Despite significant challenges, there’s value in hospital mergers

It is no secret that hospitals today are facing severe economic pressures. Most are caught between a rock and a hard place — depending on government programs for half or more of their revenue with the rest coming from highly concentrated private insurers. Meanwhile, hospitals face concentrated factor markets controlled by monopoly health system unions, large pharmaceutical, medical device and equipment manufacturers, and consolidated physician groups and private-equity players competing for their most attractive business. The result is predictable: The median operating margin of not-for-profit health systems is 0%, and the industry outlook is negative.^a

Under these conditions, most industries consolidate through mergers, and hospitals are no exception. Most hospital mergers have a sound business rationale, as shown in the sidebar “Why U.S. hospitals are merging” below.

Yet U.S. hospitals have faced substantial challenges in recent years from regulatory barriers.

Rather than acknowledging the need for industry consolidation, the Biden administration’s Federal Trade Commission and Department of Justice, along with a few state attorneys general, have intensified enforcement of antitrust laws for hospital mergers, causing many hospitals that had invested substantial time and capital in planning mergers to abandon these efforts — and likely discouraging other hospitals from initiating them. It remains to be seen what changes in policy might be enacted under the Trump administration.

Hospital mergers abandoned since 2020 (partial list)

Year	State	Party A	Party B
2020	New Jersey	Hackensack-Meridian Health	Englewood Health
2020	Tennessee	Methodist Le Bonheur	Saint Francis Health
2019-22	New Hampshire	Dartmouth Health	GraniteOne Health
2022	New Jersey	RWJ Barnabas	St. Peter’s Healthcare
2022	Utah	HCA	Steward Healthcare
2022	Rhode Island	Lifespan	Care New England
2021-23	New York	SUNY Upstate	Crouse Hospital
2021-23	Minnesota/South Dakota	Fairview Health System	Sanford Health
2023	California	John Muir Health	San Ramon MC
2023	California	Trinity Health	Madera Community Hospital
2024	North Carolina	Novant Health	Community Health Systems

Increased enforcement unwarranted

Intensified antitrust enforcement is not warranted for two reasons.

1 Price effects are modest. Regulators, economists and health policy researchers have conducted extensive research on the effects of hospital mergers on consumer welfare, as defined by the cost of hospital services, and have found that in general, hospital mergers result in higher hospital prices.^b However, while the magnitude of this effect varies, the median price increase is relatively small — about 5% above normal inflation — and hospital mergers are responsible for only 1.3% to 5% of total healthcare cost escalation over the past decade, based on this author’s research.^c

These modest effects are due to the following two factors:

• The small number of hospital mergers relative to the base of hospitals in the United States (i.e., fewer than 100 mergers per year in a population of 5,000 short-term acute care hospitals)
• Actions by antitrust regulators working in the traditional “consumer welfare” paradigm to prevent mergers with the greatest potential to raise prices

Studies examining the effect of hospital concentration on prices, whether due to mergers or other factors (e.g., hospital closures), show similar but slightly smaller effects, mainly because concentration in most markets is relatively stable.

2 Hospitals face daunting buyer power. The second reason increased antitrust enforcement is unwarranted is that it is based on models of competition that are very different from today’s markets for hospital services. The principal analytic foundation for antitrust regulation consists of microeconomic models of monopolies (a single seller facing multiple buyers) and monopsonies (a single buyer facing multiple sellers).

However, most good-sized markets for hospital services are neither monopolies nor monopsonies. Except for the largest metro areas (Los Angeles, Chicago, New York), most are bilateral oligopolies, where a small number of insurers purchase services from a small number of hospitals. As long as buyers and sellers are reasonably balanced, negotiations between them should produce more desirable outcomes than if either party were able to roll over the other and get its way.

Markets for hospital services, however, have another problem: Insurers (buyers) and hospitals (sellers) are not balanced.

Hospitals, which are mostly not-for-profit companies, face daunting buyer power. Taxpayer-funded programs like Medicare and Medicaid account for half their revenue, or more in the case of rural hospitals. CMS directly or indirectly controls prices for these programs, and their payments rarely cover the full cost of services. To make up the difference, hospital systems must either cut services or cross-subsidize government patients by raising prices to private insurers.

Private health insurers, for their part, have been consolidating rapidly. A recent AAMC study, for example, found that the top three insurers had an average 82% market share of members in states they studied, while the top three hospital systems had an average 43% market share of inpatient discharges.

Antitrust law has focused much less on buyer power than on seller power, and microeconomic models used to justify antitrust enforcement do not address markets where government a major buyer and private payers are highly concentrated.

Impacts of buyer power

Buyer power has been responsible for many healthcare innovations that have benefited consumers by reducing the cost of care. Pressure on inpatient rates has forced hospitals to reduce length of stay and shift inpatient care to less expensive outpatient centers.

Lower-cost forms of inpatient care have also been developed — e.g., inpatient rehabilitation units and skilled nursing units within hospitals. Recently, health systems have begun implementing hospital-at-home care models to treat serious conditions like chronic obstructive pulmonary disease at home to avoid expensive hospitalizations.

At some point, however, once buyer power has cut out the fat, it begins to eat into muscle, and this boundary has been crossed in most metro markets. Just as sellers with substantial market share can act like monopolists, buyers with substantial share can act like monopsonists. And because most urban hospital markets are dominated by government buyers and one or two private insurers, even if hospitals have significant market share, most of the time they have to accept the prices set by these buyers.

