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Mergers in the healthcare sector: why you'll pay more

We know all about the benefits in store for us when big hospital chains merge and bigger health insurance companies grow even bigger: 

Lower prices. More efficient healthcare. More innovation. Better customer service.

That's what hospital and insurance companies say, anyway. 

But here's what the data say: Hospital and insurance mergers almost always lead to higher costs, lower efficiencies and less innovation. The reason is simple: Mergers reduce competition -- and it's competition that drives down prices and encourages more efficiency and innovation.

Some healthcare mergers have been outright disasters for consumers; studies of mergers that took place in the 1990s and early 2000s showed price increases of as much as 40% in communities that lost competition. 

These findings are important because we are deep into a new era of healthcare consolidation. In 2015, 112 hospital mergers were announced nationwide; that's 18% more than a year earlier, and a 70% increase over 2010, according to the management consulting firm Kaufman Hall.

"The rate may even be accelerating," Edith Ramirez, chairwoman of the Federal Trade Commission, told a conference of antitrust lawyers earlier this month, as the pace picked up significantly in the second half of the year.

Many of these deals, Ramirez said, could "cause significant competitive harm," a red flag for the FTC. She quoted former FTC economics director Martin Gaynor, now a professor at Carnegie Mellon University, showing that the average cost of an inpatient stay at a hospital facing no competition is $1,900 higher than at those facing at least four rivals, producing higher premiums for insurance customers.

The largest announced hospital merger would combine Orange-based St. Joseph Health and Renton, Wash.-based Providence Health and Services. The result would be an $18-billion, 50-hospital behemoth that would rank among the largest nonprofit hospital chains in the country and control 18 healthcare facilities in Orange and Los Angeles counties and parts of Northern California.

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Meanwhile, two huge health insurance mergers are poised to reduce the number of major nationwide insurance companies from five to three. Last year, Anthem proposed a $48-billion takeover of Cigna, and Aetna proposed a $34-billion deal for Humana. Both deals are currently undergoing state and federal antitrust review. 

Typically, the merging hospitals and health insurers describe the benefits stemming from their deals rosily, if vaguely. Aetna, for instance, paints its merger as one that will bring consumers "a broader choice of products, access to higher quality and more affordable care, and a better overall experience in more geographic locations across the country."

The public justification for the Providence-St. Joseph hospital merger was even more nebulous: "We are two mission-focused organizations which truly have the potential of being better together," Deborah Proctor, president and chief executive of St. Joseph Health, said in a statement last July, when the proposed deal was made public.

The pitch is familiar. The architects of the last wave of health insurance mergers 15 to 20 years ago proclaimed a new era of efficient technology and improved customer service. Anthem and Cigna assert today that their merger will produce nearly $2 billion in "annual synergies," thanks to improved "operational" and "network efficiencies."

Studies of prior mergers show that this Nirvana seldom comes to pass. The best example may be that of Aetna's 1996 merger with U.S. Healthcare in a deal it hoped would give it entre to the booming HMO market. According to a 2004 analysis by UC Berkeley health economist James C. Robinson, the merger became a "near-death" experience for Aetna. 

The deal was expected to bring about "millions in enrollment and billions in revenue to pressure physicians and hospitals" to accept lower reimbursement rates. Instead, the merged company was too big, too inflexible and too closely tied to a business model that already was on its way out.

"The talk was all about complementarities, synergies, and economies of scale," Robinson wrote. "The reality quickly turned out to be one of incompatible product designs, operating systems, sales forces, brand images, and corporate cultures." Aetna surged from 13.7 million customers in 1996 to 21 million in 1999, but profits collapsed from a margin of nearly 14% in 1998 to a loss in 2001.

The talk about merger-related efficiencies isn't entirely about painting pretty pictures for regulators and customers. The merger partners aim to establish a court defense for their deals by claiming that the efficiencies will counterbalance their deals' anti-competitive effects. 

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Efficiency claims underlie the two leading rationales for hospital and insurance mergers: that the Affordable Care Act encourages consolidation in both sectors, and that each side has to get bigger to match the increasing size of the other -- the "Sumo wrestler theory," in the words of healthcare and antitrust expert Thomas L. Greaney of Saint Louis University.

Healthcare economists don't buy either argument. The  Affordable Care Act encourages more coordination among provider groups, but that can be achieved without mergers. Indeed, the law is "premised on a market with more competition," not less, Greaney says.

Even if mega-sized hospital groups and insurance companies extract better prices from one another, reduced competition within each sector leaves them with less incentive to pass their savings on to consumers.

Nor is there evidence that either hospitals or insurers need to reach a large critical mass to become more efficient or effective, and some studies indicate that competition, not its absence, is what drives such institutions to find innovative ways of operating more efficiently and serving patients better.

"There's a widespread belief that there are significant economies of scale in the provision of health insurance," said Leemore Dafny, a health and hospitals expert at Northwestern University's Kellogg School of Management. "But the claim that getting bigger makes you better needs to be substantiated." 

Promoters of big mergers often overstate the savings they can wring out of consolidation. 

In a 2014 analysis, insurance consultant Douglas Sherlock calculated that less than 20% of health plans' administrative costs could be lowered by economies of scale, and the reduction was small: A plan with monthly administrative expenses of $30 per member could reduce them to $29.24, Sherlock calculated -- if the merger goes perfectly. That reduction would do almost nothing for premiums, Sherlock told an investment conference in December, though it could fatten profits considerably in this low-margin business.

History provides little encouragement for thinking that big mergers can be tweaked to allow them to go through while preserving competition in local markets, say by divesting health plans in communities served by both merger partners.  

That was the remedy imposed by the Department of Justice when it approved the 2012 merger of Humana and Oakland-based Arcadian Management. Because their Medicare Advantage business overlapped in several markets, they were ordered to sell off plans with 12,700 customers in five states. The Justice Department certified three separate buyers as "long-term, viable competitors" to the merged company.

Within three years, two of the three had failed, driving away more than half their newly acquired members by imposing higher rates and exiting most of the markets they had entered via the divestiture. Many of the customers ended up with higher prices or less access to insurance.

Higher prices for consumers are likely to be the outcome of either of the newly proposed insurance mergers and most of the hospital deals on the table. Experience suggests that regulators can have only one response if they're serious about protecting the public interest: Just say no.

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