FTC Targets
Hospital Merger
In Antitrust Case

Federal regulators are targeting what they say is an elusive culprit contributing to the soaring hospital costs of recent years: mergers.

Next month, the Federal Trade Commission brings to trial an unusual case in which it is seeking to undo the January 2000 takeover of Highland Park Hospital, in suburban Chicago, by Evanston Northwestern Healthcare Corp. The FTC accuses Evanston Northwestern, which already ran two hospitals in the area, of antitrust violations, saying it used its postmerger "market power" to impose huge price increases -- of 40% to 60%, and in one case 190% -- on insurers and employers.

Evanston Northwestern, a nonprofit corporation, denies any impropriety. It says it rescued the once-struggling community hospital in Highland Park and improved the quality of care. The hospital system has said that a forced divestiture, as demanded by the FTC, would "disrupt the lives of patients, doctors, employees" and others.

It's a high-stakes case for the FTC, which is trying to reassert an aggressive stance toward hospital mergers after it and the Justice Department lost a combined seven consecutive cases challenging proposed mergers in the 1990s. If the agency succeeds, it could strengthen its power in judging and monitoring merger strategies of "multiple-hospital systems that grow by acquiring neighboring hospitals," says Michael Cowie, a former FTC official who headed an FTC task force on hospital mergers and currently works as a partner at law firm Howrey Simon Arnold & White LLP in Washington.

If the FTC prevails, it could send a signal to big hospital systems that Evanston-type mergers are likely to face stiffer challenges and could even be blocked. But an FTC loss could be a green light for similar mergers around the U.S. to accelerate at a time when they already are on the rise. In 2004, 130 hospitals were acquired or merged in the U.S. in transactions valued at a total of $9.07 billion, according to Irving Levin Associates Inc., a publisher of heath-care data based in New Canaan, Conn. The overall transaction value was about three times greater than the annual average over the previous four years.

The FTC sees the antitrust effort as a potentially powerful force in reining in health costs. Hospital costs in the U.S. exceed $500 billion a year, and are rising far faster than overall inflation, up 6.5% in 2003, according to the government. That was slower than an 8.5% rise in 2002, however, and marked the first deceleration in five years, according to an analysis in the January/February issue of the journal Health Affairs, largely because of deceleration in public spending, especially by Medicaid, the state-federal health program.

In recent years, big hospital and health systems have emerged in Boston, Cleveland, Salt Lake City and Northern California, among other places. Sacramento, Calif.-based Sutter Health System, which has grown quickly by acquisition, has come under fire for its pricing policies. Last year, in a widely publicized case, the state's retirement system cut ties with 13 of Sutter's 28 hospitals in Northern California after complaining about high prices. Overall, the number of hospitals involved in merger-and-acquisition deals rose sharply in 2004 from previous years.

FTC officials won't say if they are contemplating any further complaints to block or undo mergers in the hospital field. The Evanston Northwestern case is the only active, pending complaint against a hospital merger by the agency, which shares responsibility with the Justice Department for enforcing antitrust laws in the health arena, with Justice handling most insurance matters and the FTC handling hospital issues.

To unscramble Evanston Northwestern's merger, the FTC is armed with reams of data it believes will prove that the company acted in an anticompetitive manner, by making price increases that ultimately hurt consumers. The government charges that price increases are "far beyond those achieved by comparable hospitals" during the same period of time. The case begins Feb. 10 before an FTC administrative law judge.

An important backdrop to the FTC case is the nonprofit status of Evanston Northwestern, because in some previous mergers, courts have pointed to hospitals' nonprofit status as a reason to let mergers go through. In the mid-1990s, for example, the FTC fought unsuccessfully to block a Grand Rapids, Mich., hospital merger. A federal court allowed it to proceed, based on economic analysis that nonprofit mergers tended to reduce costs and prices. The court also ruled that nonprofit hospital boards, as community leaders, had an incentive to restrain prices. A federal appeals court upheld that ruling in 1997.

