FTC Staff Comment to the Hon. Gerald H. Law Concerning Certificate of Need Laws

V~~ooo7
UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
CLEVELAND REGIONAL OFFlCE COMMISSION AUTHORIZED
Suite 500
The Mall Building
118 St Clair A venue
Cleveland, Ohio 44114-1257
(216) 522-4210
T elecopier. 522-7239
JOHN M. MENDENHALL
Acting Regional Director
March 	7, 1988
The Honorable Gerald H. 	Law
State Representative
House of Representatives
State Capitol 	Building, Room 	#220
Lansing, Michigan 	48909
Dear Representative Law:
The staff of the 	Federal Trade Commission l 	is pleased 	to respond 	to your
invitation 	to comment on 	the overall effectiveness of 	the Certificate of Need
("CON OI
) 	process and on the 	report of the Office of Health 	and 	Medical 	Affairs/
Michigan Department of PublIc Health Certificate of Need 	Workgroup (the
"Workgroup Report"). 	Although 	we have not conducted empirical studies that
are specific to Michigan, for 	the 	reasons discussed in greater detail 	below we
believe that continued CON 	regulation is unlikely to benefit health care
consumers in Michigan. 	Ongoing improvements In health care financing are
resolving 	the principal problems that prompted CON regulation. 	Moreover, the
benefits of CON 	regulation, if any, are likely to be outweighed by its adverse
effects on competition in 	health care markets. 	Consequently, CON regulation 	is
likely 	to harm consumers on 	balance by increasing the 	price of health services
in 	Michigan.
We recognize that 	the 	legislature may, for a 	variety of reasons, choose to
retain the CON process. 	If it does, then certain of the 	proposals made by 	the
Workgroup could reduce 	the 	burden of CON regulation. 	Other proposals,
however. may increase 	that 	burden 	without conferring substantial 	benefit 	to
Michigan consumers.
These comments represent 	the views of the Federal Trade Commission's
Bureaus of Competition, Consumer Protection and Economics, and of the
Cleveland 	Regional Office, and 	not necessarily those of the Commission itself or
any individual Commissioner. 	The Commission has, however, voted to authorize
the staff to submit these comments to you ..

The Honorable Gerald 	H. Law 	Page 2.
I. 	INTEREST AND EXPERIE~CE OF THE FEDERAL TRADE COMMISSION.
For more 	than 	a decade. 	the 	Federal Trade Commission 	has engaged 	in
extensive efforts to preserve and 	promote competition in health 	care markets.
The Commission and its staff 	have 	been 	active both 	in 	antitrust 	law
enforcement and 	in 	advocacy of regulatory reforms. 	Those efforts are 	based on
the 	premise 	that competition in 	health care service 	markets. like other 	markets.
will 	benefit consumers by strengthening incentives for 	providers 	to satisfy
consumer demands. 	As a result of Commission antitrust law enforcement efforts
and economic analyses of the effects of CON 	regulation, the Commission's staff
has gained 	experience with 	the economics of health 	care competition, and 	with
the ways in which CON regulation affects that competition.2 	Indeed, part of
the Commission's antitrust 	law enforcement effort in 	the health care field
focuses on competitive problems that would 	not exist. or would 	be 	less severe,
if 	there 	were no CON 	regulation. 3
II. 	CON REGULATION IS INEFFECTIVE AND POSSIBLY COUNTER-
PRODUCTIVE I~ PROMOTING EFFICIENCY IN HEALTH CARE
MARKETS.
.
A. 	CON Regulation Is Unnecessary to Remedy
Deficiencies in Health Care Reimbursement.
CON regulation of health facilities was introduced principally on 	the
ground that 	unregulated competition would result in the construction of
unnecessary facilities, unnecessary expansion of existing facilities, or
unnecessary capital expenditures by health facilities. 	The assumption 	underlying
this theory 	was 	that 	health 	facilities 	had a tendency to expand 	excessively or
purchase 	unnecessary equipment. 	Proponents of CON regulation argued 	that
this 	tendency was 	not sufficiently constrained 	by market forces 	because 	most
consumers of heal th care were insured by 	policies that reg uired Ii ttle or no
out-of-pocket payment, making consumers generally insensitive 	to the 	price of
2 	See, e.g., Hospital Corp. of America [Chattanooga acquisitions], 1CX5 FTC
361 (1985), affd, 807 F.2d 1381 (7th Cir. 1986), cerro denied, 107 S. Ct. 1975
_(1~87); Hospital Corp. of America [Forum acquisitions11CX5 FTC 298 (1985)
(settled 	by consent order); American 	Medical 	Int'l, Inc., 104 FTC 1 (1984);
D. Sherman, The Effect of State Certificate-of-Need Lav-.:s on 	Hospital 	Costs:
A n 	Economic Policy Analvsis (1988) (FTC staff report); 	M. Noether,
Competition 	Among Hospitals (1987) (FTC staff report); K. Anderson & D. Kass,
Certificate of Need 	Regulation of Entrv 	Into Home Health Care (1986) (FTC
staff report). 	Copies of these 	three 	FTC staff reports are enclosed 	with 	this
letter.
