Hospital Mergers and Competitiveness

Ian McCarthy | Emory University

Measuring competitiveness

Measuring competitiveness

  • Common measure is Herfindahl-Hirschman Index (HHI), \(\sum_{i=1}^{N} s_{i}^{2}\).
    • 2,500 is considered highly concentrated
    • 1,800 is considered unconcentrated
  • “Willingness to pay” is more recent measure (theoretically supported)
  • Both require a measure of the geographic market

Cournot Competition Model

  • Objective: Firms \(i = 1, \dots, N\) choose quantities \(q_{i}\) to maximize profits.

  • Profit function: \[\pi_{i} = q_{i} (P(Q) - c)\]

    where:

    • \(Q = \sum_{i=1}^{N} q_{i}\): Total market output
    • \(P(Q) = a - bQ\): Inverse demand function
    • \(c\): Marginal cost (assumed identical for all firms)

First-Order Condition for Profit Maximization

  • Each firm maximizes profit by choosing \(q_{i}\) such that: \[\frac{\partial \pi_{i}}{\partial q_{i}} = P(Q) + q_{i} \frac{\partial P}{\partial Q} - c = 0\]

  • Substitute \(P(Q) = a - bQ\) and \(\frac{\partial P}{\partial Q} = -b\): \[P(Q) - c = b q_{i}\]

    This leads to a Cournot-Nash equilibrium in quantities.

Deriving the Markup Over Marginal Cost

  • Rearrange to express the markup of price over marginal cost for firm \(i\): \[\frac{P(Q) - c}{P(Q)} = \frac{b q_{i}}{P(Q)}\]

  • Using market share \(s_{i} = \frac{q_{i}}{Q}\): \[\frac{P(Q) - c}{P(Q)} = \frac{s_{i}}{\epsilon}\]

    where \(\epsilon = \frac{P}{Q} \cdot \frac{dQ}{dP}\) is the market demand elasticity.

Connecting Markup to HHI

  • Define the Herfindahl-Hirschman Index (HHI) as: \[\text{HHI} = \sum_{i=1}^{N} s_{i}^2\]

  • Conclusion: Higher market concentration (higher HHI) leads to higher markups over marginal cost, linking market power (HHI) to markup in Cournot competition.

Defining the market

Lots of subjectivity…

  • Radius around a hospital?
  • Concentric circles to define “catchment” areas?
  • Patient/physician referrals?
  • At what product-level do hospitals compete?

Hospital concentration over time

Hospital concentration over time

Hospital concentration over time

Why?

Historical perception of hospital competition as “wasteful” and assumption that more capacity means more (unnecessary) care:

  • Limit public spending by limiting competition
  • Prevalence of certificate of need (CON) laws…more odd policies to discuss later

Hospital mergers (horizontal)

Types of hospitals involved in mergers

Types of hospitals involved in mergers

  • Ascension-Presence: Largest non-profit system in US adds 10 hospitals to existing 9 hospitals in Chicago
  • Fairview-HealthEast: 11 hospital system becomes largest in Twin Cities area
  • Hospital corporation of america (HCA) adds 4 hospitals to the 10 existing HCA hospitals in Houston
  • Northwestern-Centegra: Forms 10 hospital system in Chicago
  • Emory-DeKalb: Forms 10 hospital system in Atlanta
  • Jefferson-Einstein: Forms 18 hospital system in Philadelphia area

Merger “types”

  1. “Within-market”
  2. “Out-of-market”

Within-market mergers

  • Most well-understood merger type
  • Established tools for examination in anti-trust
  • Defining the market is still a contentious issue

Within-market mergers

  • Listed previously (Emory-DeKalb, etc.)
  • Big price effects
    • 20 to 40% in many studies
    • Up to 60% in some studies
    • Bigger increases the closer are the hospitals
    • Price increases spillover to other hospitals too
  • Account for about 50% of all mergers since 2000

Out-of-market mergers

  • Less understood
  • No formal structure for analyzing in court
  • These types of mergers are essentially permitted without risk of DOJ/FTC challenge

Out-of-market mergers

  • Involve larger systems spanning different isolated markets
    • Advocate-Aurora: 27 hospital system in IL and WI
    • Baptist Memorial-Mississippi Baptist: 22 hospitals in TN, AR, and MS
    • UPMC-Pinnacle: 24 hospital system recently added 8 in central PA
    • Catholic Health Initiatives-Dignity Health: 142 hospitals in 21 states
    • HCA: 177 hospitals in 21 states
    • RCCH HealthCare Partners: 89 hospitals in 30 states, focusing on non-urban areas
  • About 35% of all mergers are out-of-market but in same state, 15% out-of-state
  • Smaller but meaningful price increases, 5 to 10%

Effects of Mergers on Prices

How do mergers increase prices?

  • Already discussed within-market mergers, outside options, and bargaining power
  • What about out-of-market mergers?

OOM mergers and prices

Two ways this can happen theoretically:

  1. Common customers (hospital markets are local, but insurance markets are more broad)
  2. Multi-market contact (particularly relevant for understanding out-of-state mergers)

1. Common customers

2. Multimarket contact

What Next?

Where do we go frome here?

  1. Adopt sensible policies
  • Certificate of need laws
  • Certificate of public advantage
  • Scope of practice laws
  • Any willing provider laws
  • Site-based payment differentials (encourage vertical integration)
  1. Antitrust enforcement

A note on surprise billing

Some hope here following the No Surprises Act (in effect January 2022):

  • Emergency care (excluding ground ambulances?)
  • In-network facilities
  • New process…
    • OON provider bills health plan
    • Health plan communicates median in-network amount
    • Provider bills cost-sharing to patient

But patient can be asked to waive rights

Final thought