Healthcare Industry Mergers

August 3, 2015

By: Kelly Diamond, Publisher

healthcare industry mergersAs you may already know, I’m in advertising. Specifically I buy and plan media placement. The cliff notes version of what I do is: I help to get advertisers on the air by negotiating their rates and getting them the most audience to see their ads as possible for the least amount of money.

Advertisers come to buying agencies because they hold a certain amount of leverage through scale and volume. For example, I worked for one agency that had Volvo, IHOP, and Geico. So when Armstrong Gardening Centers came along, that agency was able to leverage the large amounts of business from the other clients and bring in some more affordable rates for Armstrong. We were also able to negotiate a considerable amount of value added promotional activity.

GM was the same thing. Leveraging the entire GM budget meant that small dealerships were getting a huge bang for their buck for a relatively small contribution. If you buy an entire year up front, you can get an even bigger discount.

This is basic economics: the economies of scale. We see it all the time with “BOGO” sales or common taglines like “the more you buy, the more you save!”

It’s important to bear in mind that this is a common practice, and it is a very perfect example of the win-win outcomes of a free market. Savings might mean taking a lower margin… but it also means higher volume. Higher volume at a slightly lower margin means more profits. That’s from the business end.

For the consumer’s part, savings means greater access and higher volumes of consumption spanning across more of the socio-economic spectrum. So yes, a company can increase profits and offer savings. That is the premise behind the big box stores. (Granted, as corporations get larger, service gets worse as that’s one of the first corners to get cut. So the customer is left to decide if they want to pay the premium for better service or save and deal with not-so-great service.)

Healthcare Industry

This is what’s happening in the healthcare industry now. We went from five heavy hitters in the insurance industry to what might end up as three: United Healthcare, Anthem + Cigna (merger), and Aetna + Humana (merger). They aren’t the only ones merging either! Other facilities and service providers in the healthcare industry have merged as well.

Here is a list of a handful of the larger acquisitions:

  • CVS bought up Target pharmacies
  • Intermountain Healthcare in Utah takes over Amerinet, one of the nation’s largest group purchasing companies
  • United Health, the US’s largest health insurer just acquired Catamaran, the US’s fourth largest pharmacy benefits manager
  • Humana, prior to merging with Aetna, was the 6th largest health insurer. They sold their subsidiary Concentra to MJ Acquisition Corp.
  • VHA, a Texas-based supply-chain company merged with UHC, an alliance of non-profit academic medical centers “creating a single healthcare services company that ranks it among the largest in the nation”.
  • Cener Corp., an electronic health records giant, merged with Seimens Health Services
  • Kindred Health acquired Gentiva Health creating “one of the largest healthcare firms in the country, running acute-care hospitals, home health services and inpatient rehabilitation among other things”. Kindred also acquired Centerre Healthcare Corp. and their eleven in-patient rehabilitation hospitals.

In the link I provided above, there are FIFTY-SEVEN other mergers and acquisitions that are either state or region specific just this year! It’s not just health insurers, but providers, physician networks, medical devices and pharmaceuticals, information and technology, and even assisted living and ambulatory services.

Interesting side note: Do you know what I didn’t see in that list? Services that aren’t covered by insurance like cosmetic and dental services, to be exact. They have to compete on the open market for money that isn’t subsidized, but they can also make as much as they want and there are a LOT more competitors ranging in size.  They keep each other’s price points in check, offer payment plans, and don’t have the burden of paying administrators to learn and file claims with Medicare or Medicaid.

What Does This Mean?

The short answer is, they are doing what buying agencies do: increasing scale to reduce price and cost. But there is a bigger picture here. What is happening to the healthcare industry happened to the banking industry.

What does a RESPONSIBLE bank do? It safely invests money. It lends out money to low risk borrowers. It makes profitable decisions that lend to its stability and credibility in the market. It is competitive in service and rates. Yes, even in a contrived, centralized, fractional reserve system like ours, you can still have responsible and irresponsible banking.

By and large, people put their money into these banks trusting they would behave responsibly; maybe make a small amount of interest off their savings and CDs even.

Here’s what ACTUALLY happened: Banks were offered easy money at little to no risk coupled with a tremendous amount of political pressure to be a little more indiscriminate with their lending practices. Two major places where this happened is in education and housing. You can’t default on a student loan. Even if you declare bankruptcy, you cannot default on that loan. As for housing, I think we all saw the boom and bust of that little stunt.

