Full-system contracting, also variously described as full-line forcing, bundling, or all-or-nothing contracting, is a widely utilized contracting practice under which a hospital system demands that a payor include all system hospitals or other components in the payor's network as a condition of including any of the system's hospitals in its network. This practice can take a variety of forms: requiring payors who want to contract with a desirable hospital to also contract with less desirable (whether because they are less efficient, lower quality, or have a lesser reputation) system hospitals; requiring the plan to also contract with physician networks or faculty groups, ambulatory surgery centers (ASCs), home health agencies, or other entities owned by or affiliated with the hospital system; requiring plans to contract with all system hospitals in separate geographic markets; requiring plans to contract with the hospital or system for all its services; and requiring plans to include all system hospitals and all their services in the richest benefit tier (i.e., lowest copay for enrollees) of the plan's products.

Although ubiquitous, full-system contracting has not yet been meaningfully addressed by the courts, the Department of Justice Antitrust Division (DOJ) or the Federal Trade Commission (FTC), and has been largely ignored by antitrust legal and economic commentators. The best and most current discussion of the issue occurred at the joint DOJ/FTC Healthcare Hearings (the Hearings) held in 2003. Although an entire halfday session was devoted to this topic, the agencies' joint report (the Report), issued in July 2004, disappointingly contains almost no discussion of the issue. Absent directly on-point authority, antitrust analysts must turn to analogous legal doctrines such as tying theory to derive guidance on this issue, and evaluate market conditions and related contracting practices that aggravate or ameliorate the antitrust risk posed by the underlying practice of full-system contracting.

Depending on the circumstances, in general a health system faces increased antitrust exposure if it attempts to force health plans to contract against their will with all of the system's hospitals. Requiring a payor, in addition, to contract with affiliated physician faculty groups, ASCs, or other outpatient facilities, or imposing additional contract restraints, or prohibiting a payor from using tiering or other mechanisms to steer patients to lower cost providers, will further increase that exposure for the health system and those components. Finally, a health system's purpose for its full-system contracting strategy will be important in determining its antitrust exposure - if the system's primary objective is to obtain higher prices or increased bargaining power, rather than the policy being ancillary to some efficiency-generating rationale, the strategy is less likely to pass antitrust muster. A system's decision whether to implement or continue a full-system contracting policy ultimately comes down to how much risk it is willing to take, because this is an as yet undefined area of the antitrust laws.

Role of Full-system Contracting in Hospital System Contract Negotiations with Health Plans
At the Hearings, there was consensus among the commentators that full-system contracting must be viewed in the broader context of hospital-health plan contracting over the past 20 years. One panelist at the Joint Hearings stated both during the Hearings and in a subsequent publication that this contracting practice is the product of an evolving marketplace.

The early and mid-1990s saw the rise of managed care, changes in Medicare reimbursement, and growing excess hospital capacity. Although hospitals responded by doing such things as moving some surgery and ancillary services to the outpatient setting and forming hospital networks or systems to become more efficient, insurers nonetheless gained significant bargaining power over hospitals through the ability to steer patients to hospitals willing to provide price discounts in exchange for patient volume (commonly known as selective contracting). By the late 1990s, hospitals continued to make structural changes to maintain their financial viability: merging to form larger, more efficient facilities; continuing to affiliate in systems; reducing bed capacity; and taking on insurance risk as a system in an effort to control utilization and thus costs. At the same time, patients began demanding greater choice among hospitals and physicians and less restriction on their access to medical care, in what has become known as managed care backlash. To accommodate their enrollees' demands, payors began to offer broad hospital and physician networks and fewer gatekeepers, which required plans to contract with more providers and reduced their ability to steer patients to obtain discounts. As a result, some believe that the bargaining power balance nationwide has shifted from payors to hospitals (although this certainly is not true in every market in the U.S.), and that this shift has permitted many hospitals to "catch up" through higher reimbursements, less risk bearing (e.g., capitation), and different contracting terms, such as full-system contracting replacing exclusivity provisions, capitation, or volume commitments. Panelists stated that it is important to distinguish between full-system contracting instituted or "forced" by a hospital and the trend toward broad, all-inclusive networks demanded by patients and employers resulting in full-system contracts being requested by payors.

Similarly, commentators stressed the importance of examining both payor-side and hospital-side contracting trends and practices between those two entities, including understanding the "competitive baseline" for contracting practices in a competitive market and the rationale for the practices from both parties' perspective, in order to evaluate specific contracting practices such as full-system contracting. The practice must be evaluated not only in the so-called "problem" markets but also in competitive markets. Commercial contracts play an important role in the delivery of health care services, and contracting itself is an important mechanism for competition. Contracts contain complex price and non-price terms. A substantial amount of time and effort is invested by payors and hospitals in negotiating both the initial contract as well as renewals, many of which take place every year. Full-system contracting can increase the efficiency and reduce the cost for both sides in the contracting process, and for this reason also often is payor-driven as well as implemented by hospitals.