The effects of excessive buyer power are similar to the those of price controls. They include the following.

Lower hospital margins, especially where factor markets are concentrated (e.g., unionized work forces). Reduced margins can force cutbacks in capital investment and services.

Service shortages relative to what an efficient market would provide. Over-crowded emergency departments, shortages of hospital beds, patients in hallways, difficulties in getting physician appointments and the like are becoming more common, especially for hospitals with large numbers of taxpayer-funded Medicare and Medicaid patients.

Below-market rates for factors of production, including labor. As hospital efficiencies become harder to achieve, buyer power propagates pricing pressure across the hospital value chain, forcing physicians, nurses, device manufacturers, drug companies and other drivers of production to accept lower prices than they would normally be paid in a competitive market. This situation creates incentives for suppliers to consolidate and for employees to unionize to protect their share of healthcare dollars.

Closure of marginal hospitals. Inner-city and rural hospitals feel the greatest pricing pressure because they are more dependent on Medicare and Medicaid and have more uninsured, indigent patients. As a result, many inner-city and rural hospitals have closed or been converted into subacute facilities or outpatient clinics over the past two decades.

Transfer of capital from hospitals to insurers. Health insurers have performed exceptionally well financially over the past decade compared with hospitals. From 2012 to 2022, total earned premiums for the five largest health insurers (UnitedHealth Group, Elevance Health [Anthem], CVS [Aetna], Humana, and Centene) grew 231% to over $1.0 trillion, average return on equity was 12.4% and the annual ROI rate in these five stocks exceeded 22%.

The exhibit below contrasts the strong financial performance of these insurers with the that of the five largest hospital systems (HCA Healthcare, CommonSpirit Health, Advocate Health Care, Ascension and Providence), which for the most part has been marginal.

Recent financials of top 5 health insurers compared with financials of top 5 hospital systems (dollars in millions)

Mergers are important not just for the business reasons listed in the sidebar below, “Why U.S. hospitals are merging,” but also because they enable hospitals to employ countervailing market power to create a competitive balance with private insurers. Without countervailing market power, hospitals in most metro markets cannot earn enough margin to compensate for low, price-controlled government rates. Instead, they will limp along with low margins, or they will close.

What can health systems do?

Hospitals can take three approaches to counter overly aggressive antitrust enforcement action by federal and state regulators.

1 Pursue compelling mergers. In response to regulators who would try to derail their merger, hospitals should be able to forcefully demonstrate the potential benefits of the merger for patients, communities and business partners and for promoting financial sustainability. Courts have not always supported the regulators, and mergers that enhance competition may still be defensible. Of course, every situation is unique, and decisions about specific merger opportunities must be guided by internal counsel, government affairs staff and outside antitrust counsel, if needed.

2 Implement Certificates of Public Advantage (COPAs). In most states, hospitals can work with state legislators to implement COPAs that protect mergers from federal antitrust action. Unsurprisingly, the FTC doesn’t like COPAs, and they must be designed carefully to avoid reducing consumer welfare down the line. On the other hand, regulating a COPA is conceptually not very different from regulating a critical access hospital, which is essentially a CMS-sanctioned monopoly.

3 Advocate for regulatory change. Hospital mergers call into question the basic tenets of antitrust regulation and its application to hospital systems. At the federal level, facilitating hospital mergers will require changing federal antitrust policy and perhaps antitrust law, which may be more feasible in the Trump administration. In the short run, hospitals should appeal to antitrust regulators to employ a flexible and rational approach to enforcement to avoid decisions that may reduce hospital concentration but harm competition.

Eventually, new laws promoting competition are needed that are more relevant to oligopoly markets where government is a major player. The best approach for hospitals may be to work with industry associations such as the American Hospital Association and the Federation of American Hospitals to accomplish this.

Where buyer power is so pervasive and powerful, competition isn’t enhanced by preserving fragmented, inefficient hospital systems.

Footnotes

a. S&P Global, “U.S. not-for-profit health care system median financial ratios — 2023,” S&P Global Comments,
Aug. 7, 2024; American Hospital Association, “Fitch & S&P maintain gloomy outlook for not-for-profit hospital sector in 2024,” Jan. 5, 2024.
b. See, for example Vogt, W.B., Town, R.J., and Williams, C.H., How has hospital consolidation affected the price and quality of hospital care? The Synthesis Project, research synthesis report, February 2006.
c. Anderson, D.G., Hospital mergers, competition, and health care costs, Working paper, Institute for Affordable HealthCare, May 2024.
d. Dickson, A. and Hartley, R., “Bilateral oligopoly and quantity competition,” Economic Theory, Oct. 18. 2011.
e. Grover, A., et al., Why market power matters for patients, insurers, and hospitals, AAMC Research and Action Institute report, May 1, 2024.
f. Carstensen, P.C., Competition policy and the control of buyer power, 2017.
g. Blase, B., “The ACA is making health insurers much richer,” Paragon Health Institute, 2024.
h. National Association of Insurance Commissioners (NAIC), “U.S. health insurance industry analysis report: 2022 annual results,” 2023; Note: This analysis excludes Kaiser Permanente, the fourth largest health insurer by enrollment, which is both a hospital system and a not- for-profit insurer.