Why Baby Costs Less Down the Road in Silicon Valley

After Mark Logsdon tore a ligament in his knee skiing at Lake Tahoe in March, he returned home to suburban Sacramento and had an MRI scan at Sutter Davis Hospital.

Sutter’s price for the knee scan was $1,271, payable by Logsdon and his insurer. Exactly the same MRI at one of the local imaging centers owned by Radiological Associates of Sacramento would have cost $696 -- 45 percent less.

It turns out that Logsdon didn’t know something that his insurance company does: Sutter Health Co., the nonprofit that owns Sutter Davis, has market power that commands prices 40 to 70 percent higher than its rivals per typical procedure -- and pacts with insurers that keep those prices secret.

Sutter can charge these prices because it has acquired more than a third of the market in the San Francisco-to-Sacramento region through more than 20 hospital takeovers in the last 30 years, according to executives of Aetna Inc., Health Net Inc. and Blue Shield of California, who asked not to be named because their agreements with Sutter ban disclosure of prices.

Sutter operates in a competitive market, Chief Executive Officer Patrick Fry, 53, said in an interview. “I don’t see Sutter Health as having market power, given the choices that employers can make,” Fry said. “The market has a lot of room to make a lot of decisions.”

Photographer: Ken James/Bloomberg

Sutter General Hospital's main entrance in Sacramento, California. Close

Sutter General Hospital's main entrance in Sacramento, California.

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Photographer: Ken James/Bloomberg

Sutter General Hospital's main entrance in Sacramento, California.

‘Enforcement Pendulum’

The pricing power of local hospital systems has received scant attention in the search for answers to the nation’s rising medical costs, according to Alain Enthoven, an economist at Stanford University. In 2009, as consumer prices fell for the first time in 54 years, the U.S. health care bill rose by 5.7 percent to $2.47 trillion, a record 17.3 percent of the economy.

“Provider consolidation is driving up health care costs,” said Enthoven. “We need effective antitrust enforcement, and we haven’t had that for some time.”

That’s changing, said Matt Reilly, assistant director of the Federal Trade Commission’s competition bureau. Federal investigators in five states -- Connecticut, Massachusetts, Ohio, Pennsylvania and New Hampshire -- are probing proposed hospital takeovers or contracting practices for evidence of antitrust problems. Sutter spokesman William Gleeson said it knows of no federal or state antitrust investigations into its conduct.

“The enforcement pendulum has now swung back to where it should be,” said Reilly. “We feel growing confidence we’ve got the analysis right.”

‘Coercive Tactics’

After losing court battles against takeovers in prior years, the FTC in April helped shelve a Maine hospital group’s plans to merge the two biggest cardiology practices in the state. In June, it obtained a settlement order barring 25 hospitals and 70 doctors it had accused of collusion in Minnesota from using “coercive tactics” to extract higher rates from health insurers -- and by extension, higher premiums from employee plans and consumers.

The FTC is investigating Dartmouth-Hitchcock Medical Center’s proposed takeover of Catholic Medical Center in Manchester, New Hampshire; Hartford Healthcare Corp.’s plan to acquire Central Connecticut Health Alliance; and ProMedica Health System’s pending merger with St. Luke’s hospital in Maumee, Ohio, spokesmen for Dartmouth-Hitchcock, Central Connecticut and ProMedica said. Reilly declined to comment on specific investigations.

‘Cautionary Tale’

The U.S. has 5,800 hospitals, divided about evenly between nonprofits and for-profits. Nearly 3,000 of them changed owners from 1994 through 2009, according to Irving Levin Associates Inc., an investment research company in Norwalk, Connecticut. Most were rolled into regional chains like Sutter.

The federal Patient Protection and Affordable Care Act is looking for $500 billion in savings over the next decade to help pay for extending coverage to 32 million uninsured Americans. Yet it doesn’t address the problem of market concentration -- and may make it worse, said Robert Berenson, a physician and policy analyst at the Urban Institute in Washington D.C.

The “unchecked” clout of hospital and physician groups in California is a “cautionary tale for national health reform,” Berenson said in a February article in the journal Health Affairs. He warned that incentives in the new legislation to improve treatment by promoting doctor-hospital alliances -- called “accountable care organizations” -- could backfire by strengthening providers’ bargaining leverage.

‘A Textbook Case’

Higher prices stemming from hospital mergers that took place between 1997 and 2006 alone add $12 billion to annual health care costs, according to a study last year by Cory Capps, a former U.S Department of Justice economist. Capps, now a consultant, estimated that the ability of powerful hospitals to stimulate usage and the merging of doctors’ groups might be adding another $6 billion to $10 billion.

Cost never occurred to Logsdon, the Sacramento doctor who wrecked his knee skiing. He said he was “shocked” to discover afterward that the MRI cost nearly twice as much at Sutter Davis as it would have at Radiological Associates. The chairman of Radiological Associates’ oncology division, Logsdon went to Sutter Davis for convenience, he said.