3 	See Section II.C below.

The Honorable Gerald 	H. Law 	Page 3.
health care services. 4 	Moreover, health 	facilities 	were often 	reimbursed 	bv
third-party 	payers on a 	retrospective cost basis, removing 	whatever 	incentive
they might 	have had 	to contain costs.
These forces 	allegedly generated an 	incentive for 	health care 	facilities 	to
compete on 	the quality 	rather 	than 	the price of their services, although 	limited
price competition existed. 	Health care facilities 	had 	incentives to expend
resources to provide wider ranges of diagnostic and 	therapeutic services and
equipment, and 	more comfortable facilities. 5 	The concern expressed 	by health
planners when 	CON regulation 	was created 	was 	that 	the cost of these improved,
albeit under-utilized, facilities 	would 	be passed along to consumers, thereby
increasing the cost of health care. 	The principal purpose of CON 	regulation
was not 	to assure that 	needed 	facilities would be built when they otherwise
would 	not 	have been; rather, it 	was to control 	the 	perceived 	tendency 	to
provide facilities or services that 	were not needed. 6
In light of substantial changes in 	health care markets many of these
assumptions 	underlying arguments in favor of CON 	regulation appear to have
lost their validity. 	Third-paLty 	payers and consumers 	have shown 	increasing
sensitivity 	to the 	prices of hospital services. 	For example, price competition
can be stimulated 	by health maintenance organizations and 	preferred 	provider
organizations, which are well-positioned to channel subscribers to 	hospItals
offering quality care, at economical rates through selective contracting.
Improvements in conventional health benefit programs also provide their
subscribers with financial 	incentives (such as co-payment 	requirements) that
channel them 	toward economical providers, including non hospital providers.?
The increasing sensitivity of health care purchasers to 	the 	prices of hospital
services limits the ability of hospitals to pass on 	to consumers the costs of
facilities and services that are 	not 	useful in meeting consumer demands. 	There
has, accordingly, been a trend 	toward 	increased price competition among
hospi tals. 8
4 	See Health 	Planning and 	Resources Development 	Amendments of 1979, Pub.
L 	No. 9&99, § lO3(b), 93 Stat. 592 (1979), repealed, Pub. L 	~o. 99-960.
§ 701(a), 100 Stat. 2799 (1986).
5 	See Hospital Corp. of America [Chattanooga acquisitions], 106 F.T.c. at 478-
79; M. Noether, supra note 2, at 81
6 	See P. Joskow, Controlling Hospital 	Costs: 	The Role of Government
Regulation 78-79 (1981).
7 	See Insurance Coverage Drives Consumer Prices, Hospitals, Nov. 1, 1985, at
91; see also W. Manning, et al~ Health 	Insurance and 	the Demand for Medical
Care: 	Evidence 	from 	a Randomized 	Experiment, 77 American Econ. Revie\1,J 251
(1987).
8 	See, e.g., Hospital Corp. of America [Chattanooga acquisitions], 106 F.T.c.
at 480-82; Hospital 	Industry 	Price 	Wars Heat 	Up, Hospitals. Oct. 1, 1985, at 69.

The Honorable Gerald 	H. Law 	Page 4.
Programs such as Medicare's "prospective reimbursement" system 	will
reinforce this trend. 9 	Medicare presently reimburses hospital operating costs at
prospective rates 	which 	are 	based 	principally (and soon exclusively) on 	flat
rates for specific diagnosis-related groups CDRGs"), rather 	than 	the actual costs
incurred by a particular 	hospital 	for 	its Medicare 	patients. 1O 	As 	this system,
and others like it, are implemented, the costs of any inefficiencies will
increasingly come out of 	the' hospitals' own 	pockets rather 	than those of 	third-
party payers and 	individual consumers, providing hospitals the 	incentive for 	cost
effective provision of service. 	Indeed, the 	prospect of 	future 	reimbursement
reforms is already encouraging greater efficiency on 	the 	part of hospitals.ll
These improvements in 	hospital 	markets have been 	accompanied by similar
improvements in other markets currently subject to CON 	regulation 	in
Michigan. 	For example, reimbursement of nursing homes in Michigan 	by
Medicaid, an important third-party payer for 	nursing home services, now
provides significant incentives for cost containment, particularly 	with respect 	to
the construction of new capacity. 	Capital construction 	reimbursement is limited
to a specific dollar amount 	per bed. 12 	Moreover, the Medicaid program 	refuses
to 	bear capital and operating costs associated with more than a small amount of
unused capacity. 	These re~ulations deprive prospective entrants into nursing
home markets of any MedIcaid incentive to build more capacity than 	they can
reasonably expect 	to. use. 	It also gives existing firms strong incentives to serve
9 	See 1. Robinson, et al., Hospital Competition and Surgical Length of Stav,
239 Journal of the American Medical Ass'n 696 at 700 (Feb. 5, 1988)
(prospective payment systems counteract the 	tendency of hospitals to compete
for 	surgeons by allowing the surgeons to hospitalize patients for 	longer periods).
