If you are a health system or hospital thinking about a potential transaction and your lawyers have not spoken with you about hospital merger simulation, maybe you should be talking with someone else.

What is hospital merger simulation?

In recent years, the Federal Trade Commission (“FTC”) has come to rely more heavily on hospital merger simulation to predict the likely outcome of proposed hospital mergers.  At this year’s Antitrust in Health Care program co-sponsored by the American Health Lawyers Association, ABA Section of Antitrust Law, and ABA Health Law Section, attendees heard firsthand from the FTC economists (Brand and Garmon) who have applied merger simulation models used in other industries (e.g., airlines and retail products) to healthcare provider transactions.  In the paper accompanying their remarks, Brand and Garmon explain that “hospital merger simulation focuses on the extent to which a merger will change the bargaining positions of MCOs [managed care organizations] and hospitals.”  Unlike the traditional structural approach to merger analysis, “hospital merger simulations do not rely on the product and geographic market definitions.”  Instead, hospital merger simulation focuses on “willingness to pay,” or WTP for short.

What is WTP?

WTP “is defined as the value a hospital adds to an MCO’s provider network.”  Put simply, “[i]f a hospital is negotiating with a MCO for inclusion in its provider network and the network already includes similar, nearby hospitals, the hospital will add little in value to the network and will be unlikely to negotiate a high price from the MCO.”  Alternatively, “if a hospital is unique, with few nearby competitors offering similar services, the hospital will add substantial value to the MCO’s network, giving it the leverage to negotiate higher prices.”  According to Brand and Garmon, the “conceptual approach to WTP is based on the observation that the incremental profit of the hospital from reaching an agreement with the MCO should be directly related to the value the hospital adds to the MCO’s provider network from the perspective of consumers to which the MCO is selling its insurance product.”  In this way, hospital merger simulation attempts to answer the question whether the proposed merger will “alter the threat points in the negotiations between hospitals and MCOs.”

How can a hospital merger alter the threat points in the negotiations between hospitals and MCOs?

As Brand and Garmon explain, for mergers between hospitals that consumers view as substitutes, “if the hospitals bargain on an all-or-nothing basis,”—the most common negotiating strategy of hospital systems—“then the threat point of the MCO will rise (i.e., worsen) since the profit it would earn from marketing a network without one of the hospitals is lower if the other is also out of network.”  In other words, “it becomes more costly for the MCO to fail to reach an agreement with the combined hospitals if at least one hospital is part of the next-best network of the MCO in its negotiations with the other hospital.”  Thus, Brand and Garmon continue, “[t]he greater the importance of each hospital in this ‘walk away’ network for the MCO in its negotiations with the other, the greater the increase in the MCO’s threat point.”

What are the advantages of WTP?

Brand and Garmon say that there are a number of advantages with WTP, including (1) it correctly analyzes competition in hospital markets, meaning “a merger between hospitals that are close substitutes for one another from the perspective of consumers will likely induce a larger change in WTP than a merger between more-distant substitutes” and (2) “it is not necessary for the analyst to specify which hospitals are to be included ‘in the market’ and which are to be excluded.”

Is WTP the end of the story?

No.  As the FTC’s challenges to hospital mergers make clear, what you write, say, and how others (MCOs, for example) view the proposed transaction matters.  Indeed, traditional structural analysis still is deeply imbedded in how courts decide hospital merger cases, but WTP has found its way into recent court challenges (e.g., OSF and ProMedica).  In the end, WTP may help push the FTC one way or another in deciding whether to challenge a particular transaction, but the other pieces of the story still matter if a transaction ends up in court.

Drawing on the experience of members of our healthcare team in complementary areas of health law, including transactions, tax, labor and employment, and healthcare regulation, our team of antitrust lawyers have the depth and experience to handle the most significant antitrust healthcare matters, including transactions and investigations.  If you have any questions regarding this matter, or would like to learn more about our healthcare antitrust capabilities, please contact Jonathan L. Lewis, jllewis@bakerlaw.com or 202.861.1557, or Lee H. Simowitz, lsimowitz@bakerlaw.com or 202.861.1608.