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TRENDS

The Effect Of Physician-Owned Surgicenters On Hospital Outpatient Surgery

Abstract

 
Hospitals increasingly find themselves subject to competition from freestanding outpatient treatment facilities such as diagnostic imaging centers and ambulatory surgery centers. That competition causes hospitals particularly intense concern when the freestanding facility is owned by physicians who are on the hospital’s medical staff. We find some basis for that concern. Further, this particular form of rivalry raises competitive complications that differentiate it from the standard antitrust analysis of new competitive entry.

This creates some economic incentive issues, because it is the physician-investor who refer his patients, at his discretion, to either the ASC facility that he owns or to the hospital facility that he doesn’t own.¹ In the absence of this ownership interest, the physician chooses between the two facilities on the basis of various factors, presumably ranging from the best interests of the patient to the personal convenience of the physician. But adding a facility ownership interest puts a new variable into the referral equation: The physician makes an extra profit, over and above his fee for the professional services that he provides, when he refers his patient to the facility that he owns.

Illustration Through Example

Top Illustration Through Example Incentive Problems And... Assessing New Competitive Entry Concluding Observations NOTES

 
Our objective here is to illustrate, through a pair of examples, the magnitude and composition of the shift in volume that can happen to a hospital when its surgeons invest in a competing ASC. Our two examples are recent antitrust and staff-privileges disputes. Although we fully appreciate that strong generalizations cannot rest on limited data from two examples, we also appreciate that there is no systematic empirical research literature on the specific competitive phenomenon of our interest. Therefore, showing by example what sometimes happens is a useful precursor to demonstrating statistically what usually happens. One of these disputes was between North Oaks Medical Center and St. Luke’s Surgicenter, both located in Hammond, Louisiana; the other was between Avera Health System and Dakota Plains Surgical Center, both located in Aberdeen, South Dakota.²

St. Luke’s versus North Oaks. North Oaks is the only full-service acute care hospital in Hammond, Louisiana. St. Luke’s is a freestanding ASC owned by several physicians on the North Oaks medical staff.³ St. Luke’s became fully operational in December 1996. The hospital was not pleased to see its medical staff physicians set up an alternative facility harmful to the hospital’s interests. Conversely, the ASC was not pleased that the hospital had some exclusive contracts with managed care plans, in which the hospital discounted its prices to the plan if the plan designated the hospital as its exclusive health care facility in the area. An antitrust lawsuit ensued.

Surgical volume. The relevant data consist of a file on every surgery—inpatient as well as out-patient—done at the hospital over fiscal years 1996–1999.⁴ This data file is supplemented by data summaries from which we get a gross count (not broken out by physician) of monthly outpatient surgeries at the ASC over the same period.

Exhibit 1 shows the basic facts on surgical volumes at both of these institutions. The vertical line (at December 1996) marks the first full month of the ASC’s operation. Focusing first on time trends, we see that both within and across the pre- and post-ASC time periods, inpatient surgery at the hospital was roughly stable. Interpreting the inpatient volume as a sort of "surgical control group," we can see that the opening of the ASC had no detectable effect on the hospital’s inpatient surgery volume, nor is there any sign in these data of any other abnormal disruption in its inpatient surgical activity.

View larger version (16K): [in this window] [in a new window]   EXHIBIT 1 Inpatient And Outpatient Surgery Volume At North Oaks Medical Center And St. Luke’s Surgicenter, 1995–1999

Referring surgeons. We are also interested in identifying which surgeons were referring their patients away from the hospital. We see in Exhibit 2 that before the ASC opened, the physician-investors together performed more outpatient surgery than all of the other physicians combined, on average roughly 215 cases per month for the investor group and 175 for all the rest. After the ASC opened, outpatient surgery activity from the noninvestors initially continued unabated and then eventually rose above its pre-ASC level.

