A lucrative but geographically challenging market is the battleground for some of the Commonwealth's largest health networks. March 7, 2018By Nicolas Guerrero_____
In the years following the implementation of the Affordable Care Act, its provisions and resulting cost increases led to a series of reconfigurations in healthcare markets across the country. Pennsylvania is a market where healthcare providers and insurers have found a particular need for steadfast consolidation.
Three entities dominate a geographically challenging, yet lucrative healthcare market. The University of Pittsburgh Medical Center (UPMC) is the largest non-governmental employer in Pennsylvania. Headquartered in downtown Pittsburgh, UPMC operates over thirty hospitals in the western and central regions of the state. In addition, UPMC Insurance Services covers over 3.4 million members.
Penn State Health operates the flagship Milton S. Hershey Medical Center, Children’s Hospital and Cancer institute in Hershey, the Penn State Health St. Joseph Hospital in Reading, and 120 medical offices across the Commonwealth. Generating between $1.3 and $1.5 billion in annual revenue, Penn State Health is a major health system and its flagship hospital is the largest in the Greater Harrisburg region.
The University of Pennsylvania Health System, Penn Medicine is the state’s second most lucrative network after UPMC generating around $5.3 billion in annual revenue and operates six hospitals and eight multispecialty facilities along the eastern flank of the state.
The urban markets of Philadelphia and Pittsburgh are separated by 300 miles of vast, sparsely populated rural countryside where medical facilities are likely operated by a dominant regional health system.
In March 2015, the Penn State Milton S. Hershey Medical Center completed plans to merge with PinnacleHealth System, the other dominant healthcare provider in the Harrisburg area. Together, both entities would operate as a single network providing health services for Dauphin County and surrounding markets. In December of that year, The Federal Trade Commission (FTC) filed a lawsuit halting any further action and requesting further information. The FTC, along with the Pennsylvania Office of the Attorney General argued that such merger would create a regional monopoly, increasing prices and potentially lowering quality for the South-Central Pennsylvania market. Yet markets are ambiguous and difficult to make out with naked perceptions.
This particular point was made by the United States District Court, which argued that the FTC had failed to define which specific markets would be harmed by the merger. For horizontal mergers, such as the one between Penn State Hershey and PinnacleHealth—where both merging entities are within the same or similar industry—federal anti-trust authorities apply the hypothetical monopolist test to clearly define such market. In this test, the relevant geographic market is the smallest area in which a single firm could raise prices without consumers resorting to firms outside the region to avoid such a price increase.
The Harvard Law Review notes that District Court found that the FTC had not adequately defined the relevant market as the four-county area around Harrisburg, and “that 43.5% of Penn State Hershey’s patients travel to the hospital from outside of the region, suggesting that the FTC’s proposed market failed to properly account for where the hospitals draw their business”. When the Third Circuit Court of Appeals reversed the District Court’s decision, Penn State spent $17 million on legal arguments in an unsuccessful attempt to push for the merger. The motivation behind the Penn State Hershey-PinnacleHealth merger focused on the benefits by scale economies in a market perceived as underserved by University officials and Pinnacle executives. The 64% market share that both entities would have represented in the region was to be transitory, as equally large health “megasystems” such UPMC and Penn Medicine were quickly expanding into the central Pennsylvania market.
Penn State Hershey CEO Craig Hillemeier argues that with Penn State Hershey operating at near full capacity, the merger would have given the medical campus the size and efficiencies required to compete with entering firms without sacrificing patient care. According to both entities, merging the firms would have led to decreased operating costs, increased flexibility in transferring patients to other hospital locations, lower construction costs, and lower costs for patients on a case-by-case basis. The Penn State University Board Trustees dropped all litigation efforts the following year. The projected legal costs coming out of University coffers outweighed the benefits of completing what seemed to be a lengthy merger process.
PinnacleHealth already searching for capital, immediately shifted its focus to its next potential partner. In 2017 PinnacleHealth successfully merged with UPMC, further consolidating Pennsylvania’s largest health system. As predicted, the newly created UPMCPinnalce expanded quickly, operating 12 hospitals in ten counties across central Pennsylvania.
Expanding in this region is cost-effective for a behemoth like UPMC, where operating costs for existing hospitals and construction costs for new ones are relatively low. Some of these regional hospitals have between ten and sixty beds and serve markets that no other healthcare provider would likely find economic sense in entering.
Lancaster General Health was acquired by Penn Medicine in 2015. This westward encroachment by a Philadelphia-based firm alerted UPMC and Penn State Health, as the fragile central Pennsylvania market has relatively fixed demand. This contributed to Penn State’s increased “megasystems” competition argument during federal litigation. Should Penn Medicine seek to expand beyond Greater Philadelphia, it will add more pressure to competing health systems, and find several health networks already setting their eyes on the lucrative region. That is what UPMC discovered and successfully tackled when it expanded eastward of Pittsburgh. Penn Medicine has the financial resources and acclaimed reputation to be just as successful.
With health systems quickly growing across the Commonwealth, Penn State Health sought to find a partner that would be reputable and profitable in the face of aggressive competition. After the failed attempt to merge with PinnacleHealth, university resources had to be used carefully, objectives had to be clear, and litigation avoided if possible. Without being neither a merger nor acquisition, Penn State Health partnered with Highmark, the largest insurance provider in the state.
Under this agreement, Highmark ends its partnership with UPMC, and gives an infusion of capital to Penn State Health, allowing it to build new hospitals and facilities to directly compete for UPMC’s consumers. $1 billion will be used to update and expand Penn State Health operations. In exchange, Highmark will send its members to the Penn State Health system hospitals and physicians. The insurer now has three seats on Penn State Health’s fifteen-person board. Thus, Highmark becomes a healthcare insurer and provider through this partnership, just like UPMC.
___________ Featured Image: The Susquehanna River flows through central Pennsylvania Image Credit: Pubic Domain