Big Apple Hospitals: Too Big To Fail?

New York City is a pretty big town. It thus supports more service organizations than any other American city to cater to all of its residents.

No other American city, for instance, is covered by four major daily newspapers: the Times, News, Post, and Wall Street Journal. Not to mention Long Island’s Newsday and Newark’s Star Ledger!

And no other city supports nine professional sports teams, three in the National Hockey League alone. In addition to the fledgling professional teams in the Women’s NBA and Major League Soccer, along with minor league baseball teams in Brooklyn and Staten Island.

Of course, not every resident of the Big Apple reads a newspaper or roots for a sports team, and yet each should be concerned about maintaining his (her) health. So how many major hospital networks does the Big Apple need to serve its citizens?

From Hospitals to Health Systems

Hospitals are no longer simply destinations for people who become seriously ill or who require emergency treatment. They now reside at the heart of health systems, and they are focusing on the delivery and management of preventive care services.

In addition, many health systems are now growing into full-fledged Accountable Care Organizations (ACOs), entities that are responsible for managing all care for both mainstream consumers and patients with special needs. They are incorporating Patient Centered Medical Homes into their service networks, which serve as points of access for coordinating care and navigating the provider system.

Supporters of Libertarians like Ron Paul, and even traditional conservatives like Steve Forbes, might believe that these emerging entities were introduced by the Patient Protection and Affordable Care Act of 2009. In reality, though, they were already established by 2009, and few doubt that they will continue to expand whether or not the Act survives its Supreme Court hearing and the upcoming Presidential election.

The Columbus Comparison

So how many health systems does the nation’s largest city need? How many does it require to serve a bustling population of over eight million people, many of them elderly, obese, or with other severe medical conditions?

Let’s address that question with a comparative example. Nationwide Children’s Hospital of Columbus, Ohio, for instance, has established the nation’s largest pediatric ACO in a city of less than 1 million citizens. If Nationwide can succeed in a city like Columbus, then one would surmise that New York could easily support at least half a dozen major hospital systems.

In fact, considering the stunning diversity of the citizens of the Big Apple, far more than half a dozen systems may be both sustainable and appropriate. It now appears, though, that New York is well on its way to consolidating down to a mere three hospital networks.

The Drive to Consolidate

There is no single statistic that measures the size of a hospital network. A service oriented facility may provide many primary care services to uninsured patients but receive very little revenue for its efforts, whereas a cardiology or neurology unit in a teaching and research institution may earn significant revenues from relatively few surgeries.

Last week, though, two of the “largest” (as measured by any statistic) New York health systems signed an agreement to pursue a merger. New York University’s Landone Medical Center and Continuum Health Partners, itself a result of a merger between Beth Israel Medical Center and St. Luke’s Roosevelt, were the signatories.

A merger between the two entities would allow it to join New York Presbyterian Hospital and the New York City Health and Hospitals Corporation as the three major hospital networks in the city. If that occurs, The Mt. Sinai Hospital and a handful of other remaining independent players would then experience immense pressure to merge into the troika of dominant networks.

Banks vs. Hospitals

In an era when a small number of financial service institutions has generated an immense amount of systemic risk for our society by becoming “too big to fail,” can we afford to allow a small number of health care institutions to do the same? Are the financial and health care industry sectors analogous to each other in terms of the level of risk that industry consolidation imposes on us?

Let’s assume, for the sake of argument, that the hospitals of New York City consolidate eventually into three equally sized networks. If one of the networks should fail, could the government refuse to offer it a financial bail-out? The only alternative would be to rely upon the two remaining networks to immediately expand by 50% in order to serve the failed institution’s patients, an achievement that would likely prove impossible.

On the one hand, the economic forces that are driving hospitals to consolidate with each other may indeed be inexorable. But on the other hand, they are undoubtedly generating a daunting array of social and economic risks that deserve our immediate attention.

Health Care Consolidation: Efficiency or Monopoly?

Who (or what) should be blamed for the dramatic increase in the cost of private health insurance in the United States?

