Last fall, the Department of Justice (DOJ) and the Federal Trade Commission (FTC) held a public workshop on the use and impact of most-favored-nation (MFN) clauses and the implications for antitrust enforcement and policies. Although MFN clauses originated with international trade agreements, in today’s market, they don’t just apply to nations. The term is generally used to describe an agreement between a buyer and a seller that guarantees the buyer the lowest price for a product or service during the contract period.

In the healthcare industry, for example, a buyer (a payer such as an insurer) may incorporate an MFN clause in its agreement with a seller (a provider such as a hospital). If another insurer negotiates a lower rate with the hospital for a specific service, the first insurer is guaranteed to receive the same rate.

MFN clauses were originally intended to help businesses compete, or at least stay competitively neutral. But according to Joseph Wayland of the DOJ Antitrust Division, such clauses “have the potential to inflict significant harm to consumers and competitors.” Recent litigation and antitrust agency investigations have increasingly looked for anticompetitive effects resulting from the use of MFN clauses in various industries, including health care.

One such investigation involves the MFN clause in hospital contracts with Blue Cross Blue Shield of Michigan (BCBSM). The DOJ and the Michigan attorney general claim that BCBSM’s use of the MFN clause in contracts violates antitrust laws by forcing hospitals to charge higher prices to rival insurers, thus reducing competition and increasing the cost of health insurance in the state.

According to the most recent (2012) report by the American Medical Association, Michigan is one of the least competitive states for health insurance. BCBSM has 70 percent of the health insurance market in the state.

Overview and analysis
During the workshop, panelists presented various economic theories on the effects of MFN clauses. In one view, MFN clauses are protective, preventing one party from anticompetitive behavior by the other party. In another view, however, MFN clauses reduce competition by creating fewer incentives for sellers to discount prices and for buyers to bargain seriously.

The DOJ has also argued that MFN clauses may be exclusionary because they raise costs for rivals and new entrants into a market. Panelists also explained that MFN clauses can increase the bargaining power of a monopolist seller by eliminating the potential for future discounts. In such a situation, buyers give up hope for a lower price and are more willing to accept whatever is offered.

Unfortunately, little empirical data exist to determine whether MFN clauses promote or harm competition. And, in some cases, the effect might be mixed.

For example, panelists pointed out that under the Omnibus Budget Reconciliation Act (OBRA) of 1990, drug companies were required to lower the cost of prescription drugs being sold to Medicaid recipients when they lowered prices for non-Medicaid recipients. As a result, the cost of providing discounts to non-Medicaid customers increased.

The impact on drug costs was mixed, in part because the rules were different for brand-name drugs under patent protection, branded drugs facing generic competition, and generic drugs. Although prices remained stable for both generic and patent-protected drugs, they rose for branded drugs with generic competitors, suggesting that when a difference in pricing exists (such as between a branded drug and its generic competitor), an MFN clause may be anticompetitive and result in higher prices.

MFNs in health care
In health care, MFN clauses typically require a provider to give the payer the lowest rate that it gives to other payers. Sometimes, insurers employ MFN-plus clauses that require hospitals to charge other insurers higher prices for health care.

Determining the legality of MFNs in the healthcare industry is difficult, in part because healthcare customers (patients) do not typically experience price sensitivity the way customers in other industries do. Most patients do not see the full cost of health care; only the uninsured pay “retail.” As a result of this lack of consumer price sensitivity, third-party payers bear the pressure of cost control.

Additionally, varying degrees of competitiveness exist in healthcare and insurance markets. Many hospitals have geographic and reputational monopolies and insurers have varying degrees of market power across states. In some situations, health insurers may be able to obtain anticompetitive MFNs without actual contracts.

In contrast, another panelist argued that MFN clauses can facilitate negotiations, especially with initial dealings involving a new product or arrangement. In the “first mover” context, for example, an MFN clause can be used in a new market to promise an adjustment to pricing as the market develops, thereby reducing risk for the first party to accept the initial price.

All panelists agreed that MFN clauses may be less beneficial in situations where one party dominates the marketplace. Additionally, they stressed the importance of monitoring such arrangements because even the best intentioned can occasionally result in anticompetitive effects over time.

What’s next?
Although panelists agreed that MFN clauses should not be seen as illegal per se, new challenges to MFN clauses are likely and antitrust agencies, law scholars, and the healthcare community will closely monitor the results. At a time when federal and state policies are focused on the need to control rising healthcare costs, the impact of MFN clauses—whether to foster or stifle competition and reduce or raise costs—will undoubtedly be scrutinized.

In fact, some legislators are even calling for a complete repeal of the McCarran-Ferguson Act, which shields the health insurance industry from antitrust law. For example, the “Health Insurance Industry Antitrust Enforcement Act of 2009” unsuccessfully attempted to amend McCarran-Ferguson to eliminate antitrust exemptions for health insurers. Additionally, some states might choose to statutorily limit the use of MFN clauses.

The AAOS office of government relations will continue to monitor the evolving legal landscape surrounding MFN clauses and to keep AAOS members informed.

Simit Pandya is a government relations specialist in the AAOS office of government affairs; Mary Ann Porucznik is managing editor of AAOS Now.