Magazine Article | April 24, 2017

Provider Consolidation Raising Costs And Undermining Competition

Source: Life Science Leader

By John McManus, president and founder, The McManus Group

As Republicans attempt to recover from their face-plant on repealing and replacing Obamacare, policymakers are grappling with how to address the growing problem of healthcare provider consolidation, which appears to be raising costs and undermining competition.

Together, hospital and physician services account for more than half of national health spending, and their finances are increasingly intertwined. Hospitals recently embarked on a buying spree of physician practices. According to Forbes, the number of hospital-employed physicians increased 50 percent from 2012 to 2015.

This has sent ripples through the healthcare system, as hospitals seek to recoup these investments that typically far exceed the value of services the acquired physicians could possibly bill. According to the Medical Group Management Association, losses of $200,000 per hospital-employed physician are not unusual. Hospitals make up this loss by capturing highly profitable in-house imaging, laboratory services, and drug administration.

A 2015 Government Accountability Office (GAO) study found Medicare pays hospitals about twice as much for administering drugs than freestanding physician practices. Couple that windfall with the 340B revenue that many nonprofit mega-hospital systems can derive by acquiring drugs at substantially discounted prices and then providing them to both insured and uninsured patients at market rates, and it’s any wonder that independent physician practices can compete.

According to the Berkeley Research Group, sales to 340B doubled between 2010 and 2015 and expanded by 66 percent between 2012 and 2015 alone. Notice the correlation between physician practice acquisition and 340B expansion? GAO concluded that the sizeable margins 340B hospitals realize on the statutorily discounted drugs have contributed to higher utilization of Part B drugs. The 2016 Medical Pharmacy Trend Report from Magellan Rx Management noted hospitals that use the percent-of-charges approach allows them to be paid about twice as much as physician offices. When combined with 340B, this delivers 70 percent profit margin!

The migration of physicians to salaried employment at hospitals theoretically mitigates physicians’ incentives to increase utilization and also offers the potential for coordinated care. But the reality is that salaried employment actually increases health costs:

  • The Medicare Payment Advisory Commission (MedPAC) observed Medicare paid hospitals $1.8 billion more for routine evaluation and management (E&M) services provided by their employed physicians than physician office rates in 2015.
  • A recent JAMA study that examined 7.4 million Medicare beneficiaries in 240 metropolitan areas from 2008 to 2012 concluded outpatient costs increased for hospital-acquired physician practices by $500 million.
  • Similar results were found on the commercial side; a University of California, Berkeley study that reviewed 4.5 million commercial HMO enrollees found hospital- owned organizations incurred 19.8 percent higher expenditures than physician-owned organizations for professional, hospital, laboratory, pharmaceutical, and ancillary services.

Congress took a modest step in the Bipartisan Budget Act of 2015 to stop the bleeding by prohibiting the windfall of hospital payment rates for E&M services for future acquisitions of physician practices that operate off the hospital campus. Yet the underlying dynamics have not changed — the new policy does not apply to physician practice acquisitions that occurred before November 2015. Nor does the policy apply to drug administration or surgical services.

Certainly, physicians are complicit in the increasing integration with hospitals. The younger generation of doctors appears more focused on income security and balancing work-life commitments than the more entrepreneurial physicians of the baby boom generation. In a recent Jackson Healthcare survey, more than two-thirds of hospital-employed physicians reported they initiated discussions that led to employment. But physicians, like anyone, react to economic incentives inherent in the healthcare system.

One such incentive was the creation of Accountable Care Organizations (ACOs) by the Affordable Care Act. Physician practices — particularly specialists — felt under pressure to join ACOs for fear of being locked out of their markets and referrals. That program allowed 560 mostly hospital-led systems to receive bonus payments if they delivered care more efficiently than a predetermined benchmark. The thought was that this would encourage improved care coordination between hospitals and affiliated physicians and thereby lower costs.

Yet the vast majority of ACOs operated under one-sided risk, where they were not penalized if the cost of care exceeds the benchmark. Heads I win (with bonus payments); tails you lose (no penalty for excessive costs)!

Result: net losses of $216 million in 2015, according to CMS. CMS disclosed that 48 percent of Medicare ACOs produced no savings and 69 percent did not produce enough savings for bonuses in 2015. The $216 million loss is calculated by including total savings and costs, including bonuses to ACOs.

A few weeks ago, the MedPAC held a contentious meeting that failed to achieve consensus on whether Medicare payment policies should favor certain types of payment models (e.g., ACOs). Good! It should not be government’s role to pick winners and losers.

Fortunately, the Medicare Access and CHIP Reauthorization Act (MACRA) created the opportunity for physicians to enter into different alternative payment models (APMs). MACRA’s Physician-Focused Payment Model Technical Advisory Committee is presently evaluating physician-led APMs, with the goal of increasing CMS’ present projection that only 70,000 to 120,000 (or 10 to 20 percent) of doctors will be paid through APMs. The committee recently endorsed two APMs for limited-scale testing, and HHS Secretary Price has called on physicians to submit new APM ideas.

But a key hurdle for better coordinated care and physician APMs is the “Stark” self-referral law, named after Pete Stark (D-CA), the longtime chairman of the Ways and Means Health Subcommittee. That statute, originally enacted nearly three decades ago, prohibits physician compensation for “value or volume,” on the theory that physicians will order unnecessary items and services to maximize revenue.

Yet this antiquated statute does not permit physician practices operating in an at-risk or capitated APM to economically reward physicians that modify volume in order to abide by best practices. A coalition of more than 25 physician specialty organizations is now asking that the Stark law be modernized to allow the coordination and collaboration necessary for alternative payment models to succeed. Enactment of such reforms would not only improve care coordination, but allow for greater competition among specialty and integrated practices and hospitals.

And horizontal consolidation is no less concerning. Since 2010, there have been 561 hospital mergers, resulting in nearly half of all markets being anti-competitive. In 2015, mergers and acquisitions were up 70 percent compared to 2010. A Robert Wood Johnson Foundation study found when hospitals merge in already uncompetitive markets, the price increase often exceeds 20 percent.

Hospitals with fewer than four local competitors have prices that are nearly 16 percent higher than average — a difference of nearly $2,000.

In an April report, the Center for Health Policy at Brookings Institution said consolidation has led to a dearth of competition. That’s why the healthcare industry sees rising prices, price variation, and uneven quality of care.


  1. Reform the Stark self-referral laws to allow more coordination of care by physician practices and strengthen integrated practices as an important competitive counterweight to mega-hospital systems.
  2. Reform 340B so that it benefits uninsured and indigent patients, not mega-hospital systems.
  3. Build on site-of-service reforms, so that Medicare pays the same amount for the identical service regardless of where it is performed.
  4. Provide more aggressive FTC enforcement of anti-competitive provider mergers and acquisitions.