Special thanks to William Barcellona, Executive Vice President of Governmental Affairs, America’s Physician Groups; Eric Klein, Partner and Team Leader, National Healthcare Practice, Sheppard Mullin; John Carroll, Partner, Antitrust & Competition Practice, Sheppard Mullin; and Jordan Grushkin, Associate, Corporate Practice Group, Sheppard Mullin, all of whom contributed to this article.
Mergers and acquisitions have influenced the healthcare sector for years, creating everything from megasystem consolidations to small and midscale provider partnerships. But is that about to change — or at least significantly slow down?
Experts say it might, thanks to what they’re calling a perfect storm of federal and state regulations.
Impacts of new healthcare regulations
An overhaul in how the FTC and DOJ review and approve transactions now coexists with a new era of growing healthcare state regulations and filing requirements, already in place in 13 states.
As a new wave of transaction scrutiny from both federal and state agencies impacts providers, without meaningful exemptions and expedited review processes for distressed entities, those organizations’ last-ditch efforts to survive might fail.
Leaders need to be aware and prepare for the perfect storm of deal scrutiny, balancing the regulatory forces that can chill deals with the market demands that drive the need for them, including shifting to value-based care (VBC) reimbursement to meet CMS' guidelines of achieving 100% VBC reimbursement by 2030.
An antitrust revolution from the FTC and DOJ
An overhaul in how the Federal Trade Commission (FTC) and Department of Justice (DOJ) review and approve agreements now coexists with a new era of state regulations and filing requirements, such as those in 13 states including New York, California, and Illinois.
These factors could affect which types of transactions get approved, increase review times, and substantially slow or kill the kinds of deals that would have passed muster years ago. As those agreements encounter more barriers, it’s raising new questions about how antitrust activity affects providers’ concomitant business considerations, such as reimbursement models.
Deal scrutiny is anticipated in 2024 like never before from both the federal and state levels.
Healthcare accounts for roughly a sixth of the gross domestic product, but healthcare deals have represented more than half of antitrust enforcements, according to John Carroll, partner in the antitrust and competition practice group at Sheppard Mullin.
“The FTC has lost a lot of cases, but one area where they’ve been extraordinarily successful is in hospital merger enforcement,” Carroll said at the November 2023 Moss Adams annual healthcare conference. “[In that area], they’ve lost very few cases in the last 20 years. If you’re talking about an in-market strategic transaction between hospitals, that’s the FTC’s bread and butter, and it’s one of the crown jewels of their enforcement.”
FTC and DOJ final merger guidelines
In December 2023, the FTC and DOJ jointly issued their new Final Merger Guidelines — which describe how the FTC and DOJ examine mergers in all industries — following a public comment period on the Proposed Merger Guidelines first issued in July 2023. Those guidelines updated and replaced the 2010 Horizontal Merger Guidelines and the rescinded 2020 Vertical Merger Guidelines.
Now, the Final Merger Guidelines presume a deal to be unlawful based on substantially lower combined market share — just 30% — than in prior iterations of the guidelines and contain a number of other changes.
Many experts say that a 30% market share isn’t dominant and instituting that standard is likely to kill deals that pose no real monopolizing threat.
Does that mean providers should only consider agreements that would consume up to 29.99% of the market? Not hardly, explained John Carroll, a partner in the Antitrust & Competition Practice Group of Sheppard Mullin, at the 2023 conference. For one thing, market shares can be challenging to quantify. But second, it’s just one of many factors.
“If you’re evaluating potential bidders and a bidder would be considered dominant in a market by these standards, that gets factored into the scope of review,” Carroll said. “It’s about evaluating the overall competitive presence and factoring antitrust into all the other things involved in a transaction. Also keep in mind that the Final Merger Guidelines will be subject to challenges in court, though that would require merging parties to have the appetite for litigating against the FTC or DOJ.”
Changes to Hart-Scott-Rodino regulations
In July 2023, the FTC and DOJ proposed drastic changes to the Hart-Scott-Rodino (HSR) regulations which require that parties in a transaction provide certain information to the FTC and DOJ in their HSR forms, potentially mandating that parties in a transaction provide information regarding investors and other information that is not currently required.
These changes haven’t been finalized but raise concerns about deal structuring, costs, and timelines. For example, every new draft of substantive merger agreements must be filed with the FTC and DOJ, indicating a need to plan for a bumpy and potentially extended and expensive pathway toward deal approval.
Decades of federal healthcare merger guidance withdrawn
Further, the FTC and DOJ each withdrew decades of health care guidance and stated they don’t intend to replace them. These guidelines represented a cornerstone of federal antitrust enforcement and have provided U.S. healthcare industry providers, payors, employers, and others with hundreds of pages of detailed guidance regarding the application of U.S. federal antitrust laws to the healthcare industry and provided certain safe harbors for rural hospital transactions and information exchanges.
Additionally, a recent FTC press release announced a partnership between the DOJ, FTC, and Department of Health and Human Services (HHS) to — among other things — exchange data to identify high-risk deals that would have otherwise not been flagged. A deal may be considered high-risk if it hinders competition or access to care.
On Jan. 8, 2024, HHS named Stacy Sanders its first chief competition officer. The new role is intended to boost competition in healthcare to mitigate rising costs. Sanders will work with the FTC and the DOJ to focus on consolidation in the industry by “sharing data, creating reciprocal training programs, and developing new competition policy initiatives.”
New developments in state regulation and review
By the end of 2023, 13 states had passed regulations requiring M&A transactional reviews by state regulatory bodies:
California
Colorado
Connecticut
Hawaii
Illinois
Massachusetts
Minnesota
Nevada
New York
Oregon
Rhode Island
Vermont
Washington
These laws are modeled after HSR, which requires parties to a proposed transaction first provide information to the FTC and DOJ.
These laws, often referred to as so-called mini HSRs or baby HSRs, require entities to get state approval at lower threshold requirements. Similar to the scrutiny seen federally, many states define the lower transaction thresholds not by market share, but rather by transaction value, similar to federal requirements.
For example, under California’s SB 184 and its new regulations, healthcare entities, which include payors and many categories of providers, will be required to notify the Office of Healthcare Affordability (OHCA) of certain transactions, including those valued at $25 million or more.
Similarly, New York now requires heath care entities, including physician practices and management services organizations (MSO), to submit written notice to the State Department of Health prior to consummating certain material transactions, but exempting transactions that won’t increase a party’s in-state revenue by at least $25 million.
These state-based requirements could exacerbate the pressures from national antitrust activities, making already burdened deals even harder to pass through. But unlike federal regulations and enforcements channeled through the FTC and DOJ, state requirements are more nuanced, complex, and dispersed across different agencies, sometimes with overlapping scopes of review.
Case in point: California
California’s new regulations demonstrate the level of nuance and complexity the healthcare industry must contend with, in addition to the federal requirements. As previously noted, California’s SB 184 requires healthcare entities including payors to notify OHCA of certain transactions.
Under the OHCA cost and market impact reporting (CMIR) requirements, the California Department of Managed Care (DHMC) and the Department of Insurance will retain primary authority to review transactions involving Knox-Keene healthcare service plans and licensed insurers, respectively, and the attorney general will retain primary authority to review transactions involving not-for-profit corporations, notwithstanding the fact that such entities may be considered healthcare entities under SB 184.
That said, such state agencies have the ability and discretion to refer such transactions to OHCA for a separate CMIR, potentially adding significant reporting and disclosure obligations, costs, and delays to deals beyond what may be normally expected under the initial agency review.
Interference with market dynamics
These and related California-based requirements can clash with other market dynamics, such as one that Bill Barcellona, the executive vice president of government affairs of America’s Physician Groups, says is particularly concerning — a recommended 3% cost growth cap over the next seven years that OHCA contemplated in connection with its cost-target setting authority under SB 184, in addition to OHCA’s CMIR authority discussed above.
Confidentiality
Besides understanding what to file, when, and where, there’s also the concern that confidentiality is not automatically assumed when filing in California and other state agencies, unlike in federal processes. Under the recently released OHCA CMIR regulations, much of the filing materials and information is treated as a public record unless OHCA accepts a submitter's confidentiality designation.
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The bottom line is that states are creating and empowering their agencies and attorneys general to investigate proposed transactions in healthcare industries before closing.
Impact on the financially distressed
Barcellona pointed to the fact that in California — and many other places — transactions occur because the providers involved are financially distressed. With a new wave of transaction scrutiny impacting providers from both federal and state agencies, without meaningful exemptions and expedited review processes for distressed entities, it may jeopardize those organizations’ survival. In an environment where healthcare providers are already squeezed financially with razor-thin margins, enforcing price caps could hasten the demise of these organizations rather than lower the overall cost of care. “The reason why physician groups have aligned with hospitals over the last decade isn’t because the doctors were looking to make more money,” he said. “They were looking to stay solvent. I worry about this taking us back to where we were in the late 1990s and early 2000s, when we had so many insolvencies.”
In the late 1990s, over 100 risk-bearing physician organizations and four major health plans in California closed due to insolvency, as documented by consultants Cattaneo & Stroud.
This disruption led to the passage of California SB 260 to require DMHC oversight of risk-bearing provider organizations and establish minimum financial solvency standards. DMHC oversight of financially troubled providers could create clashes with OHCA oversight where one regulator requires a buyout or change of control of a troubled organization and another questions the transaction based on the market consolidation criteria.
The bottom line is that states are creating and empowering their agencies and attorneys general to investigate proposed transactions in healthcare industries before closing.
Tensions between reimbursement models and transactional pullbacks
As a transactional revolution takes place on a national and state scale, the reimbursement revolution does, too. And the effects of one are deeply enmeshed in — and potentially in conflict with — that of the other, creating an even more challenging road ahead.
Consider, for example, the Centers for Medicare & Medicaid Services (CMS), which has encouraged alternative payment models (APMs), such as risk-based and value-based arrangements, instead of fee for service (FFS). By 2030, CMS aims to have 100% of Medicare beneficiaries in accountable care programs.
To achieve that reimbursement shift, hospitals need resources, people, technologies, systems and, most of all, scale. In turn, they ink large agreements, the same type now less favored by national and state agencies.
It seems like a Catch-22. Providers need deals to make APMs more feasible, and yet those deals are at risk of being blocked or made to be longer and more expensive by anti-merger policies. What’s a hospital system to do as it bridges from one reimbursement model to the next?
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“When you have this type of additional regulation and this uncertainty, it slows down progress toward a new system as everybody hunkers down,” Klein said. “What’s going to happen is we’re going to get stuck in betwixt and in between. What happens when you’re there? We don’t get the full quality or cost benefits that we could with a more complete system transformation.”
Preparing for the shift
The best choice is to keep moving away from FFS and toward risk-based reimbursement systems that reward keeping patients healthy, Eric Klein, national healthcare practice team leader and partner at Sheppard Mullin, recommended.
Partnering for this transformation has been the primary industry choice to date, but that may change given the emerging regulatory environment, he said. We may see more targeted change, such as a health system moving its money-losing Medicare line of business into risk but maintaining its profitable commercial line of business in its current form.
“When you have this type of additional regulation and this uncertainty, it slows down progress toward a new system as everybody hunkers down,” Klein said. “What’s going to happen is we’re going to get stuck in betwixt and in between. What happens when you’re there? We don’t get the full quality or cost benefits that we could with a more complete system transformation.”
At the same time, the consumer benefit of a potential transaction could tip the scales toward regulatory approval, even if it poses an antitrust risk, Carroll added. That is, nothing is cut and dry.
“Even if the deal would be combining or reducing competition, you then get into the next level of questions about market share and benefits,” he said. “And namely, what are the benefits of what they’re doing to bring together? In that way, the potential good of the transition to value-based care could be something that the people reviewing the deal could consider a positive.”
How to prepare for the perfect storm
Many in the healthcare industry, whether they’re in the middle of a deal now or planning for deals in the next few years, are unaware of the challenges on the horizon due to federal and state scrutiny.
Leaders have a lot to consider as they balance regulatory forces that may chill deals with market demands that drive the need for them.
In the context of evaluating potential partners, experts recommend focusing on current and forecasted needs across market strategy and growth:
Where do you anticipate growing revenue over the next two to five years, for example?
What major capital investments are you considering across EHRs, facilities, analytics, and population health management?
What initiatives are you considering, for example in artificial intelligence (AI) or payor platforms?
Have you factored possible alignment strategies with payors and large employers to either prepare for a long-term merger play or compare to a merger strategy?
What efficiencies can you demonstrate with a merger strategy?
Have you factored in regulatory cost growth caps at state levels?
Additional contributors to that analysis could be those that account for other financial and economic factors, including cost trends, Barcellona said.
For example, in California, “you should make sure that your cost trend is under 4%, and potentially now lower with the OHCA’s recent recommendation,” Barcellona said. “And get ready for transparency. Organizations will need to prove their value within the system and get more efficient within the network. And, of course, you have to embrace the trend toward equity and inclusion. There’s a lot to consider.”
By assessing potential partners to ensure strengths and needs align, providers can demonstrate that deals are worth the expected increases in time, labor, and costs. And by exploring potential alignment strategies with payors and large employers before transaction talks occur, it could potentially support the review process given the FTC’s reliance on payers as a proxy for consumers.
Even so, there’s still the need to be realistic about a deal’s odds, Klein said. If a transaction is unlikely to be approved — no matter how great the offer is — it might not be worth the time and effort.
“When you’re thinking about where you want to go with your business, you have to think about the criteria that need to be satisfied from your potential partner,” he said. “It’s not just about what value will I receive, will my patients be better supported, but it’s also, what’s the certainty of getting this done in a reasonable time frame?”
When navigating those many complexities and considerations, weigh the value that third-party consultants can provide, Barcellona said.
“What these trends tell us, and what I think we’ll all find out very soon, is that we have to be very careful about the actuarial value of rates in the market for risk-bearing providers,” he said. “Providers are going to need a lot of consulting help as we move forward.”
