Answer this question: You feel sick. It’s not an emergency but you need to see a doctor. Do you make an appointment with your longtime family doc, visit the closest physician’s office or traverse several zip codes in search of the lowest prices?

Your would-be decision in that hypothetical pits critical loss analysis against the economic theory of option demand. That debate became the legal crux of the recent, precedent-setting St. Luke’s antitrust trial in Boise.

In January, U.S. District Judge B. Lynn Winmill ordered the break-up of Nampa-based primary care provider Saltzer Medical Group’s merger with St. Luke’s Health System after a nearly month-long trial that unfolded as a kind of championship match between economic theories. The case, now under appeal, saw top economists spar over geographic data, consumer behavior and national healthcare trends in an effort to define the Nampa primary care market and ultimately determine whether St. Luke’s violated antitrust laws with its 2012 acquisition of Saltzer.

“This is the first case that really sends a signal to the provider community and to the bar that (providers) run a risk if they think they can acquire 60 or 80 percent of the market. That’s why it’s a notable, headline event,” said St. Louis University School of Law Professor, Thomas L. Greaney, an antitrust legal scholar who was not involved in the case. “The reason the (FTC) brings these cases to court is to win them and send out a message that the rest of the country will listen to.”

Clayton Act antitrust laws require the government, or other plaintiffs in cases like this, to prove the establishment of a new market concentration, i.e., that the Luke’s-Saltzer merger set up a monopolistic grip on healthcare in Southwest Idaho. If that is the case, the burden falls to the hospital or provider to prove that the merger was otherwise likely, necessary and imminent.

In the past, hospitals got away with the critical loss argument that patients would just go elsewhere if prices rose too much, but this case broke the mold with Winmill accepting new economic analyses that the market was in fact limited to the Nampa area and that insurance companies play a much larger role in determining consumer health care prices. St. Lukes-Saltzer trial resources:
Statesman Big Page
St. Luke’s CEO Blog
FTC Cases and Proceedings

Behind the message the FTC sent by bringing the case lies a history of dueling economic theories — some of them so loved by the judiciary that they helped keep contested mergers intact for years while new types of analysis sometimes fell on deaf judicial ears.

In the orthodox corner of economic jurisprudence stood critical loss analysis — a tool used to define market shares that argues firms stand to lose more from a reduction in sales, leaving them unlikely to hike prices. St. Luke’s defense economists took critical loss a step further and said that if St. Luke’s costs went up, some patients would simply take their business elsewhere. The rebuttal came from a more complex option demand analysis that reasons it’s almost impossible for patients to shop around in a health care system that lacks price transparency and therefore, the health insurers, not the patients, ultimately determine medical costs. Behind both arguments lies this question: “will patients stay or will patients go?”

Dranove chart

Courtesy David Dranove
Primary care physicians and the geographic origins of their patients, from Demonstratives for the testimony of Professor David Dranove [click image to enlarge]

“The market is Nampa,” FTC attorney Tom Green said in opening statements. “If you are ill you are not going to get in the car and drive 25 miles to another city.”

St. Luke’s counsel argued against claims and charges that the deal would stifle competition and further concentrate the market, calling the buy-out a step toward integrating health care.

The science and speculation of the, “would they stay or would they go?” question came down to zip code data, patient flows and number crunching. The plaintiffs, which include St. Alphonsus Health System, Treasure Valley Hospital and the Idaho Attorney General, stated in opening arguments that the merger would stifle competition and ultimately drive up consumer prices. Plaintiff attorneys pointed to past St. Luke’s mergers that they argued funneled referrals away from St. Luke’s competitors and yielded higher health care costs — arguments defense attorneys rebutted, calling plaintiffs’ reasoning a “sleight of hand.” Competition can’t hurt competition, St. Luke’s defense attorneys said. What makes this case significant, several economists and legal experts said, is that Winmill listened to more complex economic theories.

“It shows that a court can understand the next level of economic research well enough that they will pay attention to it and give it some weight in their analyses,” said private antitrust economist James Langenfeld.