Several panelists emphasized that the arguable shift in bargaining strength from payors to hospitals does not necessarily mean that all or most hospitals today have market power. Moreover, payors have mechanisms, or defenses, to discipline or counter a hospital's exercise of any increased bargaining power (those mechanisms and their role in the competitive analysis are discussed in more detail below). And even once it has been negotiated and executed, a contract is not a guarantee of purchases (absent a specific term providing for volume commitments). Payors can still use mechanisms such as tiering to include a flagship hospital and maintain a broad network, while at the same time steering consumers to lower cost facilities by applying different copayments to different hospitals.

Of course, a health system's decision to implement full-system contracting frequently may be the result of any number of procompetitive business justifications. Commentators on full-system contracting stated that it is important to consider the business rationale for this practice, as it is for any contracting practice. Those efficiency rationales for full-system contracting are discussed in more detail below.

So, the question is: when does hospitals' new-found bargaining power, if in fact a hospital has such power, become market power? And, in turn, when does a hospital's full-system contracting policy violate the antitrust laws?

What Guidance Exists Today? Legal and Economic Analysis of Full-system Contracting
Although full-system contracting is an increasingly common practice among hospital systems today, there is no caselaw directly addressing this issue. Several cases raising this issue have settled prior to any court decision, and others have not reached the point of a court decision or do not directly address this issue. Perhaps the most significant recent case is the FTC's successful challenge to the merger of two hospital systems in Evanston, Illinois, arising out of the FTC's retrospective merger review. Evanston Northwestern Healthcare Corp., FTC Dkt. No. 9315 (Oct. 20, 2005). In its complaint filed in administrative litigation, the FTC alleged that, as a result of the merger in January 2000, the system instituted a full-system contracting policy that forced payors to accept price increases that were significantly higher than those of other comparable hospitals, or face the loss of all three system hospitals from their networks. Although the FTC did not specifically challenge this contracting practice, the ALJ found that it was anticompetitive because the merged entity used its market power to move payors (over their objection) to a single contract for all three hospitals (and demanded the same rate for all three facilities regardless of the level or complexity of services) as one mechanism to raise prices.

In addition, the transcripts and written materials from the Hearings on this topic provide both an academic and practical discussion of full-system contracting. As noted above, however, the Report states only that the agencies will challenge bundled contracting practices "where appropriate," without further discussion or even identification of those circumstances where enforcement will be appropriate (other than stating that they will "aggressively pursue" anticompetitive conduct by providers to resist health plans' tiering or other innovative practices to incentivize patients to use lower-cost facilities). Agency officials' comments after the Report, however, signal that full-system contracting will receive increased attention, and that it is more likely to raise concern where a hospital system with market power uses that power to both demand inclusion of all its hospitals and, echoing the Report, to resist tiering or other mechanisms to steer patients to lower cost hospitals.

Overall, views on whether this practice is anticompetitive are mixed. There is academic debate over whether there is any real adverse effect on consumers from fullsystem contracting. "Chicago School" economic theory would state that the system cannot increase its aggregate market power or leverage its monopoly power from one market to another through this policy because a hospital can, in effect, use its monopoly power only once, and would simply set a monopoly price in the monopoly market rather than transferring that power to another market (the one monopoly theory). As a practical matter, however, the antitrust enforcement agencies are interested in this issue. In addition to the FTC's Evanston case mentioned above, the Justice Department has acknowledged investigating this practice, and payors have complained about this contracting practice to both the Justice Department and FTC. And there are legal theories under which this practice can be viewed as a violation of the antitrust laws.

Before addressing those theories, note that antitrust exposure is possible regardless of whether some or all of the various hospitals or other components contracting as a single system are sufficiently integrated to be considered a single entity under the antitrust laws. See Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752 (1984). Of course, if one or more system components fail the Copperweld test and are deemed separate entities, the antitrust risk is greater for those entities. Even if the hospitals and other components are sufficiently integrated to comprise a single entity and avoid liability for price-fixing or a group boycott under Section 1 of the Sherman Act, full-system contracting also can be evaluated under Section 1 as a coerced vertical agreement with payors ("tying" or "full line forcing") or as unilateral conduct to maintain or expand market power under Section 2 of the Sherman Act ("leveraging" or "bundling"). Tying also can be unlawful under state antitrust statutes which parallel the federal Sherman Act, and these state statutes could be utilized by state attorneys general or private parties to challenge full-system contracting.

