On May 18, 2020, California  Senate Bill 977 (“SB-977”) was passed out of the California Senate Health Committee and is now scheduled for its first hearing before the Senate Appropriations Committee on June 1, 2020.   SB-977 as written would subject all acquisitions and affiliations on and after January 1, 2021 by larger health systems, private equity funds and hedge funds of (i) hospitals, (ii) other health facilities, (iii) physicians, (iv) clinics, (v) ambulatory surgery centers or  (vi) laboratories to prior approval by the California Attorney General.  In its current form, SB-977 would require the California Attorney General to withhold his approval from a proposed transaction unless the transaction would (i) increase clinical integration and/or (ii) increase access or availability of healthcare services to underserved populations, and would not otherwise be anti-competitive.  SB-977 would also give the Attorney General the discretion to hold a public hearing on a proposed transaction.  In short, with SB-977, the California Legislature is going far beyond earlier proposals or legislation in other states – including Connecticut and Washington State – that have prior approval requirements for healthcare transactions.

In this article, we consider the forces behind SB-977 – a decade or more of healthcare consolidations and the financial distress being experienced by hospitals and other healthcare providers as a result of the current healthcare emergency – and the potential impact that SB-977 could have on the California healthcare marketplace if it were signed into law in its current form.

SB-977: THE ORIGIN STORY

1. Two Major Factors.  SB-977 and the desire to increase State oversight of healthcare transactions in California appears, based on public reports, to be borne by two major factors – the first factor being historic and ongoing concerns regarding the merits of healthcare consolidation and the impact of such consolidations on the quality and costs of healthcare; and the second factor being the possible rush toward consolidation in the California healthcare industries post-COVID crisis as providers seek financial and operational stability in response to the instability they have experienced during the healthcare state of emergency.

a. Healthcare Consolidations: A Reconsideration.  The hospital industry has undergone significant consolidation over the last ten or more years.  The increasing pace of healthcare consolidation was accompanied by a growing body of literature and analysis focused on the impact such consolidations have on the provision of healthcare services in the U.S.   Whereas some studies showed that healthcare consolidations tended to increase healthcare quality, improve patient access to healthcare, and lower healthcare costs in the relevant healthcare markets, other studies reached the opposite conclusion – i.e., consolidations among healthcare providers tended to increase healthcare costs, decrease patient access to healthcare, and possibly lower the quality of care as provided by the consolidated providers.

On September 4, 2019, the American Hospital Association (“AHA”) issued a report entitled “Hospital Merger Benefits: Views from Hospital Leaders and Econometric Analysis – An Update.”  (the “AHA Report”).  According to the AHA Report, hospital acquisitions benefit patients by leading to “better care at reduced cost.”  More specifically and as set forth in the AHA Report’s Executive Summary, the AHA Report concludes:

i. Acquisitions decrease costs due to the increased scale of the combined system and the data-driven clinical standardization that can be realized;

ii. Hospital acquisitions are associated with a 2.3% reduction in annual operating expenses at acquired hospitals;

iii. Hospital acquisitions generally result in increased quality of care as evidenced by statistically significant reductions in rates of readmission and mortality; and

iv. Revenues per admission at acquired hospitals decline relative to non-merging hospitals by a statistically significant 3.5%.  As interpreted by the AHA, these results suggest that savings that accrue to merging hospitals are passed on to patients and their health plans.

By way of contrast, although a July 11, 2018 study issued by the National Council on Compensation Insurance (“NCCI Study”) entitled, “Impact of Hospital Consolidation on Medical Costs,” supports the AHA Report’s conclusion that healthcare consolidations can have a positive impact on healthcare quality and cost effectiveness – the NCCI Study shows that hospital mergers can lead to operating cost reductions for acquired hospitals of 15%−30% – the NCCI Study ultimately concludes that reductions in hospital operating costs do not translate into price decreases. According to the NCCI Study, “research to date shows that hospital mergers increase the average price of hospital services by 6%−18%.”  In addition, the NCCI Study goes on to say that, “hospital concentration increases costs by increasing the quantity of care rather than the price of care.”

The NCCI Study conclusions were corroborated by a New York Times study as summarized in an October 11, 2018 article, “When Hospitals Merge to Save Money, Patients Often Pay More” by Reed Abelson.  Based upon the New York Times analysis and its examination of 25 metropolitan areas with the highest rate of consolidation from 2010 through 2013, the price of an average hospital stay increased after a hospital consolidation, with prices in most areas going up between 11% and 54% in the years afterward. Overall, the study showed that one-third of the areas studied saw the cost of hospital stays increase at least 25% from 2012 to 2014.

Most recently, an oft-cited report published by the New England Journal of Medicine (“NEJM Report”) on January 2, 2020, entitled “Changes in Quality of Care after Hospital Mergers and Acquisitions” found that, despite hospital industry claims to the contrary (See, AHA Study above), hospitals acquired by other hospitals generally experienced a modest decline in their performance as to “patient experience” – a NEJM Report metric that measures the range of interactions that patients have with a healthcare system such as timely access to information or good communication.  In addition, hospital-acquired hospitals did not experience any significant changes to hospital mortality or readmissions after 30 days of discharge as compared to hospitals that weren’t acquired.

b. Financial and Operational Stability:  A Post-Pandemic Deal Surge?  In a May 5, 2020 report issued by the American Hospital Association (the “AHA”), “Hospitals and Health Systems Face Unprecedented Financial Pressures Due to COVID-19,” the AHA estimates that during a four-month period commencing on March 1, 2020 and ending on June 30, 2020, America’s hospitals and health systems will experience approximately $202.6 billion in total losses or an average total loss of $50.7 billion per month.

In response to the economic losses being experienced by California hospitals as a result of the COVID-19 pandemic, the California Hospital Association (“CHA”) and other California healthcare associations recently launched a media campaign entitled, “Protect Our Hospitals,” to encourage the California Legislature and Governor Gavin Newsom to provide an additional $4 billion in short-term and long-term State funding to hospitals as a way to address the financial strains that hospitals are experiencing as they respond to the COVID-19 public health emergency.  According to a CHA campaign piece, “Hospitals Are Protecting Californians – Now They Need the Legislature’s Help,” the current state of emergency has seen a 50% drop in statewide hospital emergency department visits, a 139% decrease in hospital operating margins, and estimated short-term losses for California’s hospitals exceeding $10 billion.

As healthcare providers around the country struggle to respond to patient needs during the COVID-19 state of emergency, healthcare financial analysts have conjectured that once the pandemic abates and hospitals fully reopen to the provision of non-COVID-19 care, many freestanding hospitals and small health systems may decide to explore joining larger systems as a way to address lingering pandemic-related financial distress and to obtain long-term financial and operational stability – stability being a highly valued commodity after the volatility of the national response to the COVID-19 pandemic.  Any such post-pandemic surge in activity could result in robust deal activity from the fall through the end of the year.

2. SB-977: A View from the Senate Committee on Healthcare. The tie between the above factors and SB-977 can be seen in a recent press releaseissued by California Senator Bill Monning, the author of SB-977, in which Senator Monning states, “As our state continues to face the devastating impacts COVID-19 has on our healthcare system, it is important to ensure costs remain affordable for patients. Physicians are facing severe financial pressures because of the current pandemic and data shows that prices skyrocket when providers consolidate and reduce competition in the marketplace.  SB-977 will protect existing services for patients and address the issue of unfair business practices that increase healthcare costs for all Californians.”

In the above statement, we see that SB-977 is intended as a reflection of the Legislature’s concerns about (i) the financial pressures being brought to bear on State providers (including physicians and hospitals) as a result of the COVID-19 pandemic, (ii) the possibility that this financial pressure could lead to further consolidation in the California healthcare provider sector, and (iii) the allegedly detrimental impact that such consolidation might have on consumer healthcare costs and provider choice.

The proposed legislation follows on the heels of a $575 million settlement against Sutter Health, the largest hospital system in Northern California, in December 2019. Indeed, the above-mentioned press release expressly frames SB-977 as “another step in Attorney General Becerra’s fight to keep California markets fair and competitive to protect patient choice and affordable care.”

The Senate Committee on Health’s formal bill analysis dated May 11, 2020 cites recent literature, including a March 2018 UC Berkeley report on health care consolidation, purportedly finding that concentrated markets are associated with higher prices for hospital and physician services and insurance premiums. The financial strain on hospitals and physician practices as a result of the COVID-19 pandemic, and the “susceptibility” of such organizations to affiliation and acquisition attempts by large health care systems, private equity groups, and hedge funds, is also mentioned as a catalyst (or at least another justification) for the bill.

SB-977: THE DETAILS

1. Affected Parties. In its current form, SB-977 would apply to (i) health care systems that include or own two or more hospitals within multiple counties or three or more hospitals within one county, (ii) hedge funds, and (iii) private equity groups, in each case to the extent pursuing certain types of transactions or engaging in certain types of conduct, as described below.  The bill does not appear to apply to stand-alone hospitals or health systems that do not meet the threshold  health insurance companies or other strategic investors that are not a health care system, hedge fund, or private equity group..

2. Affected Transactions. If passed by the state legislature and signed by Governor Gavin Newsom in its current form, SB-977 would require health care systems, private equity groups, and hedge funds to notify and obtain the written consent of the Attorney General prior to affiliating with or acquiring healthcare facilities,  providers, clinics, ambulatory surgery centers, treatment centers and laboratories in transactions exceeding $500,000 in value.

SB-977 defines “acquisition” as “the direct or indirect purchase in any manner, including, but not limited to, lease, transfer, exchange, option, receipt of a conveyance, creation of a joint venture, or any other manner of purchase, by a health care system, private equity group, or hedge fund of all, or any part of, the assets of a health care facility or provider. A transfer includes, but is not limited to, any arrangement, written or oral, that alters voting control of, responsibility for, or control of the governing body of the health care provider.” An “affiliation” is defined as “an agreement, association, partnership, joint venture, or other arrangement in which a health care system establishes a change in governance or sharing of control over health care services provided by that health care facility or provider, or in which a health care system otherwise acquires direct or indirect control over the operations of a health care facility or provider in whole or in substantial part. An affiliation does not exist where a health care system only extends an offer of employment to, or hires, a provider.”

3. Exempt Transactions. As drafted, SB-977 would not apply to acquisitions or affiliation entered into prior to January 1, 2021, including subsequent renewals, “as long as those acquisitions or affiliations do not involve a material change in the corporate relationship between a health care system and a health care facility or provider, or a material change in the corporate relationship between the private equity group or hedge fund and a health care facility or provider, on or after January 1, 2021.”

Although not expressly exempt from the statute, an acquisition or affiliation by a healthcare system for $500,000 or less would be subject to a less rigorous process than that applicable to larger transactions (described below) – in such cases, notice to the Attorney General would still be required, but the transaction would be permitted to proceed if the Attorney General did not object to the transaction within 30 days.  It does not appear that this alternative process for de minimis transactions would apply to acquisitions and affiliations by private equity groups or hedge funds.

4. Transaction Approval Process. Under SB-977, the Attorney General would have 60 days to approve subject transactions, grant a waiver, or issue a request for more information.  Once the Attorney General has certified that the parties have substantially complied with a request for more information (if applicable), the Attorney General would have 45 days to make his or her determination.  The time period could be extended by an additional 45 days if the acquisition or affiliation were substantially changed or modified by the parties or if the acquisition were to involve health care facilities or providers servicing multiple communities.  The Attorney General would be permitted to further extend the time period by 14 days if the Attorney General decided to hold a public meeting.

The Attorney General would be required to deny consent to an affiliation or acquisition unless it were demonstrated that the affiliation or acquisition would result in a substantial likelihood of clinical integration or a substantial likelihood of increasing the availability and access of services to an underserved population, or both. The bill also authorizes the Attorney General to deny consent to an affiliation or acquisition “if there is a substantial likelihood of anticompetitive effects that outweigh the benefits of a substantial likelihood of clinical integration, a substantial likelihood of an increase in services to an underserved population, or both.”  For purposes of the bill, clinical integration refers to a showing by the relevant parties that the transaction in question will likely result in a reduction in costs to the benefit of consumer care and outcomes or an increase in the quality of care as a result of the acquisition or affiliation.

5. Prohibition on Anticompetitive Conduct. SB-977 would also make it unlawful for one or more health care systems, either independently or dependently, to use their market power to “cause anticompetitive effects,” and would authorize the Attorney General to bring a civil action for a violation of this unlawful conduct. SB-977 would require a court to impose civil fines for these violations, calculated either as $1,000,000 or as twice the gross gain to the health care system or gross loss to any other party multiplied by two, whichever is greater. The bill would require a court to impose monetary relief for the state in the amount of three times the total damage sustained (plus interest and costs), as specified.  It is contemplated that any fees or fines obtained would be deposited into the Attorney General antitrust account within the General Fund.

6. Creation of Health Policy Advisory Board. NEJM Report would require the Attorney General, beginning July 1, 2021, to establish a Health Policy Advisory Board to evaluate California health care markets in order to provide recommendations to the Attorney General’s office in connection with granting or denying consent to the transaction.