FTC Staff Comment Before the Maryland Health Resources Planning Commission Concerning Certificate of Need Laws

I. .
• •11.
FEDERAL TRADE COMMISSION
WASHINGTON. D. C. 20580
BUREAU O~ ECONOMICS
Ms. San Cheang
Maryland Health Resources Planning Commission
20) West Preston Street, 1st Floor
Baltimore, Maryland 21:0 I
Dear Ms. Cheang:
;~iMMfSStPN AUTHORiifr.,
•
August 6, 1987
(
The 	Staff 	of 	the 	Federal 	Trade 	Commission 	(FTC)l 	is 	pleased 	to
respond 	to 	your 	request 	for 	comments 	on 	the 	draft 	Ambulatory 	Surgical
Services Section of the Maryland State Health Plan. 	That dr:;ft section sets
forth 	your 	proposed 	policy respecting the application of Certificate-of-Need
(CON) 	regulations 	to 	proposals 	for 	the 	construction 	and 	expansion 	of
ambulatory surgical 	centers in 	hospitals and 	in 	freestanding 	facilities. 	For
the reasons discussed below, we believe that CON regulations are, in general,
unnecessary 	in' Maryland, 	and 	that 	they 	are 	particularly 	unnecessary 	for
ambulatory surgery facilities. 	We also believe that certain specific features
of' the 	Plan 	may 	impede 	adjustments 	to 	changing 	market 	conditions 	and
discourage 	the establishment of freestanding ambulatory surgical 	units even
when 	they 	may 	be 	more 	efficient 	than 	hospital 	ambulatory 	surgery. 	For
these 	reasons, 	we 	believe 	that 	the 	proposals are 	likely 	to 	raise 	the 	overo.ll
costs 	of 	arnbulat6ry 	surgery, 	reduce 	competition 	in 	the 	market 	for 	health
services, and harm consumers .
.,' 	OUf comments 	first 	address 	the 	justification 	for 	and 	effects of 	co~
regulations in general.:! 	We then examine the specific justification for CO>J
regulation 	of 	ambulatory 	.surgical 	services, 	and 	follow 	this 	with 	an
examination 	of 	particular 	regulations 	suggested 	in 	the 	draft 	Plan. 	In
general, 	we 	conclude 	that 	you 	should 	rely 	on 	the 	market 	to 	the 	extent
possible.
1. Interest and Experience of the Federal Trade Commission
For 	more 	than a 	decade, the 	FTC has engaged 	in 	extensive efforts to
preserve and 	promote competition in health care markets. 	The FTC and 	its
staff ha\'e been active both in antitrust law enforcement (including litigated
1 These 	comments 	represent 	views 	of 	the 	Bureaus 	of 	Competition.
Consumer Protection, and 	Economics of the 	Federal Trade Commission, and
do 	not 	necessarily 	represent 	the 	views 	of 	the 	Commission 	Or 	of 	any
individual Commissio,er. 	The Commission has. however, voted to authorize
the submission of these comments.
2 We 	recognize 	that 	the 	Maryland 	Health 	Resources 	Planning
Commission is not 	in 	a 	position 	to repeal CON 	laws. 	We 	believe. however,
that discussion 	of 	the 	purpose and 	effects of CON 	regulations 	is necessary
for the efficient implementation of specific proposals.

