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Healthcare reform is encouraging the vertical integration of payers and providers. How far can this go in any one market before such efforts risk being deemed illegal? Pittsburgh provides a case study.
As the debate over reforming healthcare escalates, consider the unusual — and messy — scenario unfolding in Pittsburgh. Known in years past for steel manufacturing and championship football teams, the Pennsylvania city has recently gained an unlikely reputation for something decidedly different — a microcosm of what may occur when hospitals and insurers attempt to buy one another, otherwise known as vertical integration.
Vertical integration, of course, is nothing new in the business world. But it is becoming something of a catch phrase in healthcare these days, as the emphasis on lowering cost trends and improving outcomes increases. The impetus for such hookups dovetails with the advent of accountable care organizations (ACOs), which are pressuring nearly every participant in the healthcare universe to ratchet up performance.
The scenario in Pittsburgh, however, raises questions about the ease with which vertical integration can occur, what sort of entity may be best suited to execute such a plan, the strategy needed for success, and whether such efforts can accomplish stated healthcare goals without running afoul of antitrust regulators. In effect, the episode may test the legal boundaries of vertical integration — at least as some see the concept evolving in healthcare.
In Pittsburgh, healthcare costs are generally much higher than in similar markets relative to the quality of care. For this reason, Pittsburgh is being watched closely by third-party payers, regulators, physicians, and hospital administrators, not to mention legislators, healthcare policy experts, and drug manufacturers — all of whom have a stake in how vertical integration plays out. And while no two regions are alike, experts say Pittsburgh could provide a learning opportunity for the nation.
“A lot of this has to do with the political situation. Regulators have not only additional powers to look at mergers under the Affordable Care Act [ACA], but also the desire to do so,” says Shana Alex Lavarreda, PhD, MPP, director of health insurance studies and a research scientist at the UCLA Center for Health Policy Research. “Now, insurers are thinking of going after providers. And the way to get more control is to buy them. The situation in Pittsburgh is particularly interesting because the healthcare system is integrated.
“So we’re seeing an acceleration of this phenomenon,” she continues, “Insurers are scrambling. They know that in 2014, they can’t exclude people based on pre-existing conditions. They can’t choose populations as they have in the past, and they need another way to handle the costs. One way is to purchase providers. But this situation in Pittsburgh is so complicated and, unfortunately, it threatens to leave consumers caught in the middle.”
The story in Pittsburgh, which actually began more than a decade ago, involves three central players — Highmark Blue Cross Blue Shield, the largest insurer in Allegheny County, and two hospital systems, one of which is the University of Pittsburgh Medical Center. UPMC has about 55 percent of the regional market and operates 20 hospitals. The other hospital system is UPMC’s closest competitor, West Penn Allegheny Health System, which has been financially failing for years.
The saga has its roots in an effort in which the institutions attempted to sort out a financial imbroglio that, initially, involved a hospital and several providers whose difficulties threatened to rob many local residents of needed care. As time went on, the story became convoluted as the players struck differing bargains, changed alliances, and jockeyed for advantages that often pitted one against the other in hopes of dominating the market.
“The Pittsburgh market is unique because of the demographics, but it’s become a tremendous battle because no party has been able to get the upper hand,” says F. Randy Vogenberg, RPh, PhD, principal at the Institute for Integrated Healthcare in Sharon, Mass. “The battle is over bodies and keeping patients in the beds as well as getting the lives under contract. It’s like Republicans and Democrats — it’s one of the more ruthless markets in the country right now.
“In general, employers are not happy with any of the players because it’s been very disruptive to the market,” Vogenberg adds. “Despite the animosity and all the changes and proposed changes, the cost of care in that region isn’t going down. So it’s really [been] a lose-lose proposition for employers. But it’s an important case study, because the concept around vertical integration can play out in similar ways for insurers or hospitals in most any market.”
In 2000, West Penn merged with several financially distressed providers with $125 million in funding from Highmark, which wanted to preserve competition for hospital services. Over the years, Highmark has controlled between 60 percent and 80 percent of the greater Pittsburgh market. The insurer bank-rolled West Penn for a simple reason — if West Penn failed, UPMC would become the dominant hospital system and could demand higher rates.
As time went on, Highmark and West Penn continued to enjoy a close relationship; the insurer even provided a $42 million grant to upgrade facilities. UPMC did not stand silently by as these developments took place. The medical center filed a lawsuit challenging the earlier deal between West Penn and the smaller providers, and it attempted to discourage investors from purchasing West Penn bonds. UPMC also took aim at Highmark with an effort to hike reimbursement rates.
