing the development of these cases illustrates not only how the courts erred, but also how they became mistakenly preoccupied with a narrow legal question, how that preoccupation developed into a wholesale exemption, and how antitrust enforcers inadvertently fueled the mistaken emphasis. The narrow question that preoccupied the courts in each of these cases was whether nonprofits, especially when enjoying market power, exhibited pricing behavior that was statistically different from that of for-profit hospitals. While the question is potentially of great importance, since a nonprofit's failure to capitalize on market power (as for-profits are presumed to do) might militate against rigorous antitrust enforcement, its answer does not reveal whether nonprofits decline to exercise market power, which is the central concern in merger cases. Nonetheless, by myopically focusing on whether corporate form has any statistical significance at all, courts absolved nonprofits from appropriate scrutiny.

   Antitrust agencies had little reason to believe that courts in the 1990s would be so unreceptive to their merger challenges, since earlier courts were skeptical of carving out an antitrust exemption for nonprofit hospitals. In an important 1986 decision, Judge Richard Posner remarked, "The adoption of the nonprofit form does not change human nature, as the courts have recognized in rejecting an implicit antitrust exemption for nonprofit enterprises." (18) Judge Posner then went further, suggesting that nonprofits might even be more likely than for-profits to charge supracompetitive prices and engage in anticompetitive conduct: "[C]ompelled as they are to treat charity cases while minimizing the cost to the taxpayers of supporting the hospital, public hospitals are under added pressure to charge high prices to their paying (or insured) patients, which may make collusion particularly attractive to these hospitals." (19)

   A subsequent ruling from Judge Posner, in another FTC-challenged merger four years later, reiterated the same skepticism toward treating nonprofits differently from other hospitals: "We are aware of no evidence--and the defendants present none, only argument--that nonprofit suppliers of goods or services are more likely to compete vigorously than profit-making suppliers. Most people do not like to compete, and will seek ways of avoiding competition by agreement tacit or explicit...." (20) One year later, Judge Gerald Tjoflat expressed the same inclination to impose the antitrust laws with equal rigor on both nonprofits and for-profits. Citing both of Judge Posner's opinions, Judge Tjoflat concluded that "the nonprofit status of the acquiring firm will not, by itself, help...