“I guess I’m a textbook case of why policy makers say they need to make patients feel the cost of these things,” he said.

Sutter, as it grew by takeover, shaped a strategy geared toward raising prices and making itself “indispensable” to insurance plans, internal Sutter documents show.

10 Million People

Operating as a nonprofit, it has $8.8 billion in revenues, 24 hospitals, 17 outpatient surgery clinics and a 3,500-doctor network, making it the largest health-care provider in an 11- county region -- from San Francisco Bay to the Sierra Nevada mountains -- where 10 million people live.

Sutter has 35 percent of the revenue and 36 percent of beds that compete for patients in the region, according to a state hospital database, including 100 percent of beds the state tracks in Placer and Amador counties east of Sacramento. (The state tallies, based on 2008 hospital discharge data, exclude insurer/provider Kaiser Permanente, whose hospitals are only available to plan members.)

“They are able to dictate terms,” said Jeff Emerson, head of managed care for Aetna, the nation’s third-largest health insurer.  “Sutter says to all of its payers -- to the best of our knowledge -- ‘These are the terms by which you will deal with Sutter. Take it or leave it.’”

$4,700 CT Scan

“Instead of leveraging its system to be more cost- effective, we’ve seen Sutter leveraging its system for monopoly pricing,” said Peter V. Lee, who in June became director of health-care delivery system reform for the U.S. Department of Health and Human Services. Lee was interviewed while he worked at the Pacific Business Group on Health, a coalition that includes Chevron Corp., Walt Disney Co., General Electric Co., and Wells Fargo & Co.

In San Francisco, Aetna pays Sutter’s California Pacific Medical Center in a range with a midpoint of $4,700 for an abdominal CT scan, compared to $3,200 at St. Francis Memorial Hospital, owned by Catholic Health Care West. For colonoscopies, Aetna’s midpoint price is $3,200 at Sutter’s flagship CPMC and $2,800 at St. Francis Memorial.

In Palo Alto, Aetna pays Sutter $349 per visit for new patients to see Manju Deshpande, a family doctor in Sutter’s Palo Alto Medical Foundation clinic. Three miles away, Paul Ford’s Stanford Medical Group receives $222. If the patient needs an immunization, Aetna pays Palo Alto Medical $85, and Stanford Medical, $16. Deshpande removes wax from the ear for $175. Ford scoops it out for $104.

Top Quality Rating

Down the road in Silicon Valley, when obstetrician Sarah Azad, a solo practitioner, delivers a baby for a patient covered by Aetna, the insurer pays her $2,052. When Nicole Wilcox of Sutter’s Palo Alto Medical Foundation does the same job, Aetna pays Sutter $5,890.

The doctors practice blocks apart in Mountain View, California. Performance isn’t an issue -- Azad has Aetna’s top rating for quality of care and trained Wilcox during residency.

Asked to explain the price difference, Cecilia Montalvo, a Palo Alto Medical Foundation vice president, said it offers state-of-the-art equipment and record-keeping “that can make the health care experience and the outcome of care superior for patients” and requires higher costs than a solo practice.

The prices came from an Aetna plan members’ website. For Sutter hospitals, the prices were posted between mid-May and mid-June before they were removed. After that, the site responded to inquiries about Sutter prices with the message “Facility does not permit Aetna to disclose fees.”

Doesn’t Disclose Prices

While Sutter may have higher “unit” prices than its competitors, Fry said, it is not the most costly for patients over the long run because its integration of hospitals and doctor groups allows it to provide more efficient care, cutting down on the number of procedures.

“Our mission isn’t to maximize profits,” Fry added. “Our mission, to the extent we can, is to optimize services.” Insurers and patients have many alternatives to Sutter, according to Fry.

Sutter doesn’t allow its prices to be disclosed on insurers’ websites because it believes the information is often misleading and doesn’t reflect the variables of each patient’s case, Gleeson said.

Antitrust Authorities

Federal antitrust authorities are moving against suspected anticompetitive mergers and contracting among health-care providers. In Massachusetts, the U.S. Department of Justice is investigating Partners Healthcare to see whether it imposed anticompetitive terms in contracts with insurers, according to people familiar with the matter. Massachusetts General and Brigham & Women’s hospitals, owned by Partners, were tied as the two most expensive of 59 hospitals in the state in 2008, according to data submitted by Blue Cross Blue Shield of Massachusetts to the state attorney general.

The insurer said Mass General’s and Brigham’s prices were 66 percent higher than Boston Medical Center, 30 percent more than Caritas St. Elizabeth’s and 20 percent more than Beth Israel Deaconess, three of its biggest Boston competitors. Partners is cooperating fully with the Justice Department, spokesman Lee Chelminiak said.