To a certain extent, of course, the aging of the population and the development of technologically complex treatment options have contributed to the burgeoning costs of insurance. Consolidation activities within certain sectors of the health care industry have impacted costs as well, with hospital mergers eliminating competition among providers and insurer mergers doing likewise among payers.

Last week, however, the city of Pittsburgh, Pennysylvania witnessed a health care consolidation transaction of a different kind. Instead of a large hospital or insurer swallowing up a rival, the insurance company Highmark decided to cross industry sectors and directly acquire West Penn Allegheny Health System and its Allegheny General Hospital subsidiary.

Why would Highmark want to do such a thing? And is the emergence of insurer / provider conglomerates a beneficial public policy development … or yet another nail in the coffin of a competitive health care system?

A Case of Vertical Integration

A producer purchase of a provider system isn’t a terribly unusual event from a macro-economic perspective. Energy production companies have owned or franchised retail consumer outlets for decades; Exxon Mobil and Chevron, for instance, simultaneously drill for oil, refine it into gasoline, and then develop franchise contracts with gasoline stations to provide it to consumers. Energy firms have even coined specialized terms to describe the dual sides of their business operations: the phrase upstream activities refers to the production process, whereas downstream activities refers to the refining, sales, and marketing processes.

Economists refer to this type of merger as vertical integration, a process by which a single firm acquires (or otherwise controls) an entire value chain of the production, sales, and distribution of a category of products or services. It is distinctly different than horizontal integration, a process by which firms merge with their competitors (or potential competitors) in order to develop larger market shares in their narrowly defined segments of their value chains.

In the private sector health insurance industry, employers generally purchase access to health care from insurance companies, which then contract with hospitals and other providers to deliver services to employees. Although patient advocates and provider lobbyists may argue that hospitals and patients occupy the very center of the health care system, from a value chain perspective, insurers can be characterized as upstream organizations and hospital networks as downstream organizations.

A Mixed Record

Clearly, vertical integration strategies have succeeded in the energy industry. But can they do so in the health care industry?

Based on recent history, the track record for such business strategies among insurers and providers is most decidedly mixed. On the one hand, Kaiser Permanente of California has remained one of the most highly respected and successful health care conglomerates in the nation by managing provider and insurer functions simultaneously. On the other hand, though, Humana — one of the largest health insurers in the United States — pulled out of the provider market in 1993 after concluding that there are too many natural conflicts of interest between the two industry segments to justify a conglomerate approach.

New York State, a geographic pillar of the national health care industry, has also experienced mixed results. On the one hand, the rise of the Catholic Church’s statewide health plan Fidelis Care did nothing to save St. Vincent’s Hospital of Manhattan, or its seven fellow Catholic hospitals in New York City, from closure. On the other hand, the New York City Health and Hospitals Corporation continues to find success with its wholly owned MetroPlus health plan subsidiary.

Efficiency vs. Competition

Interestingly, California and New York represent relatively competitive health care markets, with several hospital networks and insurance companies competing for business in each state’s major population centers. It is possible that the natural forces of free market capitalism have helped blunt the deadening anti-competitive effects of vertical integration in these regions, thereby preventing conglomerates from evolving into monopolies.

Pittsburgh, though, represents a very different type of health care market. Its hospital sector is currently dominated by the University of Pittsburgh Medical Center; thus, Highmark’s acquisition of the badly trailing second tier hospital may actually result in an increase of provider competition. Usually, merger partners argue that the beneficial cost efficiencies to be derived through consolidation justify the possible harmful effects of a loss of competitive players; in Highmark’s case, though, public policy advocates in the Steel City may enjoy the twin benefits of cost efficiencies and greater (as opposed to lesser) competition.

It is understandable why Highmark was attracted to the acquisition opportunity; after all, by strengthening the closest rival to a dominant hospital system, it may be able to improve its own contracting position with both medical providers. Although conventional wisdom stipulates that competitive markets often suffer whenever major organizations merge or acquire each other, from a public policy perspective, this particular merger might well produce a different outcome.