< '
staff have been active both in antitrust law enforcement (including litigated
cases 	and 	non-public 	in v estigations)3 	and 	in 	commenting 	on 	regulatory
reforms,· 	recognizing 	that 	competition 	in 	health 	care 	service 	markets, 	like
other 	markets, 	will 	generally 	benefit 	consumers 	by 	strengthening 	the
incentives for 	providers 	to satisfy consumer demands. 	As a 	result of FTC
antitrust 	enforcement .. efforts, 	as 	well 	as 	economic 	analysis 	of 	CO:-J
regulation,S 	the 	FTC 	staff 	has 	gained 	considerable 	experience 	with 	the
economics of health care competition, and with the manner in which health
planning 	regulation 	affects that competition. 	Indeed, a 	significant part of
the 	FTC's 	antitrust 	la w 	enforcement 	effort 	in 	the 	health 	care 	field 	is
devoted 	to 	competitive 	problems 	that 	would 	not 	exist, 	or 	would 	be 	less
severe, if there were no CON regulation,6
II. 	CON 	Regulatiun 	Is 	Unnecessary 	To 	Constrain 	Health 	Care 	Costs, 	and
Repeal of CON Laws Will Promote Competition and Benefit Consumers
CON regulation of health care providers has traditionally been based on
the 	theory 	that 	un;cgulated 	competition 	would 	result 	in 	the 	unnecessary
construction 	or 	exp:l nsion 	of 	facilities. 	or 	in 	other 	unnecessary 	capital
expenditures. 	The 	assumption 	underlying' this 	theory 	is 	that 	health 	care
providers 	have 	an 	inherent 	tendency 	to 	expand 	or 	purchase 	equipment
urrnecessarily. 	It 	is 	thought 	that 	this 	alleged 	tendency 	is 	not 	sufficiently
constrained by market forces because ins\Jred patients are covered by policies
that 	require 	little 	or 	no 	out-of-pocket 	payment. 	thereby 	making 	them
insensitive to the price of medical services. 	Moreover, health care providers
are 	often 	reimbursed 	by 	third-party 	pavers 	on 	a 	retrospective 	cost 	basis.
which reduces their incentive to contain c~sts.
As 	a 	result 	of 	these 	forces. 	competition 	among 	hea Ith 	care 	providers
traditionally 	may 	have 	taken 	place 	in 	terms 	of 	quality 	rather 	than 	price,
although some price competition has existed. 1 	Providers had an incentive to
offer wider ranges of diagnostic and therapeutic services and equipment, and
more 	comfortable 	facilities, 	to 	attract 	additional 	patients 	and 	physicians,
3 ill, ~.g., Hospital Corp. of America, 106 F.T.C. 361 	(1985), aff'd 807
F.2d 	1381 	(7th 	Cir. 	1986), 	cer!. 	denied, 	107 	S.Ct. 	1975 	(1987); 	American
Medical Int'l, Inc., 10.. F.T.C. I (1984).
t
.( See, 	~.g., 	FTC 	staff 	letter 	to 	Mr. 	Giri 	Vuppala, 	Health 	Systems
Agency 	of 	New 	York 	City, 	February 	9, 	1987; 	FTC 	st3ff 	letters 	to
Congresswoman 	Mary 	George, 	Hawaii 	State 	Sen3te 	and 	Congressman 	Fred
Hemmings, Hawaii State House of Representatives, March 13. 1987.
5 See, ~.g., K. Anderson and' D. Kass. Certificate of
Entry 	Into 	Home 	Health 	Care 	(FTC 	Staff 	Report,
Competition Among Hospitals (FTC Staff Report, 1987).
Need Regulation of
1986); 	M. 	Noether.
6 See Hospital Corp. of America. supra. 106 F.T.C. at 489.
1 See IQ., at 478-79. 	But see also Noether, supra. at 81-88, who found
that there was some price competition among hospitals even in 1977-78.
2

,.
I
even if the new facilities were underutilized. 	The initial concern expressed
by 	health 	planners 	was 	that 	the 	expenditures 	on 	these 	facilities 	would 	be
passed along to consumers, thereby increasing overall health care costs. 	The
purpose 	of 	CON 	regulation 	was 	not 	to 	assure 	that 	facilities 	were 	placed
where 	needed; 	rather, 	it 	was 	to 	control 	the 	perceived 	tendency 	to 	provide
duplicative facilities or services. 8
As 	a 	result 	of 	significant 	changes 	in 	health 	care 	markets 	in 	recent
years, however, many of the assumptions that may have supported arguments
in 	favor 	of CON 	regulation are 	no 	longer 	valid.9 	There has been a 	trend
toward 	increased 	competition, 	particularly 	price competition, 	among 	health
care 	providers. lO 	Third-party 	payers 	and 	consumers 	now 	are 	clearly 	not
insensitive to the prices of health care services. 	Conventional health benefit
programs now generally provide subscribers with financial incentives (such as
co-payments) 	to 	patronize 	low-cost 	providers, 	including 	non-hospital
providers. l1 	In 	addition. 	health 	maintenance 	organizations 	and 	preferred
provider 	organizations 	are 	well-positioned 	to 	channel 	subscribers 	to 	health
care 	providers offering lower rales. 	Moreover. the recent trend toward 	use
of 	prospective 	payments. 	such 	as 	reimbursement 	by 	Medicare 	based 	on
diagnostic 	related 	groups 	rather 	than 	individual 	hospitals' 	actual 	costs, 	has
required 	health 	care 	providers 	to 	become 	more 	cost 	conscious, 	since 	some
costs 	are 	no 	longer 	reimbursable. 	All 	these changes appear 	likely to deter
h.ealth 	care 	providers 	from 	creating 	excess capacity 	and 	making 	long 	term
capital investments whose financial fea.stbility depends on the ability to shift
costs to third-party payers. 12
An additional reason for concern over CON regubtions is provided by
empirical 	evidence 	suggesting 	that 	such 	laws 	have 	not 	had 	the 	intended
effect 	of 	controlling 	unnecessary 	health 	care 	expenditures. 	Early 	studies
" 8 See P. Joskow, Controlling Hospital Costs: 	The Role of Government
Regulation (1981).
9 Indeed, 	the 	United 	States 	Congress 	recently 	repealed 	the 	National
Health Planning and Resources Development Act of 1974. which had provided
incentives and 	penalties to encourage states to enact CON 	regulations. 	See
P.L. 99-660, sec 701 (1986).
, 	10 See, 	~.g., Hospital 	Corp. 	of 	America, 	supra, 	106 	F.T.C. 	at 	480-82;
Hospital 	Industrv 	Price 	Wars 	Heat 	UP. 	Hospitals. Oct. 	I, 	1985, at 69. 	See
Noether, lliI2ll., at 81-89.
11 See 	W.G. 	Manning, 	J.P. 	Newhouse, 	A. 	Liebowitz. 	N. 	Duan. 	LB.
Keeler, 	and 	M.S. 	Marquis, 	Health 	Insurance 	and 	the 	Demand 	for 	Medical
Care, 	77 	American 	Economic 	Review, (June 	1987). at 	267-8, and 	Insurance
CoVera2e Drives Consumer Pri:~s. Hospitals, Nov. I, 1985. at 91.
12 See 	Raske. 	Association 	Seeks 	Sound 	Capital 	Pay 	Polic\'. 	:-'1odern
Healthcare, Nov. 7, 1986, at 120.
3

found 	that 	CON 	regulation 	did 	not 	constrain 	overall 	health 	care 	costs.13
Rather, the CON regulatory process may ha ve caused some hospitals to make
substantial 	capital 	investments 	in 	areas 	not 	covered 	by 	CON 	controls. 14
Later studies reached similar conclusions, finding that the CON laws did not
affect 	costs 	per 	unit 	of 	hospital 	outpULlS 	A 	recent 	FTC 	Bureau 	of
Economics study examining hospitals during 1977-78 suggests that CON laws
have led to higher expenditures by hospitals.1 6 	Similarly, the FTC's Bureau
of 	Economics found 	in 	another study that CO~ regulation 	of 	home 	health
care agencies increases the cost of home health care to consumers. 17
Furthermore, 	there 	is 	evidence 	that 	CON 	regulation 	can 	raise 	health
care 	prices, whether 	or 	not 	it causes an 	increase 	in costS.1 8 	If 	the 	effect
of 	the 	regulation 	is 	to 	restrict the supply of health 	care services provided
by existing firms or new entrants, and particularly if it restricts innovative
suppliers, 	prices 	will 	be 	higher 	than 	they 	would 	be 	in 	an 	unregulated
competitive 	environmenL 19 	Although 	the 	CON 	process 	does 	not 	formally
prohibit entry or expansion, or the development of new services, it generally
places the burden on new entrants to demonstrate that a "need" is not being
served by those currently in the market. 	Even if an application is ultimately
approved, the process of preparing and defending a CON application is often
extremely costly and time consuming. 	Incumbent firms may not need to be
as sensitive to price or to consumer demand 	for 	new services 	if they know
thIlt it will be difficult and expensive for new firms to enter the market and
offer competitive prices or services.
