The CVS-Aetna Deal is a Wake-Up Call for Incumbents

Coverage about the Aetna acquisition by CVS has been pervasive since last Monday’s announcement. The headlines in national, local and trade industry outlets reflect the balance of intrigue and skepticism that’s greeted the deal (see Fact File). Here’s what we know for sure:

It’s an acquisition by CVS. CVS is the buyer; Aetna is the seller. For the past few years, Aetna CEO Mark Bertolini had told analysts that the company was transforming itself from insurance to a multi-faceted strategy focused on analytics and partnerships with providers. He iterated the company’s acquisitions of Active Health, Medicity and several IT related entities and its partnerships with major health systems like Inova, Texas Health and others to illustrate the new focus. Meanwhile, United was pivoting to Optum as margins in the fully insured market shrank to 1.6% (Deloitte). The suspension of Aetna’s acquisition of Humana in February (costing $1 billion for the break-up fee and $775 million in transaction related expenses) coupled with continued regulatory uncertainty about the exchange marketplaces prompted the Aetna Board to ask what’s next. Concurrently, the AT&T-Time Warner combination was getting attention as a vertical integration play considered more likely to pass regulator muster than a horizontal integration deal. So, discussions started in October between the two companies who were already trading partners. In their briefing to the Wall Street Journal last week, analysts said the emphasis was on their long-term ambition to become a major player in healthcare noting the deal isn’t likely to close before the last half of 2018. They said the companies will continue to operate separately in the short term and they anticipate cost savings of $750 million by year two as administrative efficiencies are realized. And CVS is taking on $45 billion in debt to finance the deal—a source of concern to some analysts. But CVS is in the driver’s seat and Aetna will play a support role.

It’s a momentum play. The combination strategy aligns with four trends reshaping the healthcare industry in the U.S:

Increased pressure on drug costs: Drug cost reduction is gaining momentum as a political issue: recently, states like Maryland have passed legislation to limit drug price increases, and politicians are promising aggressive legislation to create more competition and quicker access to generics. In his confirmation testimony, HHS Secretary nominee Alex Azar has said that reducing drug cost is his number one priority. But in the supply chain of drugs, the juggernauts that add at least 50% to costs paid by individuals, employers, hospitals, Medicare and Medicaid are the middle-men: wholesalers and pharmacy benefits managers (PBMs). And each of these is controlled by 3 major players:  McKesson, Cardinal Health and Amerisource Bergen control 85% of the wholesale-distribution market and 70% of the 6 billion prescription claims are processed by 3 PBMs: Express Scripts, the CVS-Caremark business of CVS Health, UnitedHealth’s OptumRx. The combination of CVS’ Caremark with Aetna’s pharmacy benefits management operation will result in its control of 33% of the PBM market which will be a major focus of regulator attention. To secure approval from the FTC, assurance by CVS-Aetna that it will reduce consumer costs for drugs will be a key selling point, using its muscle as the largest PBM and operator of 1 in 6 drugstores in the country.

Increased demand for effective chronic care management: Chronic care represents 84% of total health spending and 99% of Medicare outlays (CMS). At least 50% of the population has at least one chronic ailment, attracting funding for more than 500 digital therapeutics start-ups since 2014 (CB Insights). Chronic care management is dependent on connectivity between accessible, comprehensive primary care services and individuals who are engaged in their own care. It’s more than periodic visits to primary care physicians. It’s nutrition, behavioral and physical health, health coaching, medication management, dental care and more, delivered via digital platforms, classes and personal coaching based on customized treatment plans that consider the individual’s signs, symptoms, risks, co-morbidities, genetics, preferences, values and social circumstances. That’s the rationale for CVS-Aetna’s plan to re-make their 9700 retail sites into community health centers and expand its 1100 retail clinic capabilities to include preventive health, chronic care, medication management services, infusion services alongside its healthy foods and over the counter products.  “Our vision is to create a ‘connected’ health experience that makes it radically easier for people to save time and money—and stay healthy. (Brian Tilzer Chief Digital Officer, CVS). Notably, in its outlook for investors, CVS-Aetna say they will expand their clinics to 1500 and their Transform Care diabetes to asthma, hypertension, hypercholesterolemia, and depression in the next 2 years. They already employ 30,000 clinicians—that’s likely to increase and the scope of practice offered by its nurses, pharmacists and allied health professionals expand as they execute their plan.

