The Multinational Monitor

JUNE 1996 · VOLUME 17 · NUMBER 6

M E R G E R    M A N I A    R E T U R N S

An Unhealthy
Merger Policy

by Patrick Bond and Robert Weissman

IN THE WAKE OF THE 1994 COLLAPSE of Bill Clinton's health care reform legislation, it is clear that health-care industry restructuring will be driven primarily by the market, not government policy, in the years immediately ahead.

But the recent barrage of health-care industry multibillion dollar mergers and acquisitions poses numerous and varied threats to consumer interests, and to public health. Health-care consolidations may bring some efficiencies, notably in eliminating excess capacity (such as oversupply of hospital beds). Those benefits seem sure to be overridden, however, as an extremely rapid process of consolidation and concentration intensifies in each of the major health sectors, and as large corporate networks replace smaller, locally-oriented non-profit institutions and individual providers of health services.

Mergers in the health care industry create the normal dangers of corporate concentration: inflationary tendencies stemming from oligopoly pricing power, new administrative burdens, enhanced political power for newly created conglomerates.

But it is the special nature of health care as a consumer good, and the unique way in which the industry is structured and evolving, that makes the consolidation craze so worrisome. Mergers among hospitals, insurance companies, physician groups and pharmaceutical companies are creating behemoths prepared to battle each other for control over patient care -- but none imagine a meaningful role for patients in making the critical choices concerning their care. And the bottom-line mindset to which the merger frenzy is contributing is endangering the health-care system's remaining commitment to community service.

Insuring trouble

Mergers among health maintenance organizations (HMOs) and insurers are driving the consolidation craze in the entire health-care industry. For-profit and non-profit insurers are merging and combining forces in ways that increase their leverage over health-care providers and even more so over patients. For-profit insurers' takeover of non-profits also raise questions about private plunder of the publicly created assets of non-profit insurers.

In the last few years, insurance and HMO mergers have grown to tidal wave proportions. In 1993, the acquisitions of five large publicly traded HMOs amounted to $685 million. In 1994, there were 13 major acquisitions worth $4 billion. In 1995, United Healthcare purchased MetraHealth (a joint venture of Metropolitan Life and the Travelers Insurance Company) for $1.65 billion; the Department of Justice approved the deal contingent on a sale of MetraHealth's HMO serving St. Louis. Non-profit Blue Cross-Blue Shield also entered the merger game. In the largest move, Blue Cross of California converted to for-profit Well Point and then merged with for-profit Health Systems. Blue Cross companies serving Kentucky, Indiana and part of Ohio merged into Anthem Blue Cross and Blue Shield. In May 1996, Anthem announced plans to merge with Blue Cross of New Jersey and Delaware. Meanwhile, Aetna Life and Casualty said in May 1996 that it would pay $8.9 billion to acquire U.S. Healthcare, one of the fastest growing HMOs. And in March 1996, in perhaps the most disturbing insurance deal to date, Columbia/HCA, the nation's largest hospital chain, announced plans to enter into a joint-venture agreement that amounts to a de facto purchase of Blue Cross of Ohio.

One worrisome element of the health-insurance restructuring is the conversion of non-profit Blue Cross companies to for-profit status. This process raises unusual problems: a non-profit acquires assets over time; if it converts to for-profit status, do the new owners have to pay for the assets acquired? if so, whom do they pay? and how much?

All of these questions were raised by the largest of the conversions, by Blue Cross of California. Blue Cross of California attempted to avoid the conversion issue by placing most of its assets in a for-profit subsidiary; its goal was to operate as a for-profit venture, with profits accruing to shareholders, but to avoid paying for the non-profit property acquired. Blue Cross's ruse was undermined by the state attorney general's office, prompted by Consumers Union and other citizen advocacy groups. Ultimately, the converted Blue Cross, now a part of Well Point-Health Systems, agreed to pay $3.2 billion to two foundations dedicated to improving health services for the poor.

The California citizen groups' successful efforts to prevent the potential billion-dollar grab of Blue Cross of California is "a model for how these transactions should be monitored," says Eleanor Hamburger of Consumers Union. The first phase in addressing conversions, she says, is "to make sure that the non-profit has public benefit obligations," meaning it must be established that the value of the converted entity will be paid to charity. The second phase, she says, is to ensure the converted non-profit is valued properly, and placed in an independently operated foundation. The California lessons will be important for citizens around the United States, as nearly a dozen states are now facing Blue Cross conversion issues, many in conjunction with merger proposals.

Perhaps even more troubling than the conversion issue is the control over the entire health-care market that large size gives insurers. Although there are only minimal economies of scale to be captured from mergers, large size does give insurers tremendous bargaining power against hospitals and other health-care providers. Providers not part of an insurer's network or group are locked out of the market for care of people covered by the insurer. The bigger the insurer and the more members of its group, the more serious a threat exclusion from the network is for the provider -- and the more leverage the insurer has. One effect of mergers among insurers and HMOs is thus to spur mergers in other sectors of the health-care field, as hospitals, doctor groups and others join in an effort to create countervailing power.

Consolidation in the insurance field also feeds upon itself, with small HMOs fearing an inability to bargain with providers in the same manner as giant insurers. Small HMOs thus look to combine with larger insurance operations, further fueling the consolidation frenzy.

Increased insurer power ultimately translates into decreased control over health care for patients. With giant, profit-driven bureaucracies pressuring doctors to provide patients with cheaper and quicker care, forbidding some courses of treatment and paying doctors flat per capita fees (rather than fees for services rendered) that encourage them to provide as little care as possible, patient care and control inevitably deteriorates and weakens, as legions of complaints about restrictive care in the United States now demonstrate.

A frightening specter of enhanced insurer power and decreased patient control -- combined with the worst abuses of non-profit conversion -- may be looming just over the horizon. The March announcement of a Columbia/HCA de facto takeover of Blue Cross of Ohio may mark the beginning of the next chapter of the health-care industry restructuring and concentration of power.

At first glance, the deal represents a conversion with all of the usual perils exaggerated. Top Blue Cross executives -- leaders of a non-profit -- stand to get rich on the deal, with three executives and an outside counsel ready to receive $19 million for a non-competition commitment and consulting agreements in years to come. But their profits seem paltry compared to Columbia/HCA's bargain, as revealed in documents filed with the Ohio Department of Insurance. Columbia is paying $300 million for 85 percent of Blue Cross of Ohio's assets -- including $230 million in reserves. Moreover, Columbia retains an option to purchase later the 15 percent rump Blue Cross -- for one dollar.

At second glance, the deal looks worse. Columbia currently operates three large hospitals in Northeast Ohio, where Blue Cross of Ohio is strongest, and signed a letter of intent to purchase a fourth in late May. Blue Cross itself has recently begun a joint venture with a large hospital chain in the region. All of this adds up to a unique form of vertical integration which may enable Columbia to use its new insurer status to direct patients to its hospitals at the expense of competitors -- but with less regard to quality than insurers might normally display. At the same time, Columbia will potentially be able to offer cut-rate insurance because of an unusual re-insurance arrangement it will maintain with the rump Blue Cross. The re-insurance deal will protect Columbia for losses up to $30 million annually and is backed by the $300 million purchase kitty.

Columbia denies the merit of these concerns altogether. The joint-venture deal is "a winning situation all around," says Jeff Prescott, spokesperson for Columbia/HCA. Those currently covered by Blue Cross "won't see a lick of difference" from the merger, except some benefits, he says. "Access to a fully integrated system of that nature will provide more choice in the system," he says, adding, "In the long run, it will allow us to improve quality, because we will look at it from a number of different angles," as both payer and provider.

Community hospitals: in critical condition

No element of the health-care industry has experienced more rapid concentration than hospitals. The altruistically operated, non-profit hospital, affiliated only with a university or church if private, or municipal government if public, is in jeopardy. Two hospital chains -- Columbia/HCA and Tenet -- had gained control of three quarters of the for-profit market by 1994, and the companies are continuing on an expansionist course. Although for-profits still represent a small share of the hospital market (approximately 15 percent), the for-profit chains are gobbling up for-profit and non-profit hospitals, converting non-profits to for-profit status where possible and politically attacking the tax-exempt status that permits non-profits to function. Coopers & Lybrand, the accounting and consulting firm, conservatively predicts the proportion of for-profit hospitals will rise to 25 percent in the next five years.

Underlying the hospital merger trend is the managed care phenomenon by which insurance companies oversee and control patient care in an effort to drive down costs. "While each hospital has its own reasons for taking part in a deal," write Mary Gabay and Dr. Sidney Wolfe of Public Citizen's Health Research Group in their June 1996 report, "Who Controls the Local Hospital?," "to a large extent these institutions are reacting to the ascendancy of managed care in the health care marketplace. They are hoping these deals will enhance their ability to compete for managed care contracts, allowing them to maintain their access to paying patients."

Managed care exerts a double pressure on hospitals. First, individual hospitals seek to join forces with other hospitals in an effort to create conglomerates with enough size and market power to have some bargaining power with the insurance companies. Secondly, hospitals fear getting locked out of the market by HMOs, preferred provider organizations (PPOs) and other insurance-created health care networks. "A hospital system can lower the cost to a purchaser of making contractual arrangements by providing 'one-stop' shopping," Gabay and Wolfe write; this is an arrangement individual hospitals cannot offer.

Managed care pressure has resulted in a staggering number of hospital mergers and consolidations. The Public Citizen report found 447 community hospitals involved in merger and acquisition activity in 1995, or more than 900 -- almost one fifth of all community hospitals -- if hospitals already part of chains are included.

Consider the size and activities of Columbia/HCA alone. Columbia owns facilities in 36 states, England and Switzerland. It took in $17.7 billion in revenues in 1995, up 22 percent from the year before. With more than 240,000 employees (not including 75,000 affiliated physicians), Columbia is among the dozen largest employers in the United States. In 1995, Columbia experienced the net addition of 143 hospitals, 14 ambulatory surgery centers, 139 home health agencies, 102 skilled nursing units, 36 psychiatric units, 20 rehabilitation units and 13 comprehensive outpatient rehabilitation facilities. This growth resulted primarily from Columbia's merger with Nashville, Tennessee-based HealthTrust and its 119 hospitals. Columbia also acquired, or entered into joint ventures with, 40 individual hospitals.

The Columbia-HealthTrust merger gave the combine extraordinary market power in several states, including control of 80 percent of Utah's hospital beds. After the merger announcement, the Federal Trade Commission (FTC) ordered Columbia to divest itself of three Utah hospitals, and state officials in Florida, Tennessee and Texas also undertook investigations of potential antitrust violations associated with the merger. In Florida, the combined Columbia-HealthTrust hospitals account for ownership or co-ownership of 60 percent of the market. In response, a not-for-profit co-owner of an Orlando hospital, Orlando Regional, filed an antitrust suit complaining that the enlarged Columbia "would have access to the not-for-profit system's confidential financial, clinical and strategic data" and that Columbia would control two out of Orlando's three hospitals. The FTC chimed in with a statement noting "troubling questions" concerning allegations that Columbia is attempting to discourage competition in Florida. The final approval for the merger required Columbia to sell seven hospitals, end its joint venture with Orlando Regional and acquire further FTC approval for any further hospital purchases in six markets over the next 10 years.

Columbia exerts substantial power over Florida markets nonetheless. The Florida Health Care Board alleges that the hospital chain "could be driving up hospital costs in Florida" based on evidence that Columbia has requested 10 budget increases (out of a total of 15 for all hospitals in the state) and has also appealed the Board's rejection of budget increases four times (out of a total of five such appeals).

One reflection of Columbia's concentration and market power in a given locale comes from Fort Lauderdale, Florida, where Columbia attracted more than 400 physicians into a $30 million investment in seven hospitals. Critics from the Association of Voluntary Hospitals claim that doctors who invest in the hospitals tend to admit patients with good insurance to Columbia facilities and send un- or under-insured patients to competitors. Moreover, Columbia employed two-dozen lobbyists last year to repeal 1992 Florida state legislation aimed merely at disclosure of the physician-investors. If such practices become the norm, the very integrity of the health system may be at stake.

Market leader Columbia denies there are any anti-competitive effects of the hospital mergers. "We certainly have been able to deal with any concerns of the FTC," says company spokesperson Prescott. The Columbia deals have been scrutinized by the FTC and there "hasn't been an issue," he says.

Part of the logic of merging hospitals is to eliminate excess capacity, an undisputed problem in many cities. But the unregulated closure of hospitals following consolidations may displace inordinate numbers of workers and lead to future bedding shortages or current problems with community access as chains regionalize their operations. Poor and small communities are already the hardest hit of victims of inappropriate closures.

The growth of Columbia and other merger activity in the hospital sector also creates serious problems outside of traditional antitrust concerns. The consolidation trend is spurring the conversion of non-profit community hospitals to for-profit status (58 hospitals converted as part of 1995 hospital deals); and conversions and increasing commercial competition in the industry are undermining or displacing the charitable orientation of many hospitals.

"The potential loss of services in a community is one of the biggest worries associated with these conversions," note Gabay and Wolfe. "Community-owned health care organizations provide a disproportionate share of vital health services such as trauma care, AIDS care, neonatal intensive care units, organ/tissue transplantation and burn care. These services tend to generate little revenue and may even be a loss operation for the hospital." They ask, with trepidation, "Will for-profit facilities be as committed to providing these low-volume, high-cost specialty services as community-owned hospitals are?"

Columbia asserts the mergers and conversions will not adversely affect care. "Columbia typically continues the same kinds of services with partners or joint ventures," Prescott says, adding that Columbia has many hospitals providing high-level, specialized care.

A final problem raised by the conversion of non-profit hospitals to for-profits is the danger of corporate capture of community assets at discounted prices, the same problem posed by non-profit insurers' conversion. The difficulties in valuing a hospital, combined with the non-profit board of trustees' non-pecuniary interest in the hospital it is selling and the absence of shareholders motivated to get the highest return on their ownership stake in the acquired entity, create the potential for abuse in hospital conversions. The for-profits may be acquiring the non-profits at undervalued amounts. The danger of abuse is exacerbated where non-profit hospital administrators and managers benefit personally from the sale (with higher salaries in the for-profit world, or with a stake in the for-profit venture, say). The significance of the problem, says Wolfe, is as yet uncertain.

Again, Columbia denies there is a problem at all. "In many cases, [sellers] seek a third party valuation," Prescott notes.

Speedy pharmaceutical mergers

The global pharmaceuticals sector has also seen a rash of mergers and consolidations in the last few years. Underlying the merger frenzy appears to be a widespread fear that non-merging companies will be left behind in the industry's worldwide competition. This sentiment is present from top to bottom of the industry, with the smallest biotechnology start-up firm and the largest drug makers alike feeling pressure to combine forces with competitors.

Among the global giants, there have been five huge mergers in recent years. All have been justified on similar grounds. Merging companies claim they will benefit from enhanced research and development (R&D) capacity and better access to global markets. The merger process perpetuates itself, as companies cite the mergers of competitors to justify their own conglomeration with rivals. The result:

Consumer critics deny there is any merit in the merging companies' justifications for the joint operations. Virtually all of the major merging companies were already global in scope, says Public Citizen's Dr. Wolfe. James Love of the Washington, D.C.-based Consumer Project on Technology is equally dismissive of the R&D justification. "The big companies are not noted for their R&D capacity," he says, adding that most of the research the companies do undertake is for "me-too" drugs, pharmaceuticals that closely resemble already available medicines (whose patents may soon expire). "Big drug companies are mostly marketers," says Love; combining those big companies into bigger ones is unlikely to suddenly generate a greater interest in research.