13 Salkever .and Bice, Hospital Certificate-of-Need Controls: 	Impact on
Investment. 	Cost. 	and 	Use 	(1979); 	Salkever 	and 	Bice, 	The 	Impact 	of
Certificate-of-Need 	Controls 	on 	Hospital 	In~'estment, 54 	Milbank 	Memorial
. Fund Q. 185 (Spring 1976).
1,( Id. 	While 	hospitals 	kept 	down 	their 	investments 	in 	beds, 	total
hospital assets per bed were found to increase.
15 Policy Analysis, InC.-Urban Systems Engineering, Inc., Evaluation 	of
the Effects of Certificate of Need 	PrOQrams (1980). 	See also Steinwald and
Sloan, ReQulatorv Approaches to Hospital Cost Containment: 	A Synthesis of
the Empirical Evidence, in A New Approach to the Economics of Health Care
( 	(1981); Feldstein, Health Care Economics (1983), at 275-83.
16 ~ Noether, supra, at 82.
17 ~ Anderson and Kass, supra.
18 Posner, Certificate of ~eed for 	Health Care 	F:lcilities: A Dissenting
View, 	in 	Regulating 	Health 	Facility 	Construction 	113 	(c. 	Havighurst, 	ed.
1974). 	See also Feldstein, supra, at 278 and Noether, ill.Pl.2, at 82.
19 Where 	prices are 	regulated, 	the "price 	increase" 	may 	take 	the 	form
of reductions in service quality, so that consumers receive services of lesser
value 	for 	the 	same 	price, 	instead 	of 	paying 	2 	higher 	price 	for 	the 	same
services.

Finally, 	under 	some 	circumstances, 	CON 	regulation 	can 	faC'ilitate 	the
attainment of anticompetitive objectives 2o, including supracompetitive prices.
It 	has 	also 	been 	argued 	that 	competitors 	may 	misuse 	the 	CON 	regulatory
process for the purpose of excluding potential competitors from entering the
market. 21
Ill. CON Regulation of Ambulatory Surgical Care Is EspeciallY Unnecessarv
The 	usual 	justification 	for 	CON 	laws, 	the 	avoidance 	of 	duplicJtive
facilities 	and 	services, 	rests 	in 	part 	on 	assumptions 	that 	the 	provision 	of
new services entails large expenditures on equipment or facilities, 	and 	that
the 	market 	for 	those 	services 	is 	ch:lTacterized 	by 	a 	lack 	of 	price
competition. 	These 	assumptions, 	however, 	do 	not 	appear 	to 	apply 	to
ambulatory 	or 	outpatient 	surgery, 	or 	to 	freestanding 	ambulatory 	surgical
cent::rs (F ASCs).
The provision of ambulatory surgery services entails lower expenditures
on 	equipment 	than 	does 	inpatient 	surgery. 	Inputs 	with 	high 	fixed 	costs,
such 	as 	general 	anesthesia, 	are 	often 	unnecessary 	for 	ambulatory 	surgery.
The 	rapid 	growth of ambulatory surgery conducted 	in 	Physicians offices is
indicative 	of 	the 	small 	scale 	at 	which 	these services are 	often 	provided.:!2
One commentator has concluded that because the existing capacity of FASCs
d~es not exceed their use and that the costs of FASCs are not excessive for
the 	quality 	of 	services 	provided. 	He' 'concludes 	that 	"the 	reasons 	usually
given 	for 	CON 	legislation, such as excess capacity, are 	lacking in 	the case
of these substitute services."23
In 	the absence 	of CON 	regulations, the 	low 	fixed 	costs of starting an
ambulatory 	surgery 	unit 	could 	be 	expected 	to 	permit 	relatively 	easy 	entry
fjnto 	the 	market 	for 	ambulatory surgery services, thereby encouraging 	price
competition.z.4 	Furthermore, third-party payers, such as Blue Cross and Blue
Shield, 	have 	recently 	encouraged 	outpatient 	surgery 	to 	promote 	cost
20 Hospital Corp. of America, supra, at 497-98.
21 See, ~.g., St. Joseph's 	Hospital 	v. 	Hospital Corp. of 	America, 795 	F.
2d 	948, 959 (11 th 	Cir. 	1986) (defendants' 	misrepresentations 	to state 	health
( 	planning 	body 	concerning 	plaintiff's 	CON 	application 	not 	protected 	from
antitrust scrutiny). 	ill also, Hospital Corp. of America, supra, at 492.