The closest antitrust theory applicable to this contracting practice is "tying," or its legal sibling, "full line forcing," which is usually analyzed under Section 1 of the Sherman Act. Generally, a tying arrangement results where a seller conditions its sale of one product (the tying product) on the purchaser's buying another product (the tied product) either from the seller or from a source designated by the seller. Full-line forcing is a slightly different arrangement where a seller requires its purchasers (usually dealers in the manufacturing setting) to offer the seller's complete line of products for sale. In the health care context, a plaintiff could argue that the services of a desirable "musthave," "flagship," or "anchor" hospital are the tying product and the services of less desirable hospitals or other facilities, or those located in a separate geographic market are the tied product which is being forced. Full-system contracting practices will not always fit classic tying or forcing analysis, however, so it is not crystal clear that conventional tying analysis applies to hospital full-system contracting. And even if it does apply, the uncertainty about the policy's effect on competition makes it possible, or even likely, that a court would examine full-system contracting under the rule of reason, rather than the more severe per se rule (or the "quasi per se" rule which differs from (and is less strict than) conventional per se analysis).

Market Conditions and Related Contracting Practices Affecting the Antitrust Analysis of Full-system Contracting
Economists as well as attorneys who testified at the Joint Hearings stated that a competitive effects analysis of full-system contracting should take into account competitive constraints and mechanisms available to or operating on both health systems and payors. Those constraints include both market conditions and related contracting practices or other mechanisms that payors or hospitals can use to discipline the other party. These market conditions and contracting practices can aggravate or ameliorate the antitrust risk, depending on the circumstances.

The most obvious market condition affecting the analysis is the presence and degree of market power possessed by the system, the desirable flagship hospital, or even the "tied" less desirable or geographically separate facility may determine whether or not there is antitrust exposure. Market power is a necessary, but not alone sufficient, element of an antitrust violation. Absent market power by the flagship hospital, or perhaps the overall system (although it is open to debate whether system market power alone will be sufficient to make out an antitrust violation) there can be no antitrust liability.

In addition, the contracting practice is more likely to be problematic in markets where there are significant barriers to entry or reentry that permits full-system contracting to be an effective predatory strategy. Otherwise, any market power transferred to the tied market is transitory. In fact, one commentator referred to expansion by existing rivals and new entry as the "ultimate pricing discipline on providers." Similarly, in other circumstances the payor has no alternative to contracting with the tied hospital either because it too is a desirable facility or is the only hospital in its geographic market. In this situation, the payor would likely have contracted with all the system's hospitals without being forced to, so it is unclear whether the requisite coercion is present to establish an unlawful tying arrangement. Paradoxically, then, the fact that the tied hospital has market power may defeat a tying claim (although it may face antitrust exposure under other theories depending on the circumstances). And there is academic debate whether, as a matter of economic theory, it is even possible to leverage monopoly from one market to another.

Another market factor that is a symptom of a potential antitrust problem occurs when the practice causes current market prices for the full system, and/or the "tied" or "forced" market to rise to above-market ("supracompetitive") levels. On the other hand, there is no harm where the system has lowered prices for the "must-have" facilities so that the bundled system price is competitive, and the system's cost savings are passed on as lower overall prices.

As to contracting practices or other mechanisms, the particular form of full-system contracting that the health system employs can dictate whether the practice has any antitrust risk, and if so the degree of such risk (e.g., including physician groups, ASCs, home health agencies, or other entities into the full-system contracting requirement is more likely to be evaluated under a quasi per se rule, increasing the antitrust risk significantly). And full-system contracting is more likely to be a problem when it is not payor-driven, but instead precludes payors from purchasing the mix of services or locations they would otherwise prefer to purchase a la carte other than at a monopoly price.

On the other side of the table, payors have a variety of mechanisms available to respond to any attempt by hospitals to impose supracompetitive prices through fullsystem contracting. The tools available to health plans include: playing physicians off against the hospital for such high-margin services as outpatient surgery and imaging; maintaining risk-sharing arrangements with physicians for hospital utilization where possible; using the threat of losing business through service line (e.g., moving cardiac patients to another facility) or geographic carve-outs to "punish" hospitals; employing tiering through restrictive network options or coinsurance to preserve steering and the ability to shop for discounts; and finally, terminating or threatening to terminate the contract ("terminate to negotiate" or brinksmanship strategy). One panelist at the hearings suggested that payors should exhaust all of these mechanisms and alternatives before it can be concluded that full-system contracting is a problem.

Antitrust concern is increased when hospitals have sufficient market power to block these payor mechanisms to steer patients and "shop" effectively on behalf of employers (assuming, of course, that payors' enrollees even prefer the resulting limited network, rather than a broad network that includes must-have hospitals with real or perceived higher quality and thus higher prices). This is likely true even where hospitals believe they are merely "leveling the playing field" as the bargaining power pendulum swings back their way. The federal enforcement agencies in the Report have clearly rejected such countervailing market power as a tool for providers to combat real or perceived payor market (or monopsony) power.

Because a contract is not a guarantee that a plan's enrollees will use the system's hospitals, and competition between providers also occurs after hospitals enter into contracts with payors, any anti-tiering provisions which restrain this post-contract competition increase the likelihood of anticompetitive effects, and thus increase the antitrust risk for a hospital imposing such provisions in conjunction with full-system forcing. The federal agencies' only statement of their enforcement agenda relating to full-system contracting in the Report addresses, and condemns, hospitals' and other providers' unlawful collusion or unilateral monopoly conduct to impede tiering or other perceived innovative contracting practices by payors. The Report, however, also recognizes that there are legitimate reasons why hospitals may resist tiering, such as fear of low-cost facilities being labeled as low quality and high-cost facilities labeled as inefficient; difficulty in maintaining expensive services such as burn units, trauma services, and emergency "stand by" capability; and jeopardizing indigent care, teaching functions, and innovative research by hospitals.

Full-system contracting also is much more likely to violate the antitrust laws where coupled with an exclusive dealing arrangement because the combination of these two contracting policies would be much more likely to foreclose competing hospitals than full-system contracting only. Similarly, some hospitals demand contract provisions explicitly barring geographic or service "carve-outs." Again, although perhaps only subtly different from the underlying full-system policy, these terms are more likely to have foreclosure and price effects because this prohibition makes it more difficult for payors to utilize lower-cost providers in the affected areas or for those services. Ameliorating the risk, however, a health system may have a policy encouraging contracting with the full system, but not require payors to contract with all system hospitals if any health plan opposes doing so and wants to carve out certain hospitals.

Procompetitive Business Justifications
Finally, a health system's rationale for its full-system contracting practice will be important in determining the antitrust exposure from the policy. Even if the system or its flagship facility has market power and the contracting practice has some anticompetitive effects, it may still pass muster if it is justified by legitimate business or efficiency reasons.

Although under a typical tying analysis, no or only a narrow justifications defense is permitted, many courts have entertained an efficiency defense if the defendant can show there was no "less restrictive alternative" to the tying that could achieve the same efficiencies. Metrix Warehouse, Inc. v. Daimler-Benz, 828 F.2d 033 (4th Cir. 1987); Betaseed, Inc. v. U & I, Inc., 681 F.2d 1203 (9th Cir. 1982). Moreover, because, as noted above, the present practice differs from stereotypical tying, it is likely that a health system would be permitted to fully present a business rationale to justify its fullsystem contacting. Indeed, it is likely that the enforcement agencies would look for efficiencies resulting in a lower aggregate price from a system than would otherwise be available if the member hospitals contracted and priced separately.

In addition, economists who testified at the Joint Healthcare Hearings agreed that evaluating the business justification for a full-system contracting arrangement would be an essential step in the analysis. Efficiencies that may justify full-system contracting identified by economists include: reducing transaction costs (e.g., one-stop shopping for payors); maintaining adequate patient volume at every location which permits fixed costs to be spread across more patients at each facility; common timing of contracts with individual payors or across payors; development of "best practices" in contracting provisions (the system can gain a better sense of average experience through full-system contracting); development of more sophisticated IT systems; improved budgeting or understanding of costs associated with delivering health care services; and possible savings in personnel. Another business justification for full-system contracting is simply satisfying payors' and their enrollees' demand for a broad network allowing wide choices among providers. Finally, a full-system contracting policy requiring payors to contract with affiliated physicians could be justified if the physicians practice only at the tied system hospital, or similarly, to reflect existing referral patterns.

There will not be a legitimate business justification or efficiency rationale for fullsystem contracting, however, if the primary purpose of this potential arrangement is to obtain a "better deal" for the tied hospital rather than some efficiency-generating rationale. Also, if the system has not historically contracted as a single system, an attempt to do so without undertaking some efficiency-generating steps that justify the full-system contracting would raise suspicion about its motivation for implementing the practice at this time.

Finally, where a plaintiff first shows a significant anticompetitive effect, the full-system contracting policy must be reasonably necessary to achieve the claimed justification — i.e., why do the hospitals need to contract as a single system in order to obtain the business efficiencies? The justification may not be simply a pretextual reason unrelated to the contracting practice.

The joint report of the DOJ/FTC Healthcare Hearings, Improving Health Care: A Dose of Competition is available at http://www.ftc.gov/reports/ healthcare/ 040723healthcarerpt.pdf. The transcript from the March 27, 2003, session of the Hearings on Hospital Contracting Practices is available at http://www.ftc.gov/ ogc/healthcarehearings/030327ftctrans.pdf.

Prior to joining Ober|Kaler, Mr.Berlin was a trial attorney with the DOJ's Litigation I section and the Health Care Task Force for eight years. During most of 2003, he was involved in conducting the Joint DOJ/FTC Healthcare Hearings, working with his counterparts at the FTC, and moderated hearings on several specific issues.