View larger version (17K): [in this window] [in a new window]   EXHIBIT 2 Outpatient Surgery At North Oaks Medical Center: Volume Of Procedures By Investor And Noninvestor Physicians, 1995–1999

View larger version (15K): [in this window] [in a new window]   EXHIBIT 3 Inpatient Surgery At North Oaks Medical Center: Volume Of Procedures By Investor And Noninvestor Physicians, 1995–1999

OSS was displeased with Avera’s action and brought an antitrust and staff-privileges lawsuit to block it. Compared with the Louisiana example, the relevant data disclosed in the South Dakota proceeding were limited. All that the record reveals is the physician-investors’ monthly outpatient surgical volume at the hospital before and after they opened their own ASC, which precludes a comparison of investors to noninvestors. But the case is instructive nevertheless, particularly in that the state supreme court’s opinion offers some insights into the dilemma of conflicting economic incentives.

The data we have show that the physician-investor hospital outpatient volume fell more sharply in the Avera-OSS episode than it did in the North Oaks–St. Luke’s example (Exhibit 4). When the new ASC opened, the investors’ volume of outpatient surgery at the hospital fell by 77 percent; monthly average volume declined from seventy-eight cases over the six months preceding the launch of the ASC to eighteen cases over the six months afterward.

View larger version (13K): [in this window] [in a new window]   EXHIBIT 4 Volume Of Hospital Outpatient Surgery At Avera Health System Among Orthopedic Surgery Specialists Investing In An Ambulatory Surgery Center (ASC), Before And After The ASC Opening, October 1995–September 1998

How can a doctor who is a part owner of the for-profit OSS be expected to fulfill his or her duties towards his or her co-workers and in the same instance fulfill the duties towards the principal, [Avera], who is a not for profit hospital? This does not imply ill-will on the part of the doctor, it simply faces fundamental medical issues such as at which institution does the doctor place his or her patients, OSS or [Avera]? We have often stated that an agent cannot serve two masters. This rule applies to medical professionals as well.⁵

If there is a general lesson to be drawn from this judgment, it is a reconfirmation that courts are capable of recognizing economic-incentive controversies in medical economics and of holding that, at least in some circumstances, responsive measures taken in self-defense are warranted and permissible.

These two cases may shed some preliminary light on two considerations that often come up in the antitrust assessment of such events. One is a standard hypothesis in favor of such ASCs that their main effect on incumbent hospitals is a competitive reduction in price, but on balance not a large loss of hospital outpatient surgery volume.⁶ Contrary to that hypothesis, our examples show a substantial loss of hospital volume. The second consideration is whether any such shift of outpatient surgery volume reflects an across-the-board response by physicians generally, presumably because the new ASC is a clinically superior facility. Our observation in Louisiana is that the volume shift was largely confined to physician-investors who had a financial interest in the ASC.

Incentive Problems And Contractual Solutions

Top Illustration Through Example Incentive Problems And... Assessing New Competitive Entry Concluding Observations NOTES

 
Physician self-referral puts the hospital at a potentially significant disadvantage when it competes for patients with physician-owned ASCs. At the extreme, a referring physician who responds entirely to these personal financial incentives will send all of his patients to the facility that he owns and none to the hospital at which he practices, with two principal exceptions. One exception is the patient who needs facility services that the hospital has but which the physician-owned ASC does not (for example, overnight inpatient care); the other is the patient who, based upon the level of insurance reimbursement and the severity of illness, is unlikely to pay enough to cover the physician-owned facility’s incremental cost of treatment. These patients—the unprofitable ones—also get referred to the hospital.⁷

This unusual competitive setup puts the hospital in a box. The hospital becomes, in effect, a competitor whose mix of business (the patients) is controlled by its competitive rival (the physician-owned facility) through the incentives of those who make the referrals (the physician-investors who wear two hats). The obvious concern with this setup, from the hospital’s standpoint, is that the rival facility will get all of the "good" (profitable) patients and the hospital will get only the "bad" (unprofitable) patients. When hospitals attempt to respond to this competitive problem, the solution generally involves limiting the power of the two-hatted physician-investors to split their patients into these two separate pools.

One potential solution that some hospitals have attempted (as in our Avera-OSS example) is the denial of staff privileges for physicians who engage in this practice. This approach does not really solve the underlying problem; generally it just passes it on to any other hospitals at which the physician-investors also practice. Even from the specific hospital’s perspective, though, this approach has its share of headaches.⁸

The other potential resolution to the problem (the Louisiana example) is to encourage health plans to deal exclusively with the hospital; that is, to encourage contracts that limit the number of directly competitive facilities included within the health plan’s provider network. When a given pool of patients is committed to get all of its local care from one hospital facility, then the hospital that wins the exclusive contract for the plan’s business is protected from the adverse-selection consequences of the conflicting economic incentives of any physician-investors who treat this pool of patients.⁹ This approach has its own set of drawbacks; the hospital typically will need to discount its prices to the plan in return for the exclusivity, and in any event the hospital may risk lawsuits from excluded facilities.