22 See 	~.g., State 	Health 	Plan: 	Ambulatorv 	Surgical 	Services, 	draft,
section .0 I, B(2).
:!3 See Feldstein, supra, at 278.
24 	For 	discussion 	of 	low 	fixed 	costs 	and 	ease 	of 	entry 	in 	another
health CJre market, see Anderson and Kass, supra.
5

savings. 25 	The movement toward a prospective reimbursement orientation by
Maryland's Health Services Cost Review Commission with respect to hospital
ambulatory surgery, and by Medicare with respect to ambulatory surgery in
freestanding units, also encourages competition. 26
CON regulation of ambulatory surgery is, however, likely to discourage
its 	use as a substitute for 	inpatient surgery. 	While the express goal of 	the
draft State Health Plan is to encourage ambulatory surgery, CON regulations
tend 	to 	raise 	the 	price of 	medical 	services 	by 	limiting 	their 	availability.27
Higher prices will discourage the use of ambulatory surgery where it might
otherwise substitute for inpatient surgery, thus increasing overall health care
costs.
IV. Provisions in the State' Health Plan Are Likelv To Raise Overall Costs of
Ar1bulatorv Surgery
The 	speciiic 	policies 	set 	forth 	in 	the 	Plan 	are 	likely 	to 	raise 	the
overall 	costs 	of 	ambulatory 	surgery. 	In 	particular, 	the 	Plan 	discourages
certain 	types of ambulatory surgical facilities that may 	be of lower cost or
more 	appropriate 	in 	certain 	circumstances, and 	does 	not 	provide sufficient
fIexi.bility 	for 	adapting 	rapidly 	to the changes 	in 	technolosy 	and 	consumer
demand.
Policies in the Plan that encourage the growth of ambulatory surgery in
hospitals 	relative 	to 	FASCs 	are 	likely 	to 	increase 	the 	costs 	of 	ambulatory
surgery 	overall. 	,This 	inducement 	to 	hospitals 	occurs 	through 	the 	priority
given 	to 	projects 	that 	convert 	existing 	hospital 	opacity 	over 	projects
involving new construction (policy 2), and 	the 	priority given 	to ambulatory
surgery 	facilities 	that 	provide an 	array of 	procedures (policy 	7).28 	Giving
preference 	to 	hospital 	ambulatory 	surgical 	facilities 	over 	other 	types 	of
ambulatory surgical units may discourage the growth and entry of less costly
alterna ti ves.
Several 	studies 	indicate 	that 	FASCs 	have 	lower 	ambulatory 	surgery
25 	See, 	~.g., Consumer 	Exchange, 	Blue 	Cross 	and 	Blue 	Shield, 	March
( 1987, which discusses attempts to substitute ambulatory surgery in physician
offices for m:;ny procedures done in hospitals.
26 ill ~.£.. 52 Fed. Reg., at 20466; 52 Fed. ~., at :0623.
27 	~ 	Ermann 	and 	Gabel, 	The 	ChanginQ 	Face 	of 	American 	Health
~, Medical Care, J985, at 407. 	They report that CO:-.J regulation has been
one of the primary factors inhibiting growth of FASCs.
28 	Since 	hospitals 	generally 	have 	the 	equipment 	necessary 	to 	conduct
many 	types of surgery, 	it 	is expected 	that 	hospitals 	are 	more 	likely 	to 	be
able to provide an array of procedures than FASCs.
6

costs than do hospitals.2Q 	FASCs would be more appropriate. and lower cost
for some types of surgery (such as cases in which access to the wide range
of facilities and sophisticated equipment offered in hospitals is unnecessary).