Increased use of analytics and information technologies to capture data and customize services. Each organization brings significant capability in predictive analytics: the combined CVS-Aetna will have expanded access to clinical, pharmacy, claims, and consumer data to enhance the CVS Health Engagement Engine’s capabilities. Aetna’s high-performance networks will be enhanced with the addition of CVS’s Transform Care Program and Epic’s Healthy Planet PHM platform--likely the core IT platform for the enterprise. And telehealth will play a larger role: CVS has partnered with American Well, Doctor on Demand, and Teladoc to offer customers another vehicle for low-acuity care. (Aetna is Teladoc’s biggest customer along with other insurers). The combination of these capabilities means more precision in diagnosing and treating medical problems in the community care hubs, resulting in avoidance of unnecessary emergency room visits, hospital admissions and redundant testing.

Increased consumer demand for value. 51% of the 180 million Americans with employer or individual coverage has at least a $1000 deductible—up from 31% in 2011 and 45% in 2015 (Kaiser HRET). And, over the past 20 years, household discretionary spending for healthcare has increased 105% vs. 55% overall inflation growth (US Dept. of Commerce). For workers with employer-sponsored health insurance, out-of-pocket spending for deductible and coinsurance payments increased by 230% and 89%, respectively, compared to a 56% increase in payments by health plans. In 2015, more than one-third of a brand medicine’s list price was rebated back to health plans or were kept by other stakeholders. But consumers saw little of the discounting: they paid higher prices while insurers passed on discounts to their shareholders. Beyond offering lower priced drugs to consumers, CVS says it will enhance access to services: 70% of the U.S. population lives within 3 miles of a CVS Pharmacy and a visit to a Minute Clinic from check-in to check-out is 32 minutes on average vs. 69 minutes for a scheduled appointment with a clinician (Athena Health). So, CVS-Aetna has the potential to offer an attractive value proposition to consumers—lower costs, convenient locations, online access, customized care and a business model focused on healthiness.

It’s a strategic response to Amazon, Optum and consolidation among hospitals. Skeptics and cheerleaders recognize that CVS’ brand, scale, and ambition align well with trends in the industry and pose a competitive threat to heavy weights like Optum and Amazon. The CVS-Aetna deal will result in a company with $221 billion in revenue and $18.5 billion in EBITDA. It will rank fourth on the Fortune 100 list and have a trading relationship with one in three Americans already. Meanwhile, last week rival UnitedHealth announced last week it had reached a deal to acquire the DaVita Medical Group for $4.9 billion adding 300 clinics, 35 urgent-care centers and 6 outpatient surgery centers and the creation of Optum Ventures, a $250 million venture fund to invest in startup and early-stage companies whose “innovations will help advance the health care system.” And rumors are swirling that Amazon will enter the drug distribution space and Walmart’s potential acquisition of Humana. Big vertical integration deals! The staple among hospitals and insurers has been horizontal integration: consolidation is a strategy that’s gaining momentum. Just last week, Catholic Health Initiatives and Dignity Health announced they will merge, operating 139 hospitals, 700 care sites with 25,000 physicians in 28 states and $24.8 billion revenue and Ascension said it will merge with Providence-St. Josephs resulting in 191 hospitals with $44.7 billion revenue. The big bet in vertical and horizontal integration is scale and scope. The U.S. healthcare market is big ($3.3 trillion), fragmented and growing. The CVS-Aetna combination proposes to rein in its costs, organize its care and engage consumers directly by making it more navigable, transparent and affordable. And it plans to do so on a national scale.