The Justice Department has also been investigating University of Pittsburgh Medical Center, the biggest hospital group in the city. A UPMC statement said it was cooperating with the Justice Department, which it said was looking into “any potentially anticompetitive agreements.”

‘Methodology So Flawed’

UPMC’s Presbyterian and Shadyside hospitals received an average of $35,000 for coronary bypass surgeries in 2005, compared to average payments of $24,000 at Allegheny General Hospital and $18,000 at Jefferson Regional Medical Center, according to a study by the Pennsylvania Health Care Cost Containment Council, a state agency.

”When you see the difference between the payments, the question employers ask is, ‘What am I getting for the dollars I’m spending?’” said Christine Whipple, executive director of a coalition of health-care plan sponsors including Alcoa Inc., H.J. Heinz Co. and Westinghouse Electric Co. UPMC spokesman Paul Wood said that the state’s study was based on “methodology so flawed that the results were meaningless.”

In 2008, the FTC stopped Inova Health System Foundation of Falls Church, Virginia, from acquiring nearby Prince William Health System, saying the deal would have driven up prices and boosted Inova’s share of beds in three counties to 73 percent.

Capital-Spending Plans

Inova’s prices already often surpass rivals, according to the Aetna website. For a conventional birth, Aetna pays Inova Fairfax Hospital a range of prices whose midpoint is $6,750, 32 percent more than the $5,100 midpoint at Virginia Hospital Center in nearby Arlington. The Aetna midpoint price for abdominal CT scans without contrast dye at Inova Fairfax is $2,300, twice the $1,150 at Virginia Hospital Center.

“Inova owns Northern Virginia,” said Berenson of the Urban Institute, who questioned why nonprofit Inova needs the $2.3 billion cash and investment portfolio it reported at the end of 2009. “What’s the rainy day they’re waiting for?”

Inova needs the cache to support its capital-spending plans in the next five years, according to Richard Magenheimer, Inova’s chief financial officer. He called Inova’s prices “consistent” with competitors’ rates.

Fractured Clavicle

In classic economic theory, big price gaps for the same service are narrowed by competition as customers choose the low- cost provider, forcing high-priced suppliers to come down. In the U.S., which spends more on health care than any other country, Sutter and other dominant local providers demonstrate why the theory fails to work.

As Sutter’s confidentiality terms show, the actual prices that hospitals receive are often kept secret by insurers. Patients in need of hospital care, especially in emergencies, often can’t travel very far, restricting competition. And if they have health insurance, they have little incentive to price shop.

When Timothy Sowerby took his nine-year-old daughter Catherine to Sutter’s Novato Community Hospital north of San Francisco last summer, the child was in pain from a fractured clavicle. It didn’t occur to Sowerby that her emergency-room x- ray, covered at $319, according to the explanation of benefits provided by insurer UnitedHealth Group Inc., would cost just $85 at Radnet Inc.’s imaging center in nearby Santa Rosa.

The comparison isn’t “apples to apples” because hospitals have staffing and charity commitments that imaging centers don’t have, Sutter’s Gleeson said.

73 Percent Higher

Sutter, with 48,000 employees, was among the most profitable hospital groups in the U.S. in 2009, with income of $697 million, up more than three-fold from 2008 due to large investment gains, on revenue that grew 6 percent to $8.8 billion.

Its 5.2 percent operating margin -- or operating income as a percentage of revenue -- was 73 percent higher than the median for all nonprofit hospital systems in 2009, according to Standard & Poor’s.

As of Dec. 31, Sutter had a $2.63 billion investment portfolio. Sutter paid Fry $2.8 million in 2008, according to its latest Internal Revenue Service filing. His top 14 lieutenants made between $830,000 and $1.8 million each.

In an interview, Fry said Sutter is aiming for a 5.5 percent operating margin to fund new technology, charity care and renovations to meet earthquake building codes.

Adding Hospitals

Named for the Swiss immigrant who owned the mill where the California Gold Rush began, Sutter was founded as a single hospital in Sacramento after the 1918 flu epidemic. It later added a maternity hospital in the city and stayed close to home until 1980, when then-CEO Patrick Hays began a takeover spree. The original idea was to use Sutter’s tax-free borrowing power to raise the capital needed to rescue ailing community hospitals. David Cox, Sutter’s CFO from 1982 to 1996, said Hays understood that having geographic reach and tie-ups with physician groups would give Sutter more patients and bargaining power on pricing with managed-care plans looking to cut costs.

“At some point along the way after Hays left, the attitude shifted from providing good value to communities, and charging reasonable rates, to using market leverage to obtain the maximum revenue possible,” Cox said.

‘Take No Prisoners’

At Hays’s departure in 1994 to become president of Blue Cross Blue Shield Association, Sutter had 14 hospitals. Two years later, Sutter doubled its bed count under CEO Van Johnson, with the takeover of four hospitals in and around San Francisco. The system subsequently added more.

