Aetna Surrenders To The Forces Of Obamacare

| About: Aetna, Inc. (AET)

Summary

Aetna is focused on getting its Humana merger done, and is low-balling financial expectations.

The deal combines a leader in employer-paid health with one that wins on Obamacare exchanges.

Both have something to offer, and the combined firm will compete better with United Health.

The coming merger between Aetna (NYSE:AET) and Humana (NYSE:HUM) drew a Razzie from the Center for American Progress, a group closely aligned with President Obama. They predicted the partners' share in Medicare Advantage could let it raise costs to seniors.

But in fact the merger represents a triumph of Obamacare that not even a Republican will question.

Aetna announced better-than-expected earnings for its fourth quarter on February 1, with net income up 38% to $321 million, 91 cents per share, up from $232 million or 65 cents a year ago.

The improvement came down to cost-cutting. Revenue was up only slightly, from $14.77 billion to $15.05 billion. (Analysts had expected revenue of $14.95 billion.)

Aetna stock won't be jumping out of the gates February 1, as guidance is "light," below analyst forecasts. Aetna does not want regulators to know just how good its deal with Humana is before it's complete, and it knows there are going to be costs in making the combination happen, even while its CEO re-assures Humana employees they are a key component of the combined company.

That last is not smoke. There are two ways in which the combination is going to help cut health care costs. The first, most obvious, comes from raw bargaining power. Boston Children's Hospital thought its name and reputation would cause the insurer to shut up about costs? Wrong. As insurers get bigger, they can steer patients away from high-priced hospitals, regardless of reputation, so the hospital settled after Aetna threatened to cut it off.

But it's what Humana does that is, in fact, the key to this deal. Humana controls costs by limiting the networks available to patients, by demanding facilities use best practices and keep a lid on costs. (Which they're doing the most of depends on which side of a negotiation you're on.) This model failed in the 1990s when was called a "health maintenance organization" - Humana sold the hospitals it owned in the 1990s -- but the concept of owning clinics, employing doctors, and trying to keep people out of hospitals actually works.

Of the two partners, Aetna has been doing well with employer-paid plans while Humana has been doing better on the Obamacare exchanges. Aetna sends less of its money out to hospitals and takes out less in general overhead than Humana, while Humana does a better job on keeping outside referrals and drug costs down. Some of its tactics are questionable - it does not treat emergency rooms as "in-network," ever. But Humana has done a good job with Medicare patients, and bringing this discipline to Aetna's employer plans will make them more competitive.

Combine the $13.3 billion revenues of a typical Humana quarter with the $14.9 billion of Aetna, and you still don't get close to the $41.6 billion United Healthcare (NYSE:UNH) turns in. The purpose of this market consolidation is to create competition, not destroy it.

The merger will be approved, and once the companies are combined there should be more competition for UNH, more profit for Aetna-Humana, and perhaps even better rates for customers. It's a win-win-win. I would still rather own UNH than this combination, but the gap is going to narrow.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.