10 	Medicare plans to begin reimbursing capital costs in a somewhat similar
manner. 	See 42 U.S.CA. § 1395ww(aX4), (d) (West Supp. 1987); 52 Fed. Reg.
18840 (1987) (proposed regulation to phase in 	flat 	prospective rates for capital
costs over three years for 	movable equipment, and over ten 	years for 	other
capital costs); see also Modern 	Healt!u:are, Aug. 1, 1986, at 20: Health Care
Competition Week. Jan. 12, 1987, at 4. 	But see Omnibus Budget Reconciliation
Act of 1987, Pub. L. No. 100-203, § 4006(bX1), 101 Stat. 	(1987) (delays
implementation of prospective reimbursement for capital-related costs until 1991).
11 	See Raske, Association Seeks Sound Capital 	Pav Policv, Modern 	Healt!u:are,
Nov. 7, 1986, at 120 (uncertainty about future of reimbursement for 	capital
expenses is encouraging hospitals to make more conservative capital investment
decisions for 	inpatient services).
12 	State of Michigan, Medical 	Assistance Program Bulletin No. 537()...85-O2
(1985) § 4.c.

The Honorable Gerald H. Law 	Page 5.
patients more effectively so they can 	keep their capacity fully 	utilized. 13
Moreover, price competition 	for 	nursing 	home 	patients who pay 	for 	their care
from 	their own 	funds 14 deters 	nursing homes from 	imposing excessive costs
upon 	those 	patients. 	Similarly, price competition and/or 	well-structured
governmental and 	private reimbursement 	programs limit 	incentives for 	over-
Investment and other wasteful expenditures for 	at least some of 	the other
types of health 	facilities subject 	to CON regulation 	in 	Michigan.1 5
B. 	CON Regulation Is Ineffective as a Cost-Containment Mechanism.
It 	is not clear that CON 	regulation 	has had 	the intended effect of
containing 	health 	care costs. 	A 	number of empirical studies suggest 	that CON
regulation has not controlled 	general acute care hospital costs by preventing
expenditures for 	unnecessary beds. services, and equipment. 16 	Early studies of
the effects of CON 	regulation 	found 	that instead of constraining overall 	hospital
costs, it 	may 	have simply caused 	hospitals to 	reallocate their resources. 	Thus,
13 	As we understand it, Michigan 	Medicaid computes capital and operating
cost reimbursement p.er Medicaid patient day, in most instances, by dividing a
nursing home's allowable costs by the number of patient days per year 	the
nursing home would have had if it operated at an 85 percent occupancy 	rate
(or, if greater, the actual number of patient days). 	As a result, Medicaid pays
only costs allocated to the capacity 	used by its beneficiaries. except that it
bears some of the costs of unused capacity not exceeding 15 percent of total
capacity. 	State of Michigan. Reimbursement for Skilled Nursing & 	Intermediate
Care Facilities (1982) at II-5. 	Other states, such as Virginia. bear the cost of
unused capacity only up to 5 percent.
14 	See A. Lee, H. Birnbaum & 	C. Bishop, How 	Nursing Homes Behave: 	A
Multi-Equation 	Model of Nursing Home Behavior, 17 Social Science and Medicine
1897. 1905 (1983) (private patient demand 	for 	individual 	nursing homes' services
is price elastic).
15 	See. e.g... 52 Fed. Reg. 20466 (1987). 52 Fed. Reg. 20623 (1987) (Medicare
reimburses freestanding 	ambulatory surgery centers at flat prospective rates,
and will soon 	provide half 	the reimbursement for 	hospital outpatient surgery on
the same basis (with the other half cost--based».
16 	A 	1986 FTC staff report reached a similar conclusion about 	the effect of
CON regulation on 	home health care services. 	K. Anderson & 	D. Kass, supra
note 2, at 87-92 (1986). 	A 	study of the economic behavior of nursing homes,
which did not focus on the effectiveness of CON regulation, noted 	that CON
regulation appeared to increase, rather than decrease, the average cost of
nursing home services. 	A. Lee, H. Birnbaum & C. Bishop, How Nursing Homes
Behave: 	A 	Multi-Equation 	Model of Nursing Home Behavior, 17 Social Science
and Medicine 1897 at 1906 (1983).

The Honorable Gerald 	H. Law 	Page 6.
while some 	tvpes of hospital costs were constrained by CON regulation, other
costs increase-dP 	Later studies reached similar conclusions, findmg 	that CON
regulation 	did 	not 	reduce costs per unit of hospital output. 18 	Finally, several
studies including 	two recent 	FTC staff reports, concluded 	that 	the adoption
and 	maintenance of CON 	regulation 	is associated 	with 	increases in 	hospital
costS.1 9 	These studies suggest that, as a means of cost containment, CON 	laws
may be at 	best 	ineffective and at 	worst cost 	increasing.
