Code Red: Two Economists Examine the U.S. Healthcare System

July 18, 2017

The Anthem-Cigna Merger

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 10:42 am

This blog was written by David Dranove, who served as the Department of Justice expert economist in this matter.  Dranove’s opinions do not necessarily reflect those of Craig Garthwaite or the DOJ.

Introduction

On May 12, 2017, Anthem Inc. announced that it would no longer seek to acquire Cigna Corp., putting an end to a two-year saga that reached its climax in February, 2017, when U.S. District Court Judge Amy Berman Jackson ruled that the deal violated Section 7 of the Clayton Antitrust Act.[i]  A divided panel of the Second Circuit Court of Appeals affirmed this decision in April.[ii]  When a Delaware Chancery Court, in separate but related litigation between the merging parties, subsequently ruled that Cigna was free to walk away from the deal, Anthem chose not to appeal to the U.S. Supreme Court and pulled the plug on the deal.

The two insurers announced their intention to merge in July 2015.  The DOJ had reason to be skeptical.  Anthem is the Blue Cross and Blue Shield Association licensee in fourteen states and, after United Healthcare, the nation’s second largest insurer by enrollments.  Cigna is the fourth largest insurer. A merger of this size would seem to portend an anticompetitive increase in market power, and many stakeholders came out against the deal. But appearances are not sufficient. For the DOJ block the deal it would have to demonstrate to a federal court, using rigorous quantitative methods combined with qualitative evidence from fact witnesses and other documents, that the merger would harm competition.

A lot has been written about this case, with some reporters doing a good job of laying out some of the critical issues.  In this blog I try to spell out, in detail, the key issues that ultimately decided the case.

The Key Issues

The DOJ and the Federal Trade Commission have established Horizontal Merger Guidelines (HMGs) laying out the economic issues that a merger analysis should address.[iii]  Economists representing both the DOJ and Anthem cited the HMGs, focusing on a handful of key issues[iv]:

1) In what market(s) do the insurers compete?

The answer seems obvious – the “health insurance market.”  This belies a far more complex market environment, differentiated by the nature of the insurance purchaser (e.g., individuals versus small groups versus large groups) and geographic location. Combining economic reasoning with documentary evidence, I concluded that the merger would affect two types of purchasers: “national accounts” employers (defined based on number of employees and geographic spread) and large local employers (defined as having more than 50 or 100 employees).[v] I also concluded that the merger would reduce competition in local “upstream” markets; i.e., contracting with providers. The court largely ignored the upstream issue in its decision.

2) How would the merger affect the level of concentration in these markets?

Industry participants and researchers alike may find it difficult to reliably measure market concentration due to limitations of public data sources. The DOJ used its subpoena power to obtain enrollment data from over two dozen insurers, which, when combined with census data on insurance enrollments, allowed me to produce new concentration measures. By comparing my findings to thresholds in the HMGs, I concluded that the market for national accounts headquartered in Anthem’s 14 states was highly concentrated prior to the merger, with four leading insurers – United, Aetna, Cigna, and the Blues – controlling almost 90 percent of the market.[vi] Again using HMG thresholds, I found that the increase in concentration resulting from the merger would make it “presumptively anticompetitive” in the national accounts market. I also found that the merger would be presumptively anticompetitive in the sale of health insurance to large employers in nearly three dozen local markets.  This is the most problematic conclusion one can reach using market concentration measures, and was the first step towards showing that the merger violated the Clayton Act.

Through hours of direct testimony by one of its experts, and hours of cross-examination of my own testimony, Anthem tried but failed to convince the judge that the DOJ analysis was unreliable.  Anthem claimed that there was no industry standard for defining markets and that DOJ data lacked enrollments in many small insurance plans and therefore overstated market concentration. I countered that the missing plans played a minuscule role, especially in the national accounts market, and that some of my local market analyses did account for these small plans. The court agreed that these plans had only a small impact in the relevant markets and seemed troubled that Anthem had not produced its own market concentration measures.

3) Do the merging parties compete vigorously against one another?

I presented anecdotal evidence that Anthem and Cigna competed head-to-head for many accounts. I also presented a systematic analysis of contracting data showing that Anthem took business from Cigna and vice versa. Anthem offered its own analyses suggesting it did not closely compete with Cigna. Both sides pointed out potential flaws in each other’s analyses and the court seemed ambivalent on this issue.

4)  What is the predicted impact of the merger on premiums?

Here the case moved away from simple measures of market structure and business stealing into esoteric economic models of pricing. Both sides concluded that, in the absence of efficiencies, the merger would cause an increase in premiums. My model predicted a larger increase and the debate about whose model was best was fit for an academic seminar.  The judge did not show a preference.

5) How would the merger affect innovation?

Cigna has arguably been more innovative than Anthem. It has industry-leading wellness programs, helped pioneer Collaborative Accountable Care (CAC) arrangements with providers, and is partnering with local health systems to create narrow network plans.[vii] Cigna executives testified that it needed to innovate in order to compete against larger insurers that enjoyed deeper discounts. I argued that if Anthem and Cigna merged, Cigna’s incentive to innovate would diminish. Anthem countered that in some ways it was more innovative than Cigna, but did not address whether the merger would limit the scope of innovation. The court agreed that the deal would diminish the prospects for innovation. A related issue was whether Cigna’s CACs would be equally effective if providers were paid Anthem’s rates. I argued, and the court concurred, that Anthem could not reduce Cigna’s rates without jeopardizing the effectiveness of CACs.