Assessing New Competitive Entry

Top Illustration Through Example Incentive Problems And... Assessing New Competitive Entry Concluding Observations NOTES

 
Given all of this, how do we assess the overall competitive effect on the market of the opening of a physician-owned ASC or of a hospital’s response to that event? The instinctive answer of first resort in antitrust analysis is: "Entry is good; the ASC is entry; therefore the ASC is good." Moreover, evidence likely to be offered in support of that syllogism would surely include the fact that at least in the Louisiana dispute, total output as measured by the total volume of outpatient surgeries rose by about 9 percent relative to trend.¹⁰ That finding would be relevant because the ordinary economic interpretation of changes in supply is that if market output has risen, then consumer welfare has also risen.¹¹

But in circumstances like this, the inferences for consumer welfare are much more ambiguous, because the increased output coincides with the creation of increased economic incentives for physicians to recommend more procedures to their patients.¹² The economic concern is that when a physician profits twice from a procedure—once for his own professional fee, and then once again for his cut of the facility’s fee—that physician has a greater personal financial incentive to recommend more procedures than he would have if he were not the referral facility’s owner. This is potentially a problem because the medical value to the patient of these incentive-induced procedures (sometimes referred to as "unnecessary procedures") may be negligible, even though their financial value to the self-referring physician-investor may be substantial.¹³

There are, of course, many other considerations and complications that could explain these self-referral tendencies.¹⁴ For this reason, among others, we do not interpret the body of economic research on physician self-referral to imply either a thumbs-up or a thumbs-down on physician-owned medical facilities in all circumstances. The value of the self-referral research is simply to inform us that although there is a strong general presumption of economic benefit associated with new entry, and an antitrust presumption that an expansion of market output confirms that benefit, the logic of that joint presumption is inapplicable when the new entry is associated with an increase in physician facility ownership and self-referral.

Concluding Observations

Top Illustration Through Example Incentive Problems And... Assessing New Competitive Entry Concluding Observations NOTES

 
Combined with the well-documented shift of medical care from an inpatient to an outpatient setting, the rise in physician-owned facilities has placed heavy competitive pressure on acute care hospitals. Hospitals have responded to that pressure by pushing back, in one fashion or another. The resultant collisions have sparked antitrust lawsuits in which the conduct of the physician-owned facility (the new entrant) is cast as the force for competition, while the conduct of the hospital (the established incumbent) is cast as the force against competition.

This intuitive characterization is undoubtedly apt in many instances; no competitor applauds the launch of a new rival, and an incumbent’s responses to new entry may include suppressing rather than adapting to the new competition. But the fact that the intuitive characterization is sometimes correct does not imply that the converse characterization is never correct: Adaptive responses to new competition are themselves an element of competition, and the competitive process works more effectively if incumbent competitors are responsive than if they are inert. Put differently, if economic principles imply the approval of new entry, then they equally imply the approval of competitive forms of incumbent response.

Our intended contribution to the discussion of these difficult issues is necessarily limited and suggestive, not sweeping and dispositive. It is based not on a comprehensive database, since one does not exist, but on a pair of specific examples. These examples have the modest distinction of being events in which the physician-owned ASC entrant was confident enough to bring an antitrust case against the hospital incumbent.

We draw three tentative lessons from the limited empirical evidence here, each of which tends to dispute a generalization rather than to establish one. First, the competitive threat to a hospital from a physician-owned ASC is not necessarily confined to lower prices alone; it also flows from a loss of surgical volume. Second, the hospital’s loss of volume is not necessarily led by a favorable across-the-board reaction to the new ASC by all of the surgeons; it may instead be driven disproportionately by the investors who have a stake in the ASC’s profits. Finally, in some circumstances a post-entry expansion of overall market output is not necessarily a reliable symptom of procompetitive effects; that inference is considerably more ambiguous when entry is accompanied by an expansion of physicians’ financial incentives to recommend more medical procedures.