Everyone is entitled to university education. Everyone is entitled to a house. It doesn’t matter if you can afford it or not, someone will eat the cost to make this happen for you. Right? Not much different than healthcare.

Banks were given a huge number of loan applicants. What business wouldn’t want their doors being busted down with eager leads? Well, a smart business would know the difference between a qualified and unqualified lead and turn down the latter. A reckless one, wouldn’t care. Many banks were the latter, and gave subprime loans to underqualified applicants with questionable financial standing.

Health insurers are in a similar boat. When everyone is mandated to have some level of insurance, and what constitutes the minimum level is also mandated, insurance companies are given customers with bows on them courtesy of the US government.

More customers, means more volume, means more profits, right? Not exactly. Much like the underqualified borrowers, many of these new customers are liabilities. Not just liabilities but poor liabilities.

While banks could still opt to turn down their applicants, insurance companies cannot. Yet another mandate is that insurance companies cannot turn you down if you have a preexisting condition. This flies in the face of insurance as a business model. It’s very simple: I buy insurance just in case something does go wrong… the companies sell insurance hedging on the likelihood that something won’t go wrong. THAT is the point of insurance. If something has already gone wrong, you don’t need insurance, you need care to fix it and a payment plan!

Well, if insurance companies must sell a minimum package of coverage, and they cannot deny a policy to high risk individuals, and if the high risk individuals can’t afford to pay for the risk they bring, we have price point issues.

How do we address said price point issues? The “solution”, such as it is, is three fold.

  1. Government (either state or federal) subsidies for those that qualify.
  2. Revenue fixing so that insurance companies only keep a 20% margin from the premiums.
  3. Economies of scale

Solution #1

The first was recently up for a Supreme Court ruling on whether it is even constitutional. A critical part of the ACA was saved by a 6-3 decision which favored the federal subsidies. 6.4 million people and $1.7 billion in subsidies hung in the balance. I’m still unsure to this day how this manages to be “deficit neutral”.

Solution #2

In researching this article, I wanted to see what other angle there could be behind the mergers. Cynic that I am, I thought, “Ooooooooooooh I bet these jerks lobbied for ACA just so they could merge, cut corners, and profit!” Was I wrong!

Turns out, “According to the National Journal’s Influence Alley, at the very same time the American Health Insurance Plans (AHIP)—the health insurance industry super lobby—was cutting a deal with the White House leading to its stated support of the proposed Obamacare legislation, they were secretly funneling huge amounts money to the Chamber of Commerce to be spent on advertising designed to convince the public that the legislation should be defeated”. (Source: Forbes)

How much money? $102.4 million over fifteen months.

But why? Neera Tanden, who was the senior advisor for health reform at the DHHS and served on the health reform team in the White House believes it’s because of the MLR (Medical Loss Ratio). This is a provision in the plan that requires 80% of your premium be allocated to actual healthcare expenditures. Whatever isn’t spent must be returned to the customers. It’s said that close to $1.1 billion is to be returned for 2011 alone in accordance with that mandate.

That’s a damn good reason to fight the ACA. If I own a widget company, and I offer to sell them at $5 each and the market agrees that is a good price, then it’s up to me to figure out where to get efficiencies in my profit margin from there. If I can get cheaper labor, leaner workforce, less expensive parts and materials is all up to me. Whether I make $0.01 per widget or $4.99 per widget is not your concern. Your concern is how much you have to pay, which you agreed was fair at $5.

To be fair, there are certain cooperatives where this model does work. Credit unions, the Auto Club of America, and some cooperative utility companies have that model. They share their savings with their members in some form. But it works because they each voluntarily decided to participate in this model, and they determine the return rate based on sustainability of their business (i.e. the return rate isn’t determined by fiat).

Health insurance used to be that way, too! Yes, voluntarily! It was used as an incentive mechanism to keep the claims at a minimum and to encourage their customers to participate in preventive care programs. My mom had a policy that paid her $100 if she would get an annual mammogram, for example. I used to have a plan that took $15 per month off the premium if I took a wellness and dietary survey.

But it rewarded those that helped the insurer with their efficiencies. If my business can save $20 by my customers doing X, then I’ll offer them $5 to do it. I’d still be saving $15. Win-win!

This MLR however, doesn’t reward those who take care of themselves. It just caps the margin at 20%. That’s right, the margin, not the profits. The profit is what you have left after all the overhead is paid out. What’s not spent on actual healthcare is returned without regard for how much you individually cost them. We all get the same $5 back whether you’re a smoking diabetic who sustains themselves off bacon flavored Twinkies or a vegan cross-fit instructor.