Will the deal get done? No one knows for sure. A first clue will be where the case for their combination is to be reviewed: if at the Department of Justice, market concentration consideration will weigh heavily. If at the Federal Trade Commission, where many analysts expect it to end up, the trickle-down impact on consumers and competition will get scrutiny. Regardless, it’s not likely tangible evidence of the mega-deal will be evident in communities before next year. Nonetheless, for incumbents in every sector of the system, there are obvious implications:

  • Scale, scope and cost-effectiveness will be a key differentiator. Simply dominating a local market is not enough. Advantages to achieve lower costs by controlling the supply chain directly and offering a broader range of services across a larger region is necessary for sustainability.
  • Primary care services will be the frontline. Primary care will be more than visits to internists, pediatricians, and family physicians. It will be strategically located urgent care centers, a blend of physical and behavioral health, customized care plans, health coaching, ophthalmic and dental care, financial counseling, and medication management—all coordinated through digital technologies that facilitate daily connectivity between care hubs and individuals. And these hubs will compete to manage your care and its cost, not one or the other!
  • Relationships with hospitals will be re-configured. Aetna has joint venture relationships with 5 health systems (Allina Health, Banner Health, Inova Health, Sutter Health, Texas Health Resources) and provides administrative services to several accountable care organizations (aka the Medicare Shared Savings Program). It promises to enhance these through its relationship with CVS. For other hospitals, the future is not so clear. Operating margins are thin: last week, Moody’s and Fitch each issued a negative outlook for not-for-profit healthcare, citing lower margins and increased bad debt as key factors. But hospitals employ 33% of physicians (MGMA) and more than a hundred sponsor health insurance plans (AHA). Something’s gotta’ give.
  • Managing consumer expectations and behaviors will be key to financial results.Healthcare is one of the least digitized, least price transparent and least productive industries in our economy (McKinsey) ranking above agriculture and construction but well behind others. The new normal puts a premium on managing relationships with individuals—a far cry from intermittent visits with patients. It requires enormous investments in analytics to measure and monitor needs and wants, and a well-executed strategy to deliver more value at a lower cost.
  • The regulatory framework for policing the “new normal” will be dynamic and confusing. Horizontal integration (mergers between players in the same sector) has been the staple of healthcare. Vertical integration has been slower to evolve. The CVS-Aetna deal expands and accelerates vertical integration in U.S. healthcare, forcing policymakers to re-calibrate regulations that presume all healthcare is local, healthcare is about diagnoses and treatments, competition is intramural within sectors, quality is in unmeasurable, costs are not manageable and consumers are patients or enrollees. These sacred cows are likely to be slain. And regulations like EMTALA requiring hospitals to take all comers regardless of their ability to pay, reporting about quality and safety and a myriad, scope of practice issues around pharmacists, advanced practice nursing and a host of substantive regulatory hurdles are likely to surface. They’ll not derail these vertical integration deals; they’ll simply be navigated.
  • And the role trade associations play will be tested. Trade associations provide valuable advocacy and member services to the sectors they serve. But as bigger entities emerge that operate across multiple sectors, the role, scope, dues structure and value proposition for trade associations in healthcare will change. The conflict in each trade group will be between members who seek to protect the status quo and those who see a substantially altered role for their organization.

The CVS-Aetna combination is a wake-up call for many incumbent organizations in our system. The over-riding consideration is cost: though spending growth slowed a bit to 4.3% from 5.8% in 2015, it climbed 0.2% to 17.9% of the GDP (CMS) and employer coverage dropped from 56% to 53% (HRET/Kaiser). House Majority leader Ryan said last week that reducing costs associated with Medicare and Medicaid would be priorities in next year’s legislative agenda, as deficits become an issue in the 2018 and 2020 election cycles just ahead.

Is the CVS-Aetna deal a sