Cigna's Healthspring Purchase Highlights Increasingly Attractive Industry

Includes: CI
by: Dana Blankenhorn

Real health reform starts with someone having the power to say no to rising costs. The market cares less about who that is than about the ability to enforce it. But health insurers don't see always see that. They continue trying to grow the market. Given resistance by companies like Wal-Mart (NYSE:WMT) to price increases on employee insurance, they're plunging into the Medicare Advantage market.

Cigna's (NYSE:CI) purchase of Healthspring (NYSE:HS) fits this model. It follows by less than two weeks Humana's (NYSE:HUM) purchase of MD Care, another player in the same space. HealthSpring has been scaling up the last few years, buying Bravo Health and increasing free cash flow. That's because Medicare Advantage has two payment streams – the government and the patient. What government won't pay, the patient can be convinced to through additional premiums.

Real cost control comes at companies like Intermountain, which owns facilities and provides insurance coverage. This means it has its hands on both the income and expense side of the ledger; it has an incentive to keep costs down, but also to please patients.

Reform will come when this model becomes generalized. Companies like Healthspring are a first step along this road, because one way they reduce costs is by owning community health centers. Keeping people out of hospitals by managing them more closely in facilities with controlled costs is the way forward.

The purchase of HealthSpring, like that of MD Care, is the first step down this longer road. Once enough insurers own clinics for the elderly, look for them to buy clinics for other populations and, in time, acute care facilities.

But that will take time, because most facility owners worth buying have big shares of their local markets. Such deals will make sense only with consolidation, but consolidating insurance through clinic ownership is a step down this road.

For investors, all this means the insurers are slowly becoming a better, safer place to play. The more companies like Cigna gain control over their costs, the better investments they will make.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.