A 	1987 evaluation of 	the effect of Michigan's CON 	program on 	cost
containment acknowledged 	that opinion 	is divided on 	the subject 	of the
effectiveness of CON programs in containing costs, but concluded 	that
Michigan's CON program 	had deterred 	unneeded projects. 20 	This conclusion 	was
based on 	the increased 	volume of denied CON applications [rom 1979 through
1985 and anecdotal evidence that negotiations between 	applicants and agency
staff had reduced 	the cost of proposed 	projects. 21 	The same evaluation
expressed concern about 	the amount of construction that 	would 	take place,
particularly in nursing homes, if CON were 	repealed. 22
However, the dollar amount of projects denied, withdrawn or modified 	as a
result of the CON process does not necessarily represent a savings in the
overall cost of health care nor does it 	necessarily represent an accurate
17 	Salkever & 	Eice, Hospital Certificate-of-Need Controls: Impact on
Investment, Cost, and 	Use (1979); Salkever & 	Eice, The Impact of Certificate-
of-Need Controls on 	Hospital 	Investment, 54 Milbank Memorial Fund Q. 185
(Spring 1976).
18 	Policy 	Analysis, Inc.-Urban Systems Engineering, Inc_ Evaluation of the
Effects of Certificate of Need Programs (1980); Steinwald & 	Sloan, Regulatorv
Approaches 	to Hospital 	Cost Containment: 	A 	Svnthesis of the Empirical
Evidence, in 	A 	New APr-roach 	to the Economics of Health 	Care, American
Enterprise Institute (1981.
19 	D. Sherman. supra note 2, at 	iv, 78; and M. Noether. supra note 2, at 74,
82; used cross-section data. 	F. Sloan and B. Steinwald. Effects of 	Regulation
on 	Hospital Costs and 	Input Use, 23 Journal of Law and Economics 81 (1980)
and 	C. Coelen and 	D. Sullivan An 	Analvsis of the Effects of Prospective
Reimbursement on Hospital 	Expenditures, 3 Health Care Financing 	Review 1
(1981), used pooled cross-section time-series data. 	See also Anderson & Kass,
supra note 2, at 87-92 (CON does 	not decrease, and may increase, the costs of
horne 	health care agencies).
20 	Michigan Statewide Health Coordinating Council, An 	Evaluation of the
Certificate of Need 	Program. March 19, 1987 (hereinafter "SHCC Evaluation") at
11-14.
21 	[d.
22 	ld. at 8-9.

The Honorable Gerald 	H. Law 	Page 7.
measure of 	the amount of "excessive" capital 	investment deterred. 	The
existence of CON regulation 	forces firms 	to compete for 	a 	limited 	number of
certi~i~ates of nee.d?3 	The CON p,rocess a~so provides 	incentives for. su~h 	~
actiVIties as 	the 	fIlmg of pre-emptive applIcations and 	nUisance applIcatlOns.",4
Thus, to presume that ill projects applied for 	would 	be 	built in 	the absence of
CON 	regulation and 	that 	the dollar amount of applications denied, modified or
withdrawn 	represents actual deterrence is probably incorrect. 	Furthermore,
deterrence of capital spendin~ by CON 	regulation 	may 	not 	yield 	an overall
savings in health care costs smce costs may increase in other areas not covered
by CON 	regulation, as suggested by some of the studies 	mentioned 	above. 25
Concern 	that 	unnecessary capital spending will occur if CON 	regulation 	is
repealed 	is based on early reports of the experience of Arizona and 	Utah 	with
CON 	repeal.26 	However, one detailed analysis of the post-CON events in 	these
states shows 	that 	most increases in construction 	that did occur 	were likely 	to
be short-term 	and in areas which were under-served. 27 	For example, Arizona's
"surge" in 	nursing home construction began even 	before CON expired - 	when
its bed-to-population ratio was the lowest in the nation and substantially below
the national average - 	and continued during a period 	when 	the State
experienced substantial in-migration of aged 	persons. 28 	Also, an 	initial study of
23 	This is particularly true 	where applications are subject to comparative
review. 	Even for 	applications not subject to comparative review, however, since
the burden 	is on the applicant to demonstrate need, applicants will ordinarily
assume that any CON granted reduces the likelihood that a similar CON will 	be
granted to another applicant. 	This generates pressure 	to file pre-emptively or
defensively.
24 	SHCC Evaluation at 32. 	(It has been alleged that applications are 	made 	for
the purpose of protecting 	the applicant's long-term 	interest - 	without any
present intention 	to offer 	the service - 	or to obstruct 	potential competitors.)