Its rapid rise hit a snag in 1999, when California’s attorney general sued to block a proposed takeover of Summit Hospital, in Oakland. The state argued that Sutter owned another large hospital in neighboring Berkeley, and that acquiring Summit would raise prices and stifle competition.

In an internal Sutter memo produced in the ensuing federal trial, Robert Montgomery, the company’s head of Bay Area operations, suggested Sutter should “hire a very aggressive negotiator and take no prisoners” on pricing if it obtained enough market share. Attaining a 25 to 30 percent share in its service areas would make Sutter “indispensable” to health plans and “assure us price stability,” Sutter strategists said in another document that was part of the trial evidence. Sutter’s 1997 acquisition of Eden Medical Center in Oakland’s suburbs was described in advance of that merger as a way to “protect our market from a takeover that could develop competing physician networks.”

Judge Ruled Against

Blue Cross projected that its prices at Summit would rise about 30 percent following the merger. Fry, then a Sutter regional head on the witness stand, projected Summit’s revenue would rise just 3 percent annually post-merger.

The judge ruled against the attorney general in the 1999 case, and said Summit would have plenty of competition from hospitals outside Oakland and Berkeley. In fact, Summit’s prices rose 29 to 72 percent -- representing a range of increases for different insurers -- in the two years after the merger, according to a 2008 FTC staff study of the takeover. Summit’s revenue rose 15 percent, according to the state database, far exceeding Fry’s forecast at trial.

25,000 Emergencies

The “prices were negotiated with the health plans, and the health plans had alternatives,” said Sutter’s Gleeson. He said Sutter lost $45 million on Summit in 2000 and 2001 before turning it profitable in 2002 and saved a failing entity. “Oakland is substantially better off today by having a high- quality hospital than if the hospital had closed,” said Fry, who succeeded Johnson in 2005.

Eden continues to figure into Sutter’s battles with health- care overseers. Sutter announced last year that it is closing Eden’s San Leandro Hospital campus, near Oakland’s southern border, due to San Leandro’s losses. State records show Eden earned $19 million in 2008, the last year available. Eden doesn’t report financial information for individual hospitals.

San Leandro’s emergency room, which handles about 25,000 cases a year -- 59 percent of them level-three or above in a five-level severity index -- is critical to public safety, local doctors and community activists argue. Sutter can afford to absorb San Leandro’s losses as part of its nonprofit mission, these critics contend.

Coordinating Services

“You just can’t close something that serves 25,000 people and expect nothing will go wrong,” said Alex Briscoe, director of health for Alameda County, where San Leandro is are located “The impact could cost some lives.”

Sutter has agreed to let Alameda County use the San Leandro site as a rehabilitation center and clinic, though not as an acute-care hospital with emergency-room and other services that would compete with nearby Sutter facilities. When for- profit Prime Healthcare Services of Ontario, California, offered to lease the San Leandro facility and invest $20 million to maintain it as a full-service hospital, Sutter sent Prime Healthcare a letter threatening legal action for what it said was interference with its business affairs.

“Sutter has this deliberate approach of pushing out the competition,” said Miles Adler, a gastroenterologist who was chief of the medical staff at Eden and San Leandro from 2006 through 2008. “They want to tie up the marketplace here.”

‘Over a Barrel’

Residents of Alameda County need an acute-rehabilitation facility more than they do a hospital in San Leandro, Fry said. He described the facility’s conversion as part of Sutter’s plan to coordinate services geographically for greater system efficiency.

Last November, Claire Zvanski, a San Francisco parking administrator and commissioner of the city-employees’ health insurance fund, proposed dropping Sutter hospitals from the plan offered to the city’s 110,000 workers. Zvanski said she hoped dumping Sutter would cut costs and curb an expected rate increase from Blue Shield. Her proposal stirred heated protest from plan members at commission meetings, who said they would have to drive 30 miles to find a non-Sutter hospital. Under pressure, Zvanski tabled the idea.

On July 1, the city, to cover rising costs, raised health- care contributions from employees by 13 percent -- to $6,552 a year for a firefighter with two or more dependents. It doubled co-payments to $100 for emergency-room and outpatient services and $200 for hospital stays.

“Sutter really has us over a barrel, I hate to admit it,” said Larry Barsetti, a retired police lieutenant who supported Zvanski’s proposal. His premiums went up $100 on July 1, to $10,188 a year -- more than double what he paid upon retiring in 2003. “We’re getting gouged,” Barsetti said.

Sutter has held price increases to single digits in recent years, Gleeson said. “Still,” he added, “we know we have a responsibility to make sure our services are affordable and we’re working to do so.”

To contact the reporter responsible for this story: Peter Waldman in San Francisco at pwaldman@bloomberg.net

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