The healthcare industry is currently in the midst of perhaps its most active period for dealmaking in history. The last two years have seen a dramatic rise in consolidations and collaborations among hospitals and other healthcare providers, fueled by a combination of increasing costs and new reimbursement policies that encourage quality and efficiency. Joining into larger groups through mergers, strategic alliances, joint ventures and other tie-ups affords providers the opportunity to achieve greater economies of scale and increase bargaining power with payers and suppliers, and no provider wants to be left behind. At the same time, government scrutiny of arrangements among providers is increasing, and raises the specter of substantial costs and penalties for those combinations that are deemed unlawful, either for antitrust reasons or for violations of healthcare fraud and abuse guidelines.

As government-funded reimbursement programs grow increasingly constrained, health providers are feeling intense pressure to cut costs and improve outcomes. Smaller and less well-capitalized providers are experiencing significant financial stress. For many, the choice is to join a larger organization, or die. For the rest, it is a question of how they will replace lost revenues and keep up with the escalating costs of operations.

And it’s not just that the amount of reimbursement is tightening. The very manner in which providers are reimbursed for their services is changing profoundly. Government payment programs such as Medicare and Medicaid, as well as health insurance companies, are shifting away from traditional fee-for-service models that encourage volume of procedures rather than quality of care and efficiency. Bundled payments, capitation agreements, and other incentive-based arrangements that promote and reward lower cost, better outcomes, and greater accountability are becoming more prevalent. National health reform is shifting the care paradigm toward preventive medicine that keeps patients out of the hospital and moves more procedures to outpatient settings. Under these new regimes, providers with above-average quality and cost control metrics will be rewarded, while below-average performers will see cuts in their reimbursement. By joining together in larger organizations, providers will be better able to develop the sophisticated systems and experience data to measure quality and outcomes, and to share best practices.

Even the largest healthcare companies are scrambling to position themselves for the new order. This past May DaVita Inc., one of the world’s largest providers of dialysis services, announced its plan to acquire Healthcare Partners, the nation’s largest operator of medical groups, for $4.42 billion in cash and stock. Similarly, UnitedHealth Group, the biggest health insurer in the U.S., has completed a number of physician group acquisitions, including Monarch HealthCare, the largest medical group in Orange County, CA. In all of these transactions, the companies have cited the need to integrate patient care in response to changes in reimbursement.

Perhaps the most visible government policy development regarding healthcare consolidations is the creation of the Medicare Shared Savings Program under the Patient Protection and Affordable Care Act, which rewards Accountable Care Organizations that lower their growth in healthcare costs while meeting performance standards on quality of care. An ACO, which is a group of providers and suppliers of services working together to coordinate care for the Medicare beneficiaries they serve, will be eligible to receive a share of the amount by which its Medicare expenditures are below its own specific expenditure benchmark, provided the ACO meets the program’s quality performance standards.

The pace of regulatory change within the industry is also accelerating, adding further fuel to the consolidation fire. New regulations under the Affordable Care Act are just starting to be issued, and many more are on the way. The resulting regulatory uncertainty and costs of compliance with these changes are more good reason for providers to join larger organizations, as the overall risk of being a healthcare company seems to be increasing.

All of these trends are driving providers to form larger systems that will be able to compete more effectively, spread costs over a larger revenue base, and find easier access to capital. But while market factors and government policies are propelling health companies to join together, the government at the same time is holding up its other regulatory hand and saying, “Not so fast.” In October 2011, on the same day that CMS issued its final ACO regulations, the Department of Justice Antitrust Division and Federal Trade Commission issued a joint Statement of Antitrust Policy Regarding Accountable Care Organizations Participating in the Medicare Shared Services Program. The Statement reminds those contemplating the formation of an ACO that the two agencies intend to continue to protect competition in markets served by ACOs, and that they “will vigilantly monitor complaints about an ACO’s formation or conduct and take whatever enforcement action may be appropriate.” The Statement also provides for an expedited 90-day review process by which newly formed ACOs can receive advance guidance as to the antitrust implications of the arrangement.

Plainly, although the government’s health reform policies are encouraging providers to collaborate, the antitrust enforcement agencies are going to be paying special attention to industry combinations that have the potential to reduce competition and increase prices. State attorneys general are also paying close attention, as demonstrated by the broad investigation recently launched by California Attorney General Kamala D. Harris into whether the proliferation of transactions in which hospitals are acquiring physician practice groups is driving up healthcare costs in that state.

In addition to antitrust issues, collaborations among healthcare providers will inevitably raise concerns regarding the applicability of anti-kickback, Stark, and other fraud and abuse laws that are intended to prevent improper economic arrangements between providers and referral sources. While ACOs that participate in the Medicare Shared Savings program will be granted limited waivers from some aspects of these laws, the bulk of the fraud and abuse laws continue to apply to most types of health provider collaborations. As a result, transactions designed for the new models of clinical coordination are still being tested against regulatory standards that were developed for the old fee for service healthcare payment systems.

Traditionally, any collaborative arrangement between healthcare providers was viewed with suspicion. Now, as health reform progresses, long-held beliefs about competition, collaboration and roles within the healthcare marketplace are being challenged. Healthcare companies that wish to stay in business must not only figure out how to control costs, but also find ways to benefit from the changes that are sweeping the industry. It can be expected that regulatory policy will catch up to some of these trends and evolve as well. However, combinations that lessen competition and create incentives for abuse will continue to be aggressively challenged by federal and state authorities.

While there are strong imperatives driving transactions among healthcare providers – from outright mergers to collaborative agreements – those considering such arrangements must proceed with close attention to the regulatory issues surrounding these deals. Parties must be sure to define the specific benefits of the transaction, both as to quality of care and competition in the relevant market. Expending the time and resources in advance of the transaction for a thorough investigation of the potential competitive effects, as well as the potential improvements in controlling costs and enhancing patient care, will be well worthwhile if regulators later challenge the arrangement.

Note: Michael Blass, managing partner of the New York office of Arent Fox, is a partner in the firm’s national health care practice, focusing on corporate transactions and regulatory matters for health care providers. He can be reached at blass.michael@arentfox.com.

This article was reproduced in The Deal Pipeline on October 5, 2012