The Federal Trade Commission, et. al. v. St. Luke’s suit rose as test case and the first significant trial that had the FTC challenging the now widespread buy-outs of physician groups by hospitals — a trend partly spurred by providers’ push to lower heath care costs amid waning government reimbursements. St. Luke’s lawyers argued, in part, that Affordable Care Act measures that mandate integrated, value-based care drove the merger. Defense attorneys claimed the acquisition meshed with St. Luke’s mission to provide affordable, quality care and the alignment allowed Saltzer to integrate care and among other things, transition to electronic medical records — an effort Saltzer could not have afforded on its own, defense council argued.

Courtroom doors opened then closed in the redaction-laden proceedings that kept the public shut out in an effort to protect the trade secrets of the providers, hospitals and insurance payers that took to the witness stand. Local media outlets challenged the closed proceedings. Winmill defended the closures, even after he approved the release of redacted court transcripts. But what the public did see came as challenge to an old school economic analysis and the triumph of a novel application of a core microeconomic theory sparsely tested in American courts.

St. Luke's

The Pie Shops Collection / flickr
Vintage St. Luke’s image from post card.

On the defense side, in an orthodox critical loss analysis, St. Luke’s claimed that a slight increase in consumer prices would drive some patients to seek care elsewhere. That reasoning broadened the primary care market beyond Nampa’s zip codes and helped argue the transaction preserved a healthy dose of competition.

On the plaintiffs’ side, the FTC and St. Al’s argued that Nampa remained a unique consumer market and suggested that health insurance companies rather than patients ultimately drive prices. The latter point, in the case against the St. Luke’s-Saltzer merger, became key in establishing anti-competitive practices.

St. Luke’s challenged the claim that its acquisition of Saltzer further concentrated an already concentrated market and gave the health system nearly 80 percent of the Nampa primary care market — a share that far outpaced the case law threshold that had previously unwound acquisitions as low as roughly 30 percent of the market share. A critical loss analysis presented by an economist drew the market lines beyond Nampa’s boarders and chipped away at the 80 percent market share claim. Ultimately, lawyers vied to answer: Where would you go if you feel ill?

“Is there a likelihood that the residents of Nampa will travel to Boise or anyplace else for their care? That question is a battle for the economists to look at to determine not only, ‘do people commute,’ but, ‘would they commute in the event that there is a monopoly.’ And that’s somewhat of a speculative undertaking, regardless of how the economists try to reduce it to a science,” Greaney said.

Nicholas Genna, Treasure Valley Hospital chief executive officer, testified that business at TVH dropped after St. Luke’s acquired Boise surgical clinics, including Boise Orthopedic Clinic in 2010. Genna said that BOC doctors once performed about 10 percent of the hospital’s surgeries, but after the St. Luke’s acquisition, not a single one of the former BOC physicians performed surgery at Treasure Valley Hospital. And he said the loss of business didn’t align with TVH costs. A MRI at Treasure Valley costs $622 while the same test at St. Luke’s costs $1,227.

Plaintiffs asked Smith College economics professor and Managed Care and Monopoly Power author Deborah Haas-Wilson to analyze market data from past St. Luke’s mergers, including admissions records and insurance payments. She concluded the merge would thwart market competition, leaving a dramatic dent in business at St. Luke’s biggest competitor, St. Alphonsus Health System, and ultimately drive up health care costs.

“Consumers will be worse off,” Haas-Wilson testified.

St. Luke’s attorneys told Winmill that Saltzer initiated the transaction in an effort to remain competitive and afford the costly tools of 21st Century medicine. They argued the acquisition would give St. Luke’s the physician base it needed to transition the health system from a pay-for-volume service into cost-saving, integrated, pay-for value system.

“The acquisition is intended to promote and will promote competition in the best interest of the people of Idaho,” said St. Luke’s defense attorney Jack Bierig in opening arguments.

David Argue

Economists Inc.
David Argue, economist for St. Luke’s, presented the critical loss analysis for the defense.

Defense economist David Argue suggested market forces would maintain a competitive post-merger market. Argue, vice president of Economists Incorporated, a private, Washington D.C.-based consulting firm, testified that the transaction would not harm competitors and would offer some significant pro-competitive benefits. Argue’s team crunched the numbers twice, yielding slightly different results each time, but results, Argue said, prove that if St. Luke’s did raise prices, a significant number of patients would travel outside Nampa to find care.

