Sutter Health, originally based in Sacramento, has grown rapidly since 1996, taking over 15 hospitals in northern California and more than doubling in size.

As it acquired more market share, Sutter became increasingly aggressive in negotiations with health plans. It now demands that plans contract with all of its facilities as a condition for accessing any one of them. It will not negotiate reimbursement rates for individual facilities. Sutter also insists on exclusive referral relationships with physician groups. These requirements greatly limit the ability of plans to direct their members to other hospitals, based on comparisons of quality of care.

In short, Sutter does everything in its power to restrain the choices of health care purchasers. Yet, a 2004 Blue Shield study of more than a million claims found that Sutter charges 80 percent more than the statewide average. A variety of other studies confirm the Blue Shield assessment.

Moreover, based on ten hospital quality performance measures developed by the Centers for Medicare and Medicaid, Sutter ranked in the lowest 50 percent of hospitals that provided data.

Based on a common interest in better quality and lower prices, the California Public Employee Retirement System (CalPERS) and its health maintenance organization, Blue Shield, decided to develop an exclusive provider network that would include only those hospitals that met cost and quality standards that could be verified by an independent third party. A review of California data identified 38 hospitals and 17 physician groups that failed to meet this standard. Twelve of the 38 hospitals were Sutter facilities.

After identifying the hospitals for exclusion, CalPERS and Blue Shield met with each to discuss the reasons for its exclusion and the changes that would be necessary for re-entry into the network. Ten hospitals made price and quality changes to get back in the network. Sutter, however, accepted no criticism and was excluded from the network.

By eliminating the high-cost hospitals (half of which were Sutter facilities), CalPERS saved $38 million in 2005. It expects to save $50 million a year in subsequent years.