Unless there are safety or other Quality justifications, it is important not to
favor one form of ambulatory surgical care over another, because doing so
may raise costs to consumers.
There are other 	reasons 	why 	F ASCs should 	not 	be 	discouraged 	from
providing 	ambulatOry 	surgery. 	While 	loss 	of 	patients 	to 	FASCs 	may
tempor:nily reduce 	hospitals' revenues. overall costs of 	health care 	will 	fall
if outpatient surgery is less costly. 	Competition from FASCs will reduce the
ability of hospitals to pass along costs of excess capacity to consumers and
will 	encourage 	hospitals 	to 	reduce 	excess 	capacity 	to 	the 	extent 	this 	is
possible. 	In this way. FASCs play an important role in promoting MHPRC's
goal 	of 	encouraging 	economical 	ambulatory 	surgery. 	We 	suggest 	that 	you
delete 	policies from 	the 	Plan 	that 	favor 	hospital ambulatory 	surgical 	units
over FASCs and rely on the market to a greater extent.
A 	final 	problem 	that 	arises 	in 	the 	draft 	Plan 	is 	the 	difficulty 	in
predicting the demand 	for ambulatOry surgery. 	As pointed out in the Plan,
ambulatory surgery is rapidly becoming more accessible due to improvements
in ,technology 	and 	greater 	acceptance 	by 	phY$icians. 	These 	trends 	are
difficult to predict and, in fact, the formulas for future projections tha tare
suggested in 	the Plan do not explicitly incorporate these factors. 	While the
Maryland Health Resources Planning Commission might provide inform:nion or
guidance 	on 	future 	trends, 	firms 	have 	incentives 	to 	gather 	their 	own
information and to adjust rapidly to unexpected changes in trends. 	The need
to meet CON requirements will delay adjustments in this rapidly growing and
changing market. 	For 	these reasons, 	reliance on 	market forces 	rather than
some type of enforced plan is likely to provice greater flexibility in adapting
to changing conditions.
V. Conclusion
Changes 	in 	the 	health 	care 	financing 	system, 	including 	prospective
payment 	mechanisms 	and 	increased 	consumer 	price 	sensitivity 	fostered 	by
private insurers, have undermined the original rationale for CON regula lion
of medi.:al facilities. 	Moreover, a number of studies have concluded that the
( CON 	regulatory 	process 	does 	not 	appear 	to 	serve 	its 	intended 	purpose 	of
controlling health care costs. 	Rather, it reduces the competitive constraints
on costs and prices that the market provides in the absence of regulation.
29 The Plan cites a study by Miller. 	The Plan also mentions problems
with this study, but other studies report similar findings, including those by
Detm:n, 	Ambul2torv 	Surgery, 	New 	England 	Journal 	of 	Medicine, 	1981, 	at
14('6-9, and Wolff and Dunnihoo, A Free-standing Ambulatorv Sun!ical Unit:
A Success or Failure, Journal of Obstetrics and Gynecology, 1982, at 270-'76.
Note 	Finkler, ChanQes 	in 	Certificat-of 	Need 	Laws: 	Read 	the 	Fine 	Print 	in
Incentives vs. Controls in Health Policy (1985), at 132-45; Ermann and Gabel,
supra, at 407-9.
7

The application of CON regulations to ambulatory surgery is likely to
increase costs 	to consumers. 	As currently drafted, specific proposals in 	the
Plan 	are 	likely 	to 	limit 	price 	reductions 	for 	ambulatory 	surgery. 	Further,
the implementation of the Plan may hinder market developments that provide
consumers 	with 	the 	optimal 	level 	of 	medical 	services 	consistent 	with
technological 	developments. 	For 	all 	of 	these 	reJsons. 	we 	believe 	thJt 	the
costs associated with CON regulation of ambulatory surgery probably exceed
the benefits.
We hope that these comments have been helpful. 	If we can be of any
further assistance. please conL•.:t us.
Sincerely,
~T.rc1J~
David T. Scheffman 0
Director
Bureau of Economics
8