The actual effects of the mergers are not entirely clear, since there is little price competition in the industry. But Love says "most mergers are just to avoid competition."

A formula for higher prices?

Of greater concern to consumer advocates than horizontal integration in the pharmaceutical industry is a simultaneous trend to vertical integration, as pharmaceutical manufacturers buy up pharmacy benefit management companies (PBMs).

Developed as a major market force in the 1980s, PBMs administer the prescription drug components of health insurance plans. They maintain "formularies," a list of prescription drugs preferred because of their medical value and price. Insurance companies compel patients to use listed drugs at pain of facing severe financial disincentives. PBMs are now estimated to manage drug benefits for approximately half of the U.S. population, and so represent significant buying power in the U.S. market.

In the last three years, big pharmaceutical companies have bought three of the five largest PBMs. Eli Lilly gobbled up PCS Health Systems, Merck swallowed Medco and SmithKline Beecham acquired Diversified Pharmaceutical Servicers. The drug companies paid extremely high amounts -- as compared to the PBMs' earnings -- for the pharmaceutical buying companies, lending supporting evidence to critics' claims that the purchases were motivated by anti-competitive aspirations.

Senator David Pryor, D-Arkansas, complained in April 1995 that PCS, Medco and Diversified "may be acting in the interests of their parent companies, the brand-name manufacturers. They may be favoring their parents' drugs by switching its patients from one drug to another without explicit regard to health."

A November 1995 report from the Government Accounting Office (GAO), a Congressional research office, asserted as a matter of fact that, "to increase market share, manufacturers anticipate that their partner companies will include their drugs on formularies."

Antitrust enforcement agencies appear willing to allow that advantage; their main concern is that the newly acquired PBMs might exclude from their formularies drugs made by competitors of their parent company.

The Federal Trade Commission permitted Lilly's mid-1994, $4 billion takeover of PCS on the condition that it not become sole distributor of Lilly pharmaceuticals (as had been announced) and that a "fire wall" be established so that Lilly would not discover pricing information about other drug makers. But the consumer group Citizen Action attacked the FTC-imposed fire wall, calling it "a sham," predicting that PCS would promote Lilly's generic brands at the expense of competitors and emphasizing that the FTC consent decree would not stop Lilly from gaining access to PCS patient names and medical records. Opposition also came from Minnesota Attorney General Hubert Humphrey III and the National Association of Chain Drug Stores, which predicted that the Lilly-PCS deal would stifle competition.

Evidence gathered by the GAO for its November 1995 study suggests critics' worst anticompetitive fears may already be being realized, at least with the Merck-Medco merger. "Of the eight products that represent almost all Merck sales of brand-name products to Medco enrollees, only one was on Medco's formulary in January 1993. In May 1993, two months before reaching their decision to merge and six months before closing the merger, Merck and Medco established an agreement to add the remaining seven products to Medco's formulary," the report says. Even more strikingly, "After the merger, from 1994 to 1995, four of these eight drugs faced less competition after non-Merck products were dropped from Medco's recommended formulary." Merck did not respond to requests for comment on the GAOfindings.

Perhaps the greatest testament to the far-reaching potential power of the drug-company-operated PBMs is the insurance industry's fear of them. A Prudential Insurance spokesperson complained to the Minneapolis Star Tribune, "These huge systems will have so much leverage, not only with membership, but also with actual services."

A prophecy realized

Nearly two years after the demise of the Clinton health-care plan, nearly all of the plan's right-wing critics prognostications are coming true -- but under the exact opposite circumstances they imagined. Patients are indeed finding their freedom of choice severely limited, but by emerging private oligopolies, not by a national health plan. Huge bureaucracies are making critical health-care decisions for patients, but those bureaucracies are private, not governmental. Waste is in fact widespread; but it is private, not public, red tape that is the cause.

Unfortunately, these trends are likely to continue as control over various elements of the health-care industry concentrate in ever fewer corporate hands.

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