Which Health Insurers Will Gain Most From Consolidation Trend

Includes: AET, ANTM, CI, HUM, WCG
by: Ron Sommer

Over the course of the past year, we have written several articles focusing on the effect healthcare reform is having on the health insurance sector. Our articles have primarily been about Humana (NYSE:HUM) and Amerigroup (AGP). The underlying thesis articulated in each article was that the reforms enacted during the current administration would drive merger and acquisitions, as insurers would benefit from economies of scale and greater numbers of subscribers even though reimbursement rates are expected to decline.

We expect the trend to consolidate to accelerate over the next two years, during which time the insurers are preparing for implementation of the Affordable Care Act. In recent days, Cigna Corporation (NYSE:CI) bid $3.8 billion to acquire HealthSpring Inc. (NYSE:HS), a smallish managed care organization whose primary focus is Medicare.

WellPoint (WLP), the number 2 health insurer by market share, increased its Medicare segment by acquiring CareMore Health Group earlier this year. Similarly, Humana acquired MD Care and Arcadian Management Services, both California-based Medicare Advantage providers.

Aetna, Inc. (NYSE:AET) has said it is interested in acquisitions that would boost its Medicare population. Aetna has the fewest Medicare customers among the five largest health insurers. If Aetna wants to catch up to their competitors, they may target Coventry Health Care (CVH) with 1.37 million Medicare customers or WellCare (NYSE:WCG), with 1.07 million. Amerigroup is acquiring Health Plus, a New York program with 320,000 members.

From what we can see now, many of the acquisitions are small, tuck-in types that augment the larger acquirer’s participation in a particular market or geographic region. As such, these small acquisitions do not, in themselves, create a change in market dynamics. However, in aggregate, they do change the landscape. For example, Texas, the fastest growing state also has the smallest insured population. This factor creates a fabulous opportunity for a company such as Amerigroup which is already the largest Medicaid provider in Texas. A Wall Street Journal article dated October 30, 2011, listed several companies they thought might be likely targets. This list includes Amerigroup, Coventry Health Care, among others.

Insurers are currently feeling the pressure of reduced memberships in their commercial lines as employers drop health insurance benefits. If the “individual mandate” is determined to be constitutional by the U.S. Supreme Court, tens of millions of people will be required to purchase insurance. Demographic changes are driving the Medicare segment of the market. The first of the baby boomers turned 65 this year and the population bulge from this group will be felt for years to come. Government programs are getting a more prominent, even dominant, role for the insurers.

Health system reform, in combination with economic factors, is expected to speed consolidation of health insurers. The prospect for mergers and acquisitions throughout the industry is high due to pending reform initiatives and greater access to financing. In addition, there are tax incentives for privately held companies to sell now when capital gains taxes are relatively low. There is an incentive for health care insurers to be very large to realize economies of scale and efficiency. Instead of mega-mergers among the big companies, we expect to see the majors buy-up the smaller regional providers.

We still like Humana, the second-largest Medicare provider, and Amerigroup. AGP is attractive as it continues to grow its business and offers the potential for being an acquisition target itself. We add to our list Aetna. AET is capable of doing a multi-billion dollar deal, propelling it past most of its competitors.

Disclosure: I am long HUM, AET, AGP.