The Federal Trade Commission (FTC) won a decisive victory today in its efforts to slow the record pace of health care provider consolidation, when the U.S. Court of Appeals for the Third Circuit reversed a District Court's decision denying the FTC and Pennsylvania Attorney General’s request to enjoin a merger between Penn State Hershey Medical Center and Pinnacle Health System. The Third Circuit’s decision provides the FTC with the momentum that it had lost after the lower court’s decision in this case, coupled with setbacks in Illinois and West Virginia hospital merger cases.

The District Court's decision last May in Federal Trade Commission v. Penn State Hershey Medical Center et al., provided a significant blow to the FTC’s health care enforcement agenda. The case was a test of the FTC's market definition in a rural area. The FTC alleged that the merger would create a dominant provider of general acute care inpatient services sold to commercial health plans in a relevant geographic market comprising the four-county area around Harrisburg, Pennsylvania. Rejecting that definition, the District Court was persuaded by statistics showing, among other things, 43.5 percent of Hershey Medical Center's patients traveled from outside of the FTC's proposed geographic market, and several thousand of Pinnacle's patients resided outside of that market. The court also relied on qualitative factors, considering "the realities of living in Central Pennsylvania, which is largely rural and requires driving distances for specific goods or services." The lower court also gave weight to the fact that the two hospitals had entered into contracts with their two main insurers stabilizing prices for a certain period of time.

The appeal focused on the District Court's formulation and application of the "hypothetical monopolist test" that the FTC uses, and the court adopted for purposes of this case, for examining hospital mergers. The hypothetical monopolist test asks whether the merged entity could impose a profitable small but significant non-transitory increase in price, which the Third Circuit said was "typically about 5%." This case presented the first opportunity for the Third Circuit to decide whether, and, if so, how, to apply the hypothetical monopolist test.

In its opinion, the Third Circuit adopted the test to examine the merger at issue. Although agreeing with the District Court on the proper test to apply, the Third Circuit strongly criticized the District Court’s application, finding three errors in its analysis:

• First, the court noted that the District Court should not have relied almost exclusively on the number of patients that enter the proposed market (patient flow data), finding such data to be misleading in the hospital merger context.

• Second, the Third Circuit held that the District Court should not have focused on the likely response of patients to a price increase; rather, the focus should have been, consistent with the "commercial realities" of the healthcare market, on the likely response of insurers.

• Third and finally, the Third Circuit rejected the lower court's reliance on private agreements between the two hospitals and two insurers, which the court found to be irrelevant to the hypothetical monopolist test.

The Third Circuit ultimately held that the FTC had satisfied its burden of proof and directed that the merger be preliminarily enjoined.

Hospitals, as well as other health care providers, considering mergers, as well as their competitors, must pay close attention to the Third Circuit's opinion. The decision likely will embolden the FTC's litigating positions, both in the Third Circuit and elsewhere.