6) Were there benefits from the merger that would offset the harm caused by a reduction in competition?

Anthem argued that the merger would produce substantial operational efficiencies, for example by reducing administrative costs, but I rebutted this claim. Anthem expert economist Mark Israel then put forth the crux of the Anthem case. He argued that after the merger, the combined firms would enjoy the “best-of-best” of their operations, combining Anthem’s deep discounts with Cigna’s innovative wellness programs and collaborative care arrangements. Dr. Israel claimed that applying Anthem’s discounts to Cigna patients would generate enormous savings that Anthem would pass on to consumers, who would end up with lower premiums, lower medical bills, and higher quality care.

Cognizability

Judge Jackson’s questioning of experts throughout the trial suggested that she believed some markets were highly concentrated and that, in the absence of efficiencies, the merger would harm consumers. She seemed less certain about where she would land on Dr. Israel’s best-of-best argument. Would the merger allow Anthem to reduce provider payments?  By how much?  Finally, would these be cognizable efficiencies, a standard established in the HMGs for determining whether the court should count these reductions as a benefit of the merger.

Reductions in Provider Payments

Both sides agreed that the merger would lead to lower provider payments, but sharply disagreed on the magnitude. Anthem argued that once the merger was complete, it would examine every provider contract and apply, on a provider-by-provider and service line basis, the better of Anthem and Cigna’s rates.  Using actual transactions prices obtained from Anthem and Cigna claims data, Dr. Israel estimated that the annual reduction in payments would be approximately $2.4 billion.  I argued that this analysis was biased for a variety of technical reasons. Using regression techniques that had their own limitations, I estimated that provider payments would fall by no more than $500 million.  Neither sides’ calculations proved fully convincing, so the case turned on whether the purported savings were cognizable

Cognizability

According to the DOJ/FTC Horizontal Merger Guidelines, cognizable efficiencies must be merger-specific and verifiable, and cannot arise from anticompetitive reductions in output or service.

Were the Reductions in Reimbursements Merger-Specific? 

To be merger-specific, the savings could not be achievable without the merger.  I argued that one of the tactics that Anthem would use to achieve the savings was something they could have done without merging.  This argument hinged on a crucial institutional fact.  After acquiring Cigna, Anthem would violate the Blue Cross and Blue Shield Association (BCBSA) “best efforts” rules, which limit the amount of non Blue-branded insurance business sold by Blue plans. Anthem indicated that it would attempt to remain in compliance by getting some Cigna customers to switch to Anthem Blue-branded products. I argued that Anthem could induce consumers to switch without merging, implying that some of the reductions in reimbursements that resulted when employers switched to Anthem plans was not merger-specific.

Were the Reductions in Reimbursements Verifiable?

Verifiable savings must be reliably estimated and the merging parties must substantiate the likelihood they will be realized. As discussed, I challenged the reliability of the estimates. DOJ attorneys cited documentary evidence and testimony from Anthem and Cigna executives suggesting that the merging parties did not have a reliable business plan. Anthem did not know how it would comply with BCBSA best efforts rules. Anthem did not know how many providers it would force to accept the lower Anthem rates for Cigna patients. Perhaps most troubling, Cigna executives had testified about practical difficulties in integrating two giant companies with very different business models and corporate cultures. Judge Jackson described this as “the elephant in the courtroom”.

Epilogue

Judge Jackson found that the merger would cause a substantial lessening of competition in the market for national accounts headquartered in Anthem states, and the local market in Richmond, Virginia.  She suggested that the merger might also be anticompetitive in several other local markets. She also found that the best-of-best merger efficiencies were not cognizable. She did not believe they were merger-specific or that Anthem had proved it would achieve anywhere near the claimed $2.4 billion in reduced payments. The DOJ prevailed in the District Court, the Second Circuit agreed, and the merger was doomed.

[i]  United States v. Anthem, Inc., No. CV 16-1493 (ABJ), 2017 WL

685563, at *4 (D.D.C. Feb. 21, 2017).

[ii] United States v. Anthem, Inc., 2017 U.S. App. LEXIS 7521, *13 (D.C. Cir. Apr. 28, 2017)

[iii]  Academic economists who have been on both sides of merger cases developed the HMGs, which have become the de facto standard for the courts to use when assessing mergers. The HMGs may be found here:  https://www.justice.gov/atr/horizontal-merger-guidelines-08192010 (accessed 6/19/2017)

[iv] Cigna did not call independent experts to testify at trial.

[v] California, Colorado, New York, and Vermont define “large groups” to be employers with between 2 and 100 employees.

[vi] With just a few exceptions, Blues plans have exclusive licenses to sell to local employers, based on the location of the employers’ headquarters.  Thus, Blues do not compete head-to-head against one another.  I argued that it was appropriate to combine the Blues’ market shares when calculating concentration.

[vii] For more on Cigna’s CACs, see Salmon, RB, Sanderson, MI, Walters, BA, et al., “A collaborative accountable care model in three practices showed promising early results on costs and quality of care,” Health Affairs, 2012; 31(11):2379–2387.

Leave a Comment »

No comments yet.

RSS feed for comments on this post. TrackBack URI

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Blog at WordPress.com.

%d bloggers like this: