In the recent bylined article for The National Law Journal, Bass, Berry & Sims attorney Leigh Walton provides insight on the healthcare reform’s anticipated impact on the industry’s mergers and acquisitions, including the potential effects on hospitals, HMOs, physician practice groups, drug manufacturers and device makers. Read below for the article.

Reprinted with permission from the July 26, 2010 edition of The National Law Journal © 2010 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.

Reform could spur consolidation in health sector
By Leigh Walton and Christopher Y. Chi
The National Law Journal
July 26, 2010

This year’s historic health care reform legislation did more than pave the way for millions of uninsured Americans to join the nation’s health care system. It also may have set the stage for a surge in consolidations across the industry.

Nothing can stall deal-making like uncertainty. And for months after President Obama’s election, health care dealmakers were left to speculate about whether health care reform would pass — and, if it did, how far it would go.

This speculation ended with the approval of the Patient Protection and Affordable Care Act and related legislation in March. With the new laws in place, health care dealmakers now have a set of rules — albeit a lengthy, complicated and incomplete set — from which to plan for the future.

The early sentiment among industry professionals is that, during the next several years, reform will fuel already existing pressure within the health care industry to consolidate. Hospital systems, experts believe, will respond to profit-margin pressure and reform incentives by getting bigger to bolster their bargaining power with insurers.

Insurers may merge to counter this hospital consolidation and to develop greater economies of scale to offset reform-related costs. This may have a ripple effect, spurring consolidation among drug manufacturers and device makers, which will need the leverage that comes with size to negotiate with insurers who pay for their products.

Meanwhile, industry observers expect physicians to continue a trend toward joining larger medical groups or becoming hospital employees. Health care reform limits physicians’ ability to make money by investing in hospitals. This may cause more doctors to get out of the “business of medicine.”

Indeed, 2010 has already seen some big health care deals that may reflect where industry mergers-and-acquisitions activity is heading post-reform. For example, publicly traded Vanguard Health Systems Inc. is buying the nonprofit Detroit Medical Center for $1.3 billion. Press Release, Vanguard, DMC Announce Letter of Intent (March 19, 2010). And private equity giant Cerberus Capital Management L.P. has struck an $830 million deal to buy Cari­tas Christi Health Care, the Catholic hospital system in Massachusetts. Press Release, Caritas Christi Health Care System to be Acquired by Cerberus Capital Management L.P. (March 25, 2010).


To be sure, long before this year’s health care reform, hospitals began a trend toward consolidation, driven by a desire to achieve economies of scale and enhanced bargaining power. According to a recent Morgan Stanley report, in 1997, 44% of community hospitals belonged to a hospital system and 56% were independent. A decade later, after a surge in hospital mergers, those numbers had flipped: Only 44% of community hospitals remained independent and 56% were part of a system. Doug R. Simpson & Melissa McGinnis, Managed Care Opportunities in a Still Fragmented Market, Morgan Stanley, May 14, 2010.

Health care industry observers believe that, in this difficult economy, both for-profit and nonprofit hospitals with relatively strong financial positions may bargain shop among struggling nonprofits. Many of these independent nonprofits are being pressured by bad debt, pension liabilities, aging facilities and lower charitable giving. And they often lack the scale and access to capital that hospital systems enjoy.

Health care reform’s implementation timeline adds to this pressure on smaller hospitals. On the one hand, in anticipation of an influx of newly insured patients (an estimated 32 million currently uninsured Americans will be covered by Medicaid or private insurance under health care reform), hospitals need to spend money on facility and technology updates. On the other hand, the massive expansion of coverage won’t take effect until 2014. Still, the downward pressure on government reimbursements begins immediately. Specifically, to help pay for the expansion of coverage, the reform legislation reduces the federal government’s Medicare and Medicaid spending by an estimated $155 billion through 2019, with significant cuts in annual inflation adjustments that apply to physician and hospital fee schedules.

The reform legislation includes financial incentives for “coordinated care,” or collaboration among hospitals, physicians and other health care providers to raise the quality and efficiency of care. In 2013, the federal government will launch a program aimed at encouraging coordination among hospitals, physician groups, skilled nursing facilities and home health agencies.

Under this initiative, a single Medicare payment, rather than multiple payments, will cover the services provided by these practitioners and facilities. Furthermore, the reform legislation encourages the formation of “accountable care organizations” consisting of hospitals, physicians and other industry professionals or some combination thereof, which would be rewarded for collectively achieving quality and efficiency standards. This focus on the “continuum of care” may lead to vertical integration among health care providers. In order to control this care continuum, hospitals may seek to snap up rehabilitation and skilled nursing facilities, home health agencies and physician practices.

Many independent physicians and small physician groups already view consolidation as an attractive option, if not a necessity. Left with weak bargaining power relative to hospital and insurers, and forced to contend with rising operational costs such as implementing expensive electronic health-record systems, physicians can gain stability and leverage by entering into partnerships with a hospital company or larger groups In fact, according to a recent PricewaterhouseCoopers report, nearly 3,000 physicians were involved in mergers and acquisitions last year, nearly double the total for the previous year. Behind the Numbers Medical Cost Trends for 2011, PricewaterhouseCoopers’ Health Research Institute, June 2010, 5.

Moreover, the act places severe limitations on physicians’ ability to invest in hospitals. These investment restrictions, many experts believe, will fuel the existing trend toward hospitals employing physicians. The American Medical Association cites financial pressures on doctors and the desire for work/life balance as driving physicians toward employment arrangements that allow them to “keep semi-regular hours and have less responsibility for the business side of medicine, and possibly gain greater leverage in contract talks” with health insurers. Bob Cook, Finances Driving Physicians Out of Solo Practice,, Sept. 10, 2007.


Insurers, of course, were the prime target of health care reform. Beginning in the fall, health plans no longer may impose lifetime limits on the coverage available to members; must provide specified preventive care and immunizations; and must offer coverage for dependent children up to age 26. And beginning in January 2011, health plans are required to spend a minimum proportion of the premiums they charge customers on medical care — 80% for smaller plans and 85% for larger ones. If health plans do not meet these minimum ratios, they must rebate their customers the excess amount not spent on medical care.

Many health care industry observers predict that these insurance reforms will lead to widespread acquisition of smaller health plans by larger industry players. The thinking is that smaller health plans will find it difficult to meet the required medical loss ratios and stay profitable, because their nonmedical costs — such as claims processing, actuarial services and other overhead — constitute a higher proportion of premium revenue compared to larger plans.

Insurance reforms that will be phased in during the next few years could further spur consolidation. For instance, beginning in 2014, plans will be prohibited from using pre-existing conditions to exclude adult members and will be prohibited from basing the premiums they charge on gender or health status. These changes will dramatically alter the manner in which health insurers analyze and underwrite risk. Many health care professionals believe that, under such a regime, insurers with large and demographically diverse membership pools will be best situated to spread the risk of unanticipated health care costs.

The pressures on insurer profit margins won’t end there. The act significantly reduces federal funding for Medicare Advantage plans, the private health plans for senior citizens that health insurers offer as an alternative to original Medicare. Furthermore, the reform legislation will result in an industry tax on health insurance companies and a 40% excise tax on employers and insurers that offer high-cost health plans. Moreover, the act requires states to establish “insurance exchanges” — organized marketplaces that are intended to make the industry more competitive by allowing consumers to more easily comparison shop among insurance plans.

But the greatest pressure driving insurers toward consolidation is coming from the parallel trend among health care providers toward size and scale. With hospital systems and physician practices merging to wield greater bargaining power in their local markets, insurers feel the need to do the same. Such insurer consolidation, according to the Morgan Stanley report, is a clear way for insurers to “diminish the market power of providers.” Simpson and McGinnis, supra.

Most health care experts anticipate consolidation in the pharmaceutical and medical-device industries. Many drug manufacturers face looming patent expirations and face the challenge of getting U.S. Food and Drug Administration (FDA) approval for new drugs. Drug companies under such pressure may seek to acquire or merge with peer companies that don’t face patent expiration pressure or have ample new drugs far along in the FDA approval process and ready to go to market.

Of course, some uncertainty remains. Merger activity could be dampened by a continued sluggish economy and restrained access to the credit markets. Moreover, the reform legislation — itself several thousand pages long — is just beginning to be interpreted by regulatory agencies. The resulting regulations will give clarity and detail to the legislation itself, some of which is frustratingly vague.

And any megamergers in the health care industry must clear federal and state antitrust review. The Obama administration has promised to be especially tough in its review of managed care mergers that require federal antitrust consent.

Because it will take time for regulatory clarity to develop — and because many health care dealmakers will need to see at least a few more months of economic stability in order to aggressively pursue deals — most industry observers predict that a true surge in post-reform deals is still a way off. In its recent managed care report, Morgan Stanley sees 2010 as setting the stage for a 2011-2013 consolidation phase, with the next year or so the time during which companies “digest coming reforms and the fundamental backdrop stabilizes.” Simpson and McGinnis, supra.

Leigh Walton ( and Christopher Y. Chi are partners in the Nashville, Tenn., office of Bass, Berry & Sims. Associate Lauren Gaffney assisted in the preparation of this article.