Speaking of mergers and/or acquisitions, the same lobby that funneled over $100 million to anti-Obamacare campaigns, AHIP, now has a new person at its helm: Marilyn Tavenner. She was head of the Centers for Medicare and Medicaid Services (CMS). Responsible for the myriad – and let’s face it tedious – rules, protocols, and procedures within the ACA, she stepped down as caretaker in chief within the Administration in January and is assuming a role as chief executive at AHIP.

I guess now that she’s done everything she can to get Obamacare off the ground and running (stunning job on that healthcare-dot-gov launch, sweetheart), she will be protecting it from the largest healthcare lobby by joining its ranks. So she is fluent in the minutia of the ACA and is very well connected with the Obama administration. Gotta love that revolving door! It’s like Obamacare merged with or acquired its biggest dissenter.

Solution #3

The only one of the three that is a free market solution is the 3rd, for what is otherwise a fascistic law.

Reason described Obamacare perfectly:

Obamacare does not nationalize health insurance, but it turns the industry—already subject to extensive, (though mostly state-based) mandates and regulations—into a kind of quasi-public utility: a heavily subsidized, federally regulated product, with profit margins capped and rates subject to regulatory review, sold through government designed and run marketplaces to people who are required by law to buy the product.”

According to the Washington Post, “insurance companies are increasing their scales in an effort to cut administrative costs because the ACA has limited the amount of profit the plans can make. Larger companies will also allow insurers to make more efficient technology investments and eliminate duplicate departments and give them more negotiating power when dealing with hospitals and physicians”.

Does this mean the savings are passed down to us? Or does this mean costs will go up?

Neither are inherent to mergers. Mergers are meant to be profitable, and often can be seen as a market correction mechanism. So customers could benefit; whether that is a long or short term benefit is relative to the actors. It could allow for a vicious price war to get all the little players off the field and once the competition is eliminated, they can exploit their customers. Mergers unto themselves don’t make prices rise. The change in the competitive landscape brought on by mergers, however, can.

When Aetna and Prudential merged in 1999, a study in 2012 found that premiums went up by 7%. An analysis done by American Journal of Health Economics found that, “if all insurers active in each state’s individual insurance market in 2011 had participated in all ratings areas in that state’s HIM, we estimate this key premium would be 11.1% lower and 2014 federal subsidies would be reduced by $1.7 billion”. I.e. more participants, and more choices brings the price down. Shocker.

The AAFP, American Academy of Family Physicians, believes the mergers would have a negative effect on the availability and affordability of health insurance. “Bigger insurance companies mean increased leverage and unfair power over negotiating rates with hospitals and physicians,” the AAFP wrote. “More often than not, consolidation increases costs and reduces options for consumers.” (Source: CNN Money)

Will all the mergers even go through as is? I mean, it’s not like every merger has to have all or nothing terms. Perhaps the more appropriate question is: Will the government ALLOW the mergers to go through?

Some criteria through which regulators will filter these propositions according to FOX Business:

  • What does competition look like in the markets — in states and for different insurance products — where the companies now operate, and how might that change after the mergers?
  • How easy is it for new competitors to enter those markets? If the number of big companies is reduced, would new ones come in to fill the gap?
  • What is the impact of the health-care overhaul law on competition in the industry?

 

Wouldn’t it have been nice if this analysis was done BEFORE the law was passed?   I mean, ever think that the law would lead to mergers in the first place? And what kind of competition can you have when the products are dictated and the revenue margin is dictated?

As for the second filter, how could any new competitors enter the market without the same amount of scale but still working under the same mandates and restrictions?

The last question is too little too late! If it requires subsidies, mergers, and fixing the margins then it was never going to work in the first place.

Either these insurers are going to keep consolidating until there is only a single payer, or they are being set up to fail so that there will only be a single payer system. The 3rd possibility is one I sincerely hope is not true: a new healthcare bubble. Something about government subsidizing something to the tune of $700 billion over the next decade tells me we are in the midst of a possible new bubble.  The only players who have their margins capped are the insurance companies… not the data management, IT, device, or pharmaceutical companies; nor the doctors or hospitals.  So price controls on the insurers only won’t stop inflation.

The market is volatile and vulnerable at several points. Whether this law explodes or implodes is yet to be seen, but it isn’t even remotely sustainable. Can the US really afford to take a hit on what is currently 1/5 of their economy? Can YOU afford it, is the more important question.

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