Editor's Notes

 
William Lynk is senior vice-president and senior economist, and Carina Longley is an economist, at Lexecon Inc., an economics consulting firm in Chicago.

The authors are grateful to Kali A. Davidson and Judy E. Smith for their excellent research assistance, and to two anonymous reviewers for their helpful comments.

NOTES

Top Illustration Through Example Incentive Problems And... Assessing New Competitive Entry Concluding Observations NOTES

 

1. For a useful summary of regulatory law on the practice of "self-referral" as it applies to ASCs, see P.R. DeMuro, "A Review of Key Legal Requirements Affecting Ambulatory Surgical Centers," Health Lawyer (July 1999): 1–11.
2. Surgical Care Center of Hammond d/b/a St. Luke’s Surgicenter v. Hospital Service District No. 1 of Tangipahoa Parish d/b/a North Oaks Medical Center, U.S. Dist. Court E.D. Louisiana 2001 U.S. Dist., LEXIS 138 (3 January 2001); and John Mahan, M.D., et al. and Orthopedic Surgery Specialists, Ltd. v. Avera St. Luke’s, Supreme Court of South Dakota 2001 S.D., Lexis 9 (10 January 2001). Our analysis is based on the limited amount of relevant data on outpatient surgery that was produced during pretrial fact discovery in these cases.
3. St. Luke’s equity ownership is divided between these North Oaks physicians and outside medical industry corporations.
4. The data file identifies which physicians performed which surgeries, allowing us to segregate the eighteen physician-investors from the noninvestor physicians.
5. John Mahan, M.D., et al. and Orthopedic Surgery Specialists, Ltd. v. Avera St. Luke’s, para. 34.
6. To elaborate, the argument is that overall volume in the outpatient surgery market rises when price in the market falls and that that increase in total market volume offsets the incremental volume that the ASC takes from the hospital.
7. A practice that is called "revenue management" by its proponents and "cream-skimming" by its critics.
8. For one, the hospital loses all of the referrals from these physicians for those services that the hospital offers but the physician-owned ASC does not. For another, it is not uncommon for physicians to bring lawsuits opposing the loss of their privileges on diverse legal grounds that include but are not limited to antitrust and contract.
9. This is not the only or even the principal general economic benefit of hospitals’ exclusive contracts with health plans, but it is a consequence of such contracts nevertheless.
10. Specifically, we estimated a regression of the logarithm of the sum of Exhibit 1’s total monthly outpatient surgeries on (1) a time trend variable and (2) a binary (1,0) variable for the ASC post-entry time period. That analysis yields a coefficient estimate for the ASC effect of .0932 (with a statistical significance level of p = 0238) and an adjusted R-square of .8449.
11. See F.H. Easterbrook, "Vertical Arrangements and the Rule of Reason," Antitrust Law Journal 53, no. 1 (1984): 135–173.
12. "One difficulty [with the output expansion criterion] is the implicit assumption that consumer choices are, at least on average, informed. But if the reason that a practice is challenged is that it may be deceptive, then this underlying assumption may require further investigation."; W.J. Lynk, "Establishing Competitive Effects in Markets for Medical Services," in Developments in Antitrust Health Care Law, ed. P.A. Proger, R.C. Busey, and T. Miller (Chicago: American Bar Association, 1990), 211–225, at 216 (footnote omitted).
13. See B.J. Hillman et al., "Frequency and Costs of Diagnostic Imaging in Office Practice—A Comparison of Self-Referring and Radiologist-Referring Physicians," New England Journal of Medicine (6 December 1990): 1604–1608; and J.M. Mitchell, "Physician Joint Ventures and Self-Referral: An Empirical Perspective," in Conflicts of Interest in Clinical Practice and Research, ed. R.G. Spece, D.S. Shimm, and A.E. Buchanan (New York: Oxford University Press, 1996), 300–317.
14. For just one example, even an elementary reflection on the diversity of physicians’ clinical practices suggests that physicians who are uncommonly enthusiastic about the merits of diagnostic imaging or outpatient surgery might be both heavy users of those procedures and more likely to invest in facilities to perform them.

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