Nonprofit hospitals, the FTC argues, do have an incentive to maintain a "surplus" of revenue over expenses, and while they don't distribute these "profits" to shareholders, they can use them for salaries, equipment or expansion.

Contributing to that stinging Grand Rapids defeat for the FTC was the expert testimony of William Lynk, an economist whose analysis had concluded that nonprofit mergers had contributed to lower, not higher prices. In the years since, the issue of postmerger hospital pricing has attracted attention from many experts; many of these analyses concluded that the mergers either resulted in higher prices or had no effect on pricing.

"When hospitals are nonprofit, members of the community and judges as well tend to think of them as institutions with a strong humanitarian bent," says Martin Gaynor, professor of economics and public policy at Carnegie Mellon University in Pittsburgh. But Prof. Gaynor, like the litigators at the FTC, says he believes that "these firms aren't existing on philanthropy. They live and die on sales revenue, and will exercise market power if they have the opportunity."

FTC litigators say winning the Evanston case will be tough. "We believe the cases we bring are strong and meritorious, but there's no slam dunk in any litigation," says Chul Pak, one of the FTC's lead litigators.

One problem: The FTC must prove that undoing the merger is worth the pain and expense involved. Another difficulty is that the FTC will try to prove its case by a process of elimination, seeking to rule out other explanations, such as catch-up price increases, leaving "market power" as the only explanation. The FTC probably will find itself fighting with Evanston Northwestern lawyers and witnesses over the proper definition of the "market" to determine how much concentration exists in the immediate region.

The FTC case is a fresh assault on a nonprofit hospital system at a time when the industry, which accounts for 82% of U.S. hospitals, is under intensified scrutiny. In a separate action, Richard Scruggs, a well-known Mississippi-based tobacco lawyer, has helped coordinate several lawsuits against nonprofit hospitals, seeking to revoke their tax-exempt status, alleging that the hospitals charge uninsured patients the highest rates and hound patients for unpaid debts. Evanston Northwestern isn't among the hospitals sued by Mr. Scruggs.

Evanston Northwestern, affiliated with Northwestern University, is a major teaching facility and medical powerhouse in Chicago's northern suburbs, with 850 beds in three hospitals, about 7,600 employees and annual revenue of $1.8 billion. After merging 239-bed Highland Park into its system in early 2000, the FTC alleges, Evanston Northwestern moved to impose big price increases on insurers such as Aetna Inc., Humana Inc. Cigna Corp., United Healthcare and others who pay hospitals under contracts for medical care received by patients. Several of the insurance companies, unhappy with the price increases, are expected to be called as witnesses by the FTC at the trial.

In 2000, for example, the hospital system raised United Healthcare's health-maintenance-organization rates by 52% at its Evanston and Glenbrook hospitals and by 38% at Highland Park, the FTC alleges. The hospital raised its preferred-provider rates by 190% at Evanston and Glenbrook hospitals and by 20% at Highland Park.

Evanston Northwestern, responding to the allegations, has said that the hospital system "renegotiated its contract with United after the merger, and that such contract documents speak for themselves."

The FTC also has accused Evanston Northwestern of price-fixing of physician fees, after combining two large groups of physicians following the merger. Evanston Northwestern has denied the price-fixing charges.

The case will be heard and ruled on by the FTC administrative law judge. Any appeal of his ruling goes to the full five-member FTC for a vote; further appeals go to a federal appeals court.

The FTC is taking a highly unusual step in seeking to undo a merger. Most recently, in June 2003, an FTC administrative law judge challenged an $84 million acquisition by Chicago Bridge & Iron Co., of certain assets of Pitt-Des Moines Inc. The judge ordered Chicago Bridge to split its industrial division in two and to sell certain storage-tank assets it bought from Pitt-Des Moines. The company appealed that verdict, but earlier this month, the full FTC commission upheld the judge's ruling.

Write to Bernard Wysocki Jr. at bernie.wysocki@wsj.com