25 	See sources cited supra notes 17 and 18 and 	Anderson & Kass, supra note
2. at 87·92; See also, C. Havighurst, Regulation of Health 	Facilities and 	Services
bv "Certificate of Need," 59 Virginia 	L 	Rev. 1143. 1218 (1973).
26 	SHCC Evaluation at 8-9. 	While we argue in 	this paragraph 	that
predictions of increased hospital and 	nursing home construction 	are overstated,
It should 	not 	be inferred 	that we consider such construction 	to be undesirable.
As we have discussed 	in 	previous sections, CON regulation 	restricts supply, so
it is expected that construction 	will occur where supply has not 	kept 	pace with
demand. 	On 	the other hand, if there is an over-supply in a particular area
(e.g., acute care hospital 	beds) new construction is unlikely to occur.
27 	M. Lerner, et al., Investigation of Certain Issues in Connection 	With 	the
Virginia Certificate of Need 	Law, at VI, 9-17, 27-40; VII, 5-7 (final report,
August 10, 1987) (hereinafter "Johns Hopkins Report").
28 	Id. at VII, 12, 27.

The Honorable Gerald H. Law 	Page 8.
the effects of CON 	repeal 	in 	Arizona 	reported a strong surge 	in 	applications for
hospital 	projects. 	A 	later study found. however. that 	much of 	the 	planned
construction did 	not materialize.29 	The Johns Hopkins Report 	found 	that 	Utah
experienced an 	increase, but 	not a "surge" in 	nursing home construction. while
new 	hospital construction 	was limited 	to freestanding 	psychiatric hospitals.30
The 	Report concluded that 	the change 	to a 	prospective 	payment system 	by
Medicare had diminished 	the incentives 	toward 	new capital 	investment 	by
hospi ta Is.31
C. 	CON Regulation Interferes with Competition in Health Care Markets.
CON regulation, on 	balance, may be not only ineffective 	but actually
counterproductive in the control of health care costs. 	As discussed 	below, the
CON regulatory 	process itself imposes substantial costs on applicants, in 	terms
29 	Results of both studies are summarized, Id. at VII, 5. 	Arizona did
experience substantial growth in the number of open-heart surgery units, but
other states that repealed CON did not. 	Id. at VII, 10.
30 	Id. at VI, 12-13, 16.
31 	Id. at 	VI, 14-16. 	The experience of Arizona, Utah, Kansas and Texas is
summarized at VII. 5-6. 	The Report concludes that "indications from 	these 	four
states are 	that substantial growth in hospital 	beds is unlikely on 	CON sunset."
Id. at 	VIr, 6.
Just as Medicare is influencing capital investment decisions 	by hospitals.
state Medicaid 	reimbursement policies are an important influence on 	the growth
of nursing homes. 	Id. at 	VI, 13-14 and 	VIr. 14-15 (states with 	very 	high
occupancy 	ratios can expect an increase in construction or conversion of beds
upon CON 	repeal. but the level of Medicaid reimbursement is an 	important
influence on 	the amount of growth, along with other factors, such as 	the
existing bed-to-population 	ratio and 	the geographic distribution 	of existing 	_
beds). 	Michigan already has in place some Medicaid reimbursement 	policies 	that
should deter unnecessary nursing home construction in 	the event of CON
repeal. 	Current regulations impose a cap on reimbursement for 	capital costs for
new long-term-care beds which is well 	under the actual capital cost of
construction. 	See Workgroup Report. Attachment C-4. PosItion Statement of
Health 	Care Association 	of Michigan. 	Since operating-cost reimbursement 	levels
are at actual cost. there is no incentive to build unnecessarily. 	To further
discourage new construction, the occupancy rate necessary to obtain 	full-cost
reimbursement for 	unused capacity (supra note 13) could be raised from
85 percent to 90 percent, or even 95 percent.

The Honorable Gerald H. Law 	Page 9.
of both 	the effort 	required 	to obtain 	regulatory approval and 	the delays
occasioned 	by 	the 	regulatory 	process. 	To the extent that CON 	regulation
reduces 	the supply of particular health services below competitive levels. their
prices can 	be expected to be higher 	than 	they 	would 	be in an 	unregulated
market. 32 	CurtaIlment of available services or 	facilities 	may create shortages
which 	force 	consumers to resort 	to 	more expensive or otherwise less desirable
substitutes. thus increasing costs for 	third-party 	payers and/or patients. 	For
example, a shortage of nursing home beds can delay 	the discharge of patients
from 	more expensive general acute care hospital 	beds 33 or force 	patients to use
nursing 	homes 	far 	from 	home.
Even 	if it does not yield acute shortages of services, CON regulation can
substantially 	interfere with competition in health care markets. 	FIrst. the CON
regulatory 	process may increase prices to consumers by protecting firms 	in 	the
market 	from 	competition 	from 	innovators and 	new entrants.34 	Although 	the
CON process does not always prohibit the entry or expansion of health facility
enterprises, 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. 	In ,addition, the process of preparing and defending a
CON application 	is often extremely costly and 	time consuming (particularly 	if
the applIcation is opposed 	by firms already in the market~35 	CON regulation
may also create opportunities for existing firms 	to abuse the regulatory 	process
32 	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 more money for 	the same services.
Severe shortages of capacity can protect firms providing substandard
service 	to consumers not only from competitive pressures to upgrade
performance. but also from 	regula tory pressures to adhere to licensure
requirements. 	For example, a state agency may 	be reluctant to close a nursing
home for 	major violations of licensure requirements if the patients cannot 	be
placed elsewhere. 	See 1. Feder & 	W. Scanlon. Regulating the Bed Supply in
Nursing Homes, 58 Milbank Memorial Fund Q. 54. 76 (1980).
33 	U.S. General Accounting Office, Constraining Health Care Expenditures:
Achieving Quality Care at 	Affordable Cost, at 9~94 (1985).
34 	Posner, Certificate of Need 	for 	Health Care 	Facilities: 	A 	Dissenting 	View.
in Regulating Health 	Facifitv ·Construction at 113 (c. Havighurst, ed. 1974);
M. Noether, supra note 2. at 82 (CON restrictions on entry associated with
hospital 	price increases of approximately 4 to 5 percent, as well as increases In
hospital costs of approximately 3 to 4 percent).
35 	SHCC 	Evaluation at 29-34. 	(Number and complexity of CON appeals
increased 	dramatically from 1979 to 1986. 	Comparative reviews are particularly
protracted.) 	See also Hospital Corp. of America [Chattanooga acquisitions].
106 F.T.c. at 490-92.

The Honorable Gerald 	H. Law 	Page 10.
so as further 	to prevent or delay 	new competition.36 	CON 	regulation,
therefore, makes entry and expansion 	less likely, or at 	least 	less 	rapid. 	Firms
in any given 	market 	need 	not 	be as competitive in 	price or as sensitive 	to
consumer demand 	for 	new services if they 	know that 	it 	will 	be difficult and
eXPt:nsive for 	new 	firms 	to enter 	the 	market and offer competitive prices or
servIces.
Second, by reducing 	the likelihood of (or at 	least 	increasing 	the cost and
time required for) entry and expansion, CON 	regulation can 	make it more likely
that 	providers will exploit whatever market 	power they have, individually or
collectively, to raise 	prices above (or reduce quality below) the competitive
level. 37 	That is why, in 	both of the 	hospital 	merger decisions issued 	by 	the
Federal Trade Commission in 	litigated cases, the Commission cited 	the entry
barrier created by CON regulation 	as a factor significantly contributing to the
potential for anti-competitive effects from 	the mergers. 38 	CON 	regulation can
thus render anti-competitive otherwise lawful conduct, and aggravate the anti-
competitive effects of antitrust violations. 39
36 	T. Calvani & N. Averitt, The Federal Trade Commission and 	Competition in
the Delivery of Health 	Care, 17 Cumberland L. Rev. 293, 298-99 (1987)
(discussing potential for 	health 	providers to use CON process for "non-price
predation"); St. Joseph's Hospital v. Hospital Corp. of America, 795 F.2d 948, 959
(11th Cir. 1986) (defendants' misrepresentations to state health 	planning body
concerning plaintiff's CON 	application not 	protected from 	antitrust scrutiny);
Hospital Corp. of America [Chattanooga acquisitions], 105 F.TC at 492.
37 	This is most likely 	to occur where 	there are few 	competing providers in a
particular market, see Hospital Corp. of America [Chattanooga acquisitions],
105 ~.TC at 487-89, such as in rural areas, or for certain 	hospital specialty
serVIces.
38 	American 	Medical Int'l, Inc., 104 F.TC at 200-01 (1984\ Hospital Corp. of
America [Chattanooga acq uisi tions], 105 F.TC at 489-496.
39 	In particular, the entry barriers created by CON regulation can transform
into possible antitrust violations potentially efficient joint activities by health
care providers that would otherwise 	be lawful. 	For example, in 	some cases
shared service arrangements and consolidations could significantly 	threaten
competition, unless the prospect of new entry would keep the 	market
competitive by making any significant, sustained price 	increases unprofitable.
CON regulation can thus conflict 	with the achievement of health 	planning
objectives by 	limiting the freedom 	of providers to realize efficiencIes without
creating unacceptable risks of anti-competitive effects.

The Honorable Gerald 	H. Law
D. 	CON Regulation Is Not a Good Mechanism for Addressing
Concerns Related to Access for Indigent Patients.
Page 11.
It 	has been 	proposed 	that 	the CON 	process in 	Michigan 	be extended 	to
deal 	specifically 	with 	problems of access to the 	health 	care system 	for 	indigent
patients. 40 	In our 	view, CON regulation 	may be a poor 	method 	for 	addressing
the 	issue of access, so that concerns for access may 	not 	justify 	its 	retention.