“The data shows that about 40 percent of the patients in Nampa who use primary care service choose [primary care providers] outside of Nampa. That 40 percent is a substantial number,” Argue testified.

“If I look at information about substantial flow of patients, there’s a real basis to believe that there would be some additional patients who would travel if there were a price increase,” Argue said.

In a different courtroom, in a different time, a judge may have bought that analysis, said economist James Langenfeld, managing director and head of Antitrust and Competition Practice at Navigant Economics, an international economic consulting firm.

The case tasked Winmill to consider, in part, whether it would be profitable for the merging entities to raise prices, and to weigh the critical loss analysis argument that consumers would leave their zip code in the face of a price increase.

“There’s no empirical basis to this,” said Langenfeld, who was not involved with the case.

In Langenfeld’s account of economic history, much as the times change, economic analysis also changes. Once upon a time attorneys presented judges with a critical loss analysis that essentially drew a big circle around a geographic area.

“If there is a physician’s group or hospital within 90 percent of that draw area, or a zip code had 20 percent (of patients) outside of the area then they would say they are contestable zips and people would go elsewhere and they could expand the market,” Langenfeld said.

“With that approach, you could have gone all the way to Boise. My problem with that approach is that it can go on forever. I consider it to be a simplistic analysis.”

In a 2004 Antitrust Law Journal article, Langenfeld, F.E. Frech and R. Forrest McCluer [link] noted that prior to 1992, all but one of the rarely challenged hospital mergers went forward, in part, the authors conclude, because of economic analysis that too broadly defined geographic markets. “One of the main reasons behind this U-turn in court decisions is not difficult to identify. The courts’ approach to geographic market definition has changed dramatically, and has led to lower market shares and concentration measure.” — Langenfeld, et al. (2004)

They analyzed prevailing market analysis wisdom in health care antitrust jurisprudence and called for a prudent application of broad market definitions drawn from patient flow data or critical loss analysis.

“One must carefully evaluate how the data and tests are being implemented and include other economic analysis,” Langenfeld, et. al wrote.

A number of challenged mergers moved forward under judicial adoption of economic analysis that drew broad market definitions. An exception came with the 1990 decision of United States v. Rockford Memorial where the Seventh Circuit Court unwound a contested hospital merger. Judge Richard Posner noted in his decision that, “… for the most part hospital services are local. People want to be hospitalized near their families and home in hospitals in which their own — local — doctors have hospital privileges.”

Langenfeld and his colleagues found that research more closely aligns with Posner’s wisdom and more recent market analysis shows that prices almost always go up when hospitals merge, Langenfeld said.

“There are more of those types of analyses and (Winmill) was paying a lot of attention,” Langenfeld said. “The body of literature doesn’t say that these type of mergers need to be challenged but that you need to do a more sophisticated type of analysis and in the past, judges just haven’t been willing to dig into it. “

More recent economic analysis focuses on the alternatives that the insurers face.

David Dranove


Economist David Dranove presented the option demand theory for the FTC.

Northwestern University economist David Dranove offered the court a two-part analysis rooted in option demand theory  which explains the relationship between consumer demand for goods and services and their prices. Read Dranove’s report via FTC [pdf] Dranove’s novel application of option demand depended on the fact that insurance companies negotiate prices on behalf of patients. And since the insurers don’t know who’s going to get sick and how much money they’ll spend, they have to negotiate with a range of providers to deal with unforeseen needs. In other words, it’s the payers and not the patients that determine prices, Dranove told The Blue Review. Patients won’t shop around and expand the market if doctors jack up prices, according to the theory and Dranvoe’s testimony.

“We just can’t expect pricing pressure to be imposed by patients,” he testified.

The second part of the theoretical model explains that patients are not sensitive to price differences. Heath care prices lack transparency and the sick find it almost impossible to shop around for a cheaper doctor, Dranove testified.

Dranvoe’s testimony figured prominently in Winmill’s findings. It’s a prominence that won’t go forgotten, Greaney said.

“Theory drives the economics and economics drives the cases,” Greaney said. “This will be a prominent, lead cited case.”

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The views and opinions expressed here are those of the writer and do not necessarily reflect those of Boise State University, the Center for Idaho History and Politics, or the School of Public Service.