The attorneys general (AGs) of 16 states warn that hospital employment of physicians, which is considered in many quarters to be the inevitable fate of medical practice, is driving up healthcare costs without necessarily improving the quality of care.

The AGs sounded this alarm last month in a federal appellate case in which the Federal Trade Commission is seeking to prevent St. Luke's Health System in Boise, Idaho, from merging with Saltzer Medical Group in nearby Nampa on antitrust grounds. The AGs side with the government, as do America's Health Insurance Plans, a trade association. The case spotlights the economics of hospitals employing physicians and the challenges of implementing the Affordable Care Act.

Healthcare reform was the ostensible rationale for St. Luke's, Idaho's largest health system, to acquire the 40-physician Saltzer Medical Group, the state's largest, independent multispecialty practice. Both parties viewed the merger as a step toward creating an integrated, more efficient system of care in which reimbursement depends on patient outcomes, not the volume of services. The Affordable Care Act is pushing hospitals and physicians in that direction.

Another local hospital, however, did not view the merger so favorably. St. Alphonsus Medical Center in Nampa and its parent health system sued in federal district court in 2012 to overturn the merger, saying it would stifle competition. The Federal Trade Commission made the same objection in a second suit that was combined with the first. The federal agency contended that the merger would give the new entity a dominant, 80% market share in terms of adult primary care in Nampa and would raise healthcare costs in the process.

Siding with St. Alphonsus and the Federal Trade Commission, US District Judge B. Lynn Winmill ordered St. Luke's in June to divest itself of the Saltzer Medical Group. Winmill noted that the merger would give St. Luke's greater leverage to negotiate higher reimbursement rates from insurers. In addition, the hospital system could boost revenue for X-rays, laboratory tests, and other ancillary services performed in physician offices by charging insurers a higher hospital facility rate, even though the location of the services remained the same. Winmill cited an estimate from Blue Cross of Idaho that put this markup at 30% to 35%.

The Saltzer physicians would benefit from this simple billing technicality, Winmill said in a court document titled "Findings of Fact and Conclusion of Law." Their new employer, St. Luke's, planned to give them a 30% raise "by obtaining 'higher hospital reimbursement' from the health plans."

The referral patterns of the Saltzer physicians once they joined St. Luke's also would likely hurt competition among area hospitals, according to Winmill. The professional service agreements signed by the physicians permitted them to admit patients to any hospital they wanted to, but Winmill pointed to evidence showing that employed physicians invariably reduce referrals to other hospitals in favor of their own.

Winmill lauded the stated intention behind the merger — creating an integrated system that could improve the quality of care and reduce costs in a pay-for-performance environment — but said that St. Luke's and the medical group could achieve that goal without combining.

The Might of 800-Pound Gorillas

St. Luke's and the Saltzer Medical Group quickly took their cause to the US Court of Appeals for the Ninth Circuit. In their initial brief, they said Winmill should not have based his antitrust analysis on the small healthcare market in Nampa, just 20 miles outside Boise, one of several nearby communities in which Nampa patients could find lower-cost providers. Nearly one third of Nampa residents were already traveling outside of Nampa for adult primary care.

In addition, the ability of St. Luke's to charge higher prices for ancillary services in physician offices translates into increased costs only if patients cannot avail themselves of lower-price competitors because of the health system's market power in Nampa, the health system and medical group argued. However, Winmill failed to assess whether St. Luke's indeed would wield that market power postmerger, they said. "The district court finding is meaningless."

St. Luke's and Saltzer also said higher prices for ancillary services were not necessarily in the cards. Although Blue Cross of Idaho predicted a 30% to 35% increase, it had negotiated a contract with St. Luke's before the merger that would prevent a price hike of this magnitude from materializing if it acquired the medical group. "The district court failed entirely to consider Blue Cross's countervailing leverage," they said.

The appellate court put the unwinding of the St. Luke's-Saltzer merger on hold until it reached a decision.

National Implications

The appellate case has national implications for marriages between hospitals and physician groups, as evidenced by the friend-of-the-court brief from the AGs of California, Illinois, Pennsylvania, and 13 other states. These officials stated that they have seen first-hand the effects of hospitals acquiring physician practices; namely, increased bargaining power with health insurers, higher hospital facility fees for physician services, and loss of referrals to rival hospitals.