CON 	regulation 	might serve as a means of ensuring access to 	health care
in 	two related 	ways. 	First, CON 	regulation 	may enable 	the State 	to steer
health 	care capital expenditures to under-served and "economically
disadvantaged 	regions" (defined as areas with a substantial percentage of
indigent households).41 	Second, providers who serve indigent patients and
subsidize care for 	them 	through 	revenues from 	paying patients can 	be
protected against the establishment or expansion of other providers who would
draw off the paying patients without serving indigent patients. 42
Insulation 	from 	competition 	is the inducement offered to providers in order
to encourage them 	to locate. facilities near indigent populations and 	to provide
care for 	indigent patients without 	full 	reimbursement. 	However, this insulation
itself imposes substantial costs on the health care system, resulting in 	higher
prices and, possibly, lower quality as wel1.43 	Moreover, this method of funding
access may 	be 	less equitable than direct taxation. 	CON regulation, in effect,
imposes a "hidden tax" on all consumers of health services in the form 	of
higher prices and lower quality. 	That "tax" may be more costly to society
than conventional forms of taxation because of its interference with 	health
facility competition; moreover, the. burden of that "tax" falls disproportionately
on those 	in poor health. 44 	In fact, other ways of fundin§. 	care for 	the
indigent are available which do not 	restrain competition. 5
~ 	SHCC Evaluation at 1-2; Workgroup Report at 7.
41 	SHCC Evaluation at 20-21.
42 	SHCC Evaluation 	at 21-22 (proposal 	to give "preference" 10 CON
proceedings to facilities 	which serve indigent populations).
43 	See p. 9, supra, note 32 and accompanying text.
44 	See R. Posner, Taxation bv Regulation, 2 Bell 1. of Econ. 22 (1971); C.
Havighurst, supra, note 25 at 1188-94 (1973).
45 	The Johns Hopkins Report contains a brief summary of methods used 	in
various states to fund 	hospital care for the indigent. 	/d. at 	VII, 2~24, citing
"Review's 1986 State-by-State Survey: 	A 	Special Report;' FAHS Review, Sept.!
Oct. 1986, at 27-42.

The Honorable Gerald 	H. Law 	Page 12.
III. 	IF THE CON PROCESS IS RETAINED, THE THRESHOLDS SHOULD BE
RAISED, AND THE SCOPE OF COVERAGE SHOULD BE
RESTRICTED, IN ORDER TO REDUCE THE NEGATIVE EFFECTS OF
CON ON THE COMPETITIVE PROCESS.
Michigan's current 	thresholds for CON coverage - 	$150.000 for 	capital
expenditures 	including major medical equipment. and 	zero for 	new 	institutional
services - 	are 	the 	lowest in 	the 	nation. 	The Workgroup £roposal 	would
increase the 	threshold 	for capital expenditures to $750,000. 	It is anticipated
that 	the increase 	in 	the 	threshold 	for carital expenditures to $750,000 could
eliminate 50 percent of the applications.4 	In 	practice. even this benefit is not
certain because some CON 	applications with capital expenditures below 	the
threshold 	would 	be covered as 	new services or under other provisions of 	the
CON law.48 	Several states have increased 	their thresholds to considerably
higher figures. 	The Michigan Senate has passed a bill 	that would 	raise the
threshold 	for caRital expenditures to $1.5 million 	with 	annual 	indexing to allow
future 	increases. 9 	A 1988 report by the FTC's Bureau of Economics found 	that
hospitals in states with 	higher CON thresholds actually have lower overall
costs. 50
The Workgroup proposes to broaden coverage of major medical equipment
by listing covered eq\.llpment specifically, and subjecting it to CON coverage
regardless of where it IS 10cated.51 	Thus, equipment would be covered if
located either in a hospital or in a doctor's office. 	The reason given 	for
broadening CON coverage of major medical equipment purchases is to make CON
coverage more equitable. 52 	However, the facial appearance of inequity may not
be a reality. 	Even 	if the legislature decides that hospitals still 	have 	incentives
to make unnecessary capital investments. 53 and 	therefore continues CON review
of their capital investments, physicians' groups and other providers 	not
reimbursed on a retrospective-cost basis for capital expenditures may 	have no
such incentives. 	Thus, CON review of their 	proposed expenditures offers 	little
prospect of public benefit while imposing costs both on 	the providers (complying
46
47
48
49
50
Workgroup Report at 4. 6.
SHCC Evaluation at 14-15.
Id.
Sena te Bill 	No. 64, Section 1 (March 31, 1987).
D. Sherman, supra note 2, at vi, 7, 59~, 78.
51 	Workgroup Report at 4.
52 	ld~ SHCC Evaluation at 16.
53 	\Ve disagree with 	this proposition (see Section ILA.. supra).

The Honorable Gerald 	H. Law 	Page 13.
56
with 	the 	process) and 	the public (administering it and 	being unable 	to benefit
from 	the 	new 	technology 	while the CON 	review 	is underway).