Highmark responded by forming a low-cost insurance plan. To participate, a hospital had to agree to accept lower payments in exchange for higher volume. West Penn participated but UPMC refused, saying reimbursement was too low. So UPMC formed its own health insurer, which became Highmark’s main competitor.
As ugly as this appeared, there was more. In a bid to lower the heat, Highmark and UPMC took a series of mutually beneficial steps that eventually prompted West Penn to charge that a conspiracy was under way. Highmark paid UPMC unusually high reimbursement rates and provided $230 million for a new facility. The insurer also supported UPMC’s acquisition of a hospital that, other than West Penn, was its only tertiary care competition.
The battle intensified when Highmark allegedly leaked confidential information about West Penn to UPMC, refused to refinance a loan to West Penn, and maintained artificially depressed reimbursement rates for West Penn, according to court documents from the litigation that ensued. Highmark also eliminated its own low-cost insurance plan, which had benefited West Penn by excluding UPMC. Though none of the institutions would comment for this article, West Penn essentially claimed that Highmark was trying to strangle its ability to compete.
The results were predictable. Over time, insurance premiums rose in Allegheny County; UPMC and Highmark recorded higher profits; and provider choice dropped as a struggling West Penn scaled back services, according to Axel Bernabe, a partner at the New York office of Constantine Cannon, a law firm that focuses on antitrust and commercial litigation.
“This story has become so sexy because you have a number of lawsuits and allegations laying bare the competitive interests that are normally articulated behind closed doors,” says Bernabe. “You have these ‘I’ll scratch your back and you scratch mine’ scenarios in which an insurer and a provider describe how to carve up a market. They highlight the kinds of discussions that are likely happening around the country. The Highmark/UPMC story serves as a blueprint for what to look for in vertical integration — to understand what can and can’t be done.”
The issue, Bernabe says, is whether vertical integration excludes competitors. “Here, you had a dominant insurer and a dominant provider discussing an exclusive agreement that would keep each other’s competitors out of the market.” By keeping West Penn out of its network, he says, Highmark ensured that West Penn would not be a viable competitor to UPMC. And by agreeing to offer Highmark better rates than it would have offered to other insurers, UPMC ensured that no other carrier could compete with Highmark.
“This way, Highmark can keep its premiums high — since it is the only game in town — and pay some of the profits from the inflated premiums to UPMC in the form of higher reimbursements. It’s a win-win situation for both of them,” Bernabe says. “As long as the hospital doesn’t offer a better rate to another insurer, they can both keep higher profits. Everyone is happy — except consumers, who pay higher premiums for less provider choice.”
Last year, Highmark surprised everyone by abandoning its hostile posture toward West Penn and striking a deal to purchase the ailing hospital system for $475 million. This put Highmark at odds once again with UPMC. But by then, the flurry of activity had attracted the attention of the U.S. Department of Justice, underscoring concerns that vertical integration may be anticompetitive rather than an economically efficient model for offering consumers viable care and services.
Regulators were concerned about the effects on local customers: rates paid, whether customers would be in or out of network, and — most of all — the extent to which they would continue to have coverage. “People just want to know they’re getting good care for a good price, but consumers can get caught in the middle in these situations,” says UCLA’s Lavarreda.
The deal between Highmark and West Penn caused a regional crisis because contract renewal talks between Highmark and UPMC were breaking down. In fact, a UPMC spokesman was quoted as saying that “there cannot be any reasonable prospect for a contract renewal” between the two entities. The contract was set to expire last June, but Pennsylvania politicians brokered a deal through June 2013 that allows Highmark consumers to receive in-network rates at UPMC hospitals and physicians.
Meanwhile, the Justice Department decided that the deal between Highmark and West Penn, referred to as an affiliation, would not reduce competition and thus warranted no further action. How so? For one thing, the $475 million commitment from Highmark will give West Penn a significant capital infusion that provides competition to UPMC. And the deal will not eliminate any “material horizontal competition,” meaning consumer choices should remain available.
For biotechs, the upshot of provider integration is a greater need for compelling evidence of cost-effective clinical outcomes — because providers will be taking more financial risks.
“Vertical agreements can reduce competition by limiting entry of expansion by third parties,” the Justice Department explained in announcing its decision. “Such effects are unlikely here for several reasons. ... Other than [West Penn], the only other significant hospital network is UPMC, the region’s dominant network. In the absence of the affiliation agreement, Highmark would likely not sponsor expansion by a hospital network other than [West Penn] because there is no other significant network with which Highmark could partner.”
And West Penn “on its own likely would not have promoted entry or expansion by other health insurers,” the feds continued. West Penn “has previously tried to sponsor entry by national insurers and largely failed. The affiliation agreement is not likely to reduce West Penn’s incentive to offer competitive rates to insurers other than Highmark, because [West Penn] has strong incentives to increase its patient volume.”
The Justice Department also noted that national insurers are, for the first time in many years, aggressively attempting to enter the market and reduce Highmark’s dominant share by signing agreements with UPMC. And the signs of increased competition are appearing just as an existing long-term contract between Highmark and UPMC comes up for renewal. This expiration, the feds noted, only increases the need for both UPMC and Highmark to find alternative counterparts.
Still, the Justice Department offered a warning. “Vertical acquisitions and affiliations between health insurers and hospitals with market power can potentially reduce competition.” And so the feds will monitor developments in the market “as part of our broader commitment to vigilantly enforce the antitrust laws and protect competition.”
Bernabe believes similar scenarios are likely to play out elsewhere and invite similar scrutiny, even if the feds ultimately decline to take any action. “The Pittsburgh situation is a beacon of what can go wrong,” he cautions. “A lot of metropolitan areas [have] the same kind of insurer concentration found in Pittsburgh, with one or two companies dominating the area. On the provider side, we have seen a proliferation of cooperation and integration between providers in recent years.”
With the ACA encouraging the creation of integrated delivery systems, large regional and national hospital and health groups have formed, he says, with significant clout to negotiate rates and potential exclusivity arrangements with insurers. “This means insurers can’t use the old techniques of playing one provider against another to obtain the lowest possible prices. They have to find a situation in which both the insurer and the dominant provider can benefit” — hence, the potential for a scenario like Highmark/UPMC.
“The lesson,” Bernabe says, “is don’t get into bed with a dominant provider. But if you do, be very careful about how you describe any kind of exclusivity you are going to give the provider.”
Others are skeptical the government will do much. “In many cases, the Justice Department is powerless to take down a monopoly,” says Dan Mendelson, chief executive at Avalere Health, in Washington, D.C. “In a dominant system in an area without a lot of competition, what can it do? Generally, you don’t see it breaking up large health systems.”
Even though the Justice Department may have decided that a healthy dose of competition is finally coming to Pittsburgh, observers are not convinced the outcome is assured. The enmity between the key players remains strong, and it may take months or longer for other insurers to establish a meaningful foothold. Meanwhile, West Penn must persuade providers that it offers a viable platform for physicians who may otherwise stick with UPMC.
Consequently, the boundaries for successful vertical integration are unclear. There is little question that hospitals and insurers will continue to consider acquisitions and affiliations, because the increasing emphasis on patient outcomes demands greater synergies and cooperation. But each locality will offer its own challenges as market share shifts and rivals jockey for advantages that may attract the ire of regulators.
“The jury is still out on this. Pittsburgh is a good market to examine because the players are better defined and the market, to some extent, is self-contained,” says John Santilli, president of Knowledge Source, a healthcare and pharmaceutical consulting firm, in Trumbull, Conn. “But you’re going to see many geographic regions where a lot of entities will try to figure out whom to team up with. Will vertical integration work? It’s very difficult to tell. We’re at the early stages.”
What does vertical integration mean for biotechs and other drug makers? For now, the landscape may not change appreciably. Regardless of whether an insurer or hospital dominates an area, manufacturers that have little or no competition for their specialty drugs are unlikely to feel a pinch as ownership is realigned, according to Vogenberg.
The sort of changes that are more likely to surface have less to do with pricing, contract terms, or formularies. Rather, manufacturers can expect to spend more resources on gathering evidence and providing information about outcomes to providers, who are going to be taking more risks. Such scenarios are less likely in therapeutic categories where sufficient competition exists, such as rheumatoid arthritis. But vertically integrated systems are going to want data to justify usage and how medications are administered.
“Some ACOs are vertically integrated and they’re challenging the system. We’re seeing that pressure now, which we didn’t see two or three years ago,” says Ron Marchessault, vice president of corporate accounts at Genzyme. “We are concerned about rebates and the pressure on pricing, but I think if there is no competing treatment, they [ACOs] will be less controlling. What may change is the site of service and how different locations within an integrated system translate into different costs.”
Says Greg Judd of Bentelligence, a Connecticut-based consulting firm, “For drug manufacturers, it’s going to change by degrees. Vertical integration will not upend the business, but it may change how you go to an employer and conduct the contracting discussion. The assumption that you’ll always be a monopoly because you’re the only one with a product for a particular therapeutic category is not a wise business strategy. The greater integration of healthcare systems means that people paying for healthcare are paying for outcomes and quality. On balance, that’s better for the manufacturers. They need to get into details and emphasize their superior results.”