Company Intelligence

Analysts See Slow Start to M&A in 2010,
But Volume May Increase in Wake of Reform

Uncertainty created by possible health care reform legislation and the slow pace of economic recovery has had a chilling effect on mergers and acquisitions (M&A) in the health insurance industry. But the underlying trend of consolidation will continue — and purchases, alliances and sales are likely to pick up in 2010 once health insurers assess the impact of reform, according to equities and ratings analysts. Among likely acquisition targets are Medicaid health plans, care coordination companies and other firms that could help round out insurers’ capabilities.

In 2010, “I don’t think it’s likely that we’ll see any large deals,” says Matthew Coffina, an equities analyst at Morningstar, Inc. “It’s unlikely that you’d see any of the publicly traded plans buy each other.”

Smaller insurers also aren’t particularly acquisitive now, says Joseph Marinucci, a credit analyst at ratings company Standard & Poor’s (S&P), partly because of difficulties accessing financing. He adds that “the largest players clearly still have the ability to pursue transactions.” And although access to capital has improved recently, many insurers still have underlying issues with cash flow, according to Marinucci.

The managed care segment had 28 M&A transactions in 2007 and 16 in 2008, according to Irving Levin Associates. There was just one deal in the first quarter of 2009, four in the second quarter and seven in the third quarter, the company says.

Another barrier to acquisitions is the “regulatory spotlight” insurers are under right now, Coffina tells HPW. “After health care reform is complete, I think that opens up the door for some more deals,” he predicts — “assuming that there are no new hurdles” like the repeal of the federal antitrust exemption granted to health insurers, which may be eliminated as part of health care reform legislation.

“I think the M&A front will remain slow until there’s greater clarity as to what will come out of Congress,” agrees Steve Shubitz, an equities analyst with St. Louis-based Edward Jones. That’s “largely because plans will remain cautious in adding to areas such as the individual/small-group or Medicare markets, which may come under increased pressure from health reform.” Still, the individual, small-group and Medicare markets could grow much larger if legislation leading to coverage expansion is enacted.

“If some legislation does become law,…health insurers should be better positioned” to develop alliances that will allow them to remain viable — or implement exit strategies for business lines that have become more risky, Marinucci says. And while there won’t be a “flurry of activity” before the ink dries on the bill, the pace of M&A should increase six to 12 months later, he predicts.

Some provisions in pending health care reform legislation would make certain types of transactions more likely than others, says Brad Ellis, a director at Fitch Ratings in Chicago. “The worst-case scenario would be that the government comes up with a public plan that reimburses providers at Medicare rates. They would then be able to charge the public below-market [premium] rates,” he tells HPW.

In such a situation, “there’s going to be a focus on cost reduction,” Ellis reasons. For example, “some of the larger plans are going to try to acquire some type of way to lower costs,” perhaps by finding an innovative way to integrate delivery and insurance systems, he says.

Plans Could Sell Non-Core Lines

Insurers also may sell off non-core businesses such as PBMs in an effort to retire debt and restructure balance sheets. For example, both CIGNA Corp. and Aetna Inc. reportedly have evaluated possible sales of their PBM units. CIGNA told investors Nov. 5 that it had ruled out a sale after taking a “thorough and hard look” at its PBM subsidiary. Aetna has not addressed speculation regarding a spinoff of its PBM.

Among sectors and companies that may be 2010 acquisition targets:

Such deals would be “strategic in nature, buying competencies or enhancing skill sets,” Marinucci says — and may be particularly important if health reform brings new pressure to cut costs.

But Coffina disagrees. “My impression is that these companies are trying to get out of ancillary businesses more so than they’re trying to acquire new ones,” he says.

The exception to that rule is UnitedHealth Group, he says, since United executives “already have a lot of experience with these complementary businesses. They can operate them through [the] Ingenix or OptumHealth [subsidiaries].”

But, Ellis warns, “it’s a difficult market for Medicaid right now. We’re seeing growth in the volume of markets” because of rising unemployment. “But state budgets are in bad shape, and reimbursement rate increases probably aren’t what they need to be.”

Coffina calls Health Net “a logical acquisition target” among publicly traded health insurers. “The remaining business is relatively small,” he says.

Health Net’s Fate Is Tied to TRICARE

Health Net’s fate likely is tied to the outcome of its TRICARE bid, analysts says. “If they aren’t successful in that contract [renewal], it’s more likely that they would be acquired by somebody,” says Ellis. And if Health Net does retain the contract, “it may have some bearing on it [i.e., a possible sale] — or at least on the price” Health Net could hope to negotiate, he says.

Health Net’s share price rose 7% to $17.16 on Nov. 5 after the company disclosed that the Government Accountability Office upheld its protest of the Department of Defense’s decision to award a TRICARE contract to rival Aetna Inc.

Ellis adds that there aren’t many potential purchasers for Health Net’s operations. WellPoint, Inc. and local Blue Cross plans likely would be blocked by state regulators from acquiring Health Net’s 2.5 million members in Arizona, California and Oregon. And UnitedHealth Group already has a large West Coast presence via its PacifiCare subsidiary.

Health Net spokesperson Margita Thompson declines to comment on the speculation.

Major Mergers and Acquisitions by Managed Care Firms in 2008

Reprinted from the December 22, 2008, issue of HEALTH PLAN WEEK, the industry's leading source of business, financial and regulatory news of health plans, PPOs, and POS plans.