The Workgroup recommendations also propose to delete certain 	types of
facilities 	from 	coverage by CON.54 	The deletion of 	these facilities should
encourage competition and 	innovation 	in 	these areas of health care. 	Since
many of the facilities 	to be deleted 	from 	CON coverage 	represent 	less costly
alternatives to 	inpatient care, competition and 	innovatIOn 	in 	these areas will
contribute 	to cost containment in 	health care generally.55 	A 	staff 	report 	by
the Commission's Bureau of Economics has concluded 	that CON 	re~ulation of
entry 	into one of these areas - 	home health care - 	did 	not 	result In 	lower
costs, and 	may 	have increased costs while imposing administrative costs and
restricting entry.56 	Indeed. the legislature may 	wish 	to consider additional
facilities for deletion 	from 	CON regulation. 57
The Workgroup did 	not recommend a change in 	the threshold 	for 	new
institutional services offered by covered facilities, leaving it at zero. 58 	Thus, a
new clinical 	health service offered by a facility subject 	to CON 	regulations
54 	These are: 	homes for 	the aged, organized ambulatory care facilities, home
health care facilities, facilities operated by the Michigan 	Department of Mental
Health, outpatient pl)ysical therapy facilities, tertiary health care service
facilities, substance abuse treatment programs, outpatient 	psychiatric clinics, and
clinical laboratories. 	Workgroup Report at 2.
55 	CON regulations tend to raise the price of medical services by 	limiting
their availability. 	See Ermann & 	Gabel. The Changing Face of American
Health 	Care. Medical Care, 1985, at 407.
Anderson & 	Kass, supra note 2.
57 	For example, the 	Workgroup Report proposes to continue CON coverage for
freestanding surgical outpatient facilIties. 	Workgroup Report at 1 	However,
the evidence suggests that growth of such 	facilities, which in many cases are
an 	innovative. less costly alternative to inpatient surgery. has been 	hampered bv
the CON 	process. 	See Ermann & 	Gabel, supra, note 60. 	It is particularly in
such areas of innovation that CON regulation has 	been shown 	to be
counterproductive to cost containment. 	See. e.g., Anderson & 	Kass. supra
note 2. 	In addition, it is difficult to predict demand 	for ambulatory surgery
because it is raplary becoming more accessible due to improvements in
technology and greater acceptance by physicians. 	While state health-planning
agencies might provide information 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 may delay adjustments
in this rapidly growing and changing market. 	For these reasons, reliance on
market 	forces, rather 	than CON regulation, is likely 	to provide greater
flexibility 	in adapting to changing conditions.
58 	Workgroup Report at 3-5.

The 	Honorable Gerald H. 	Law 	Page 14.
would 	be covered 	regardless of its capital or operating costs. 	This restriction
l)n 	the 	activities of covered 	facilities may reduce 	the 	benefits 	which 	would
otherwise 	be obtained 	by 	raising thresholds for 	CON 	coverage of capital
~xpenditures and 	by deleting many types of facilities 	from 	coverage (depending
on 	how 	the 	term "clinIcal 	health 	service" is defined). 	\\'c 	urge 	the 	legislature
to evaluate carefully 	whether this 	restriction 	is necessary 	in li~ht of the
changes 	in 	the 	health 	care 	marketplace described 	earlier 	In 	thIs 	letter.
IV. 	CONCLUSION.
We believe 	that 	the continued existence of CO~ 	regulation 	would 	be
contrary to 	the 	interests of health 	care consumers in 	~fichigan. 	Ongoing
changes in 	the health 	care financing system. including 	prospective 	payment
mechanisms and 	increased 	consumer rricc sensitivity fostered 	by 	private
insurers. are 	eliminating 	the 	principa 	problem 	that 	prompted CON 	regulation.
Moreover, the CON 	regulatory process does not appear 	to serve 	its intended
purpose of cODtrolling health 9are costs. 	Indeed, It 	may defeat 	that purpose by
Interfering 	with competitive market forces 	that 	would otherwise 	hell? contain
costs. 	However, should 	the 	legislature decide to retain 	CON 	regulatIon, then
decreases in coverage and 	increases in the threshold for 	covered services may
reduce the 	negative cf,fects of the CON system .
. We would 	be happy 	to answer any questions you 	may 	have 	regarding 	these
comments. and 	to provIde any other assistance you may 	find 	helpful.
Sin:.:;:..el\, 	y(')urs~~ 	, /'
,"/ 	( 	(~ 	, 	'C
':,:#:Af,/:irv 	/ ~ ,-/ ~.' .'/
//J::'hn 	M.' Mendenhall
Acting 	Director
Cleveland 	Regional 	Office
Enclosed FTC Staff Reports:
The 	Effect of State Cenificatc-of-~eed Laws on
Hospital 	Costs: 	An 	Economic Policy Analysis (1988);
Competition 	Among Hospitals (1987~ and
Certificate of N~ed Regulation of Entry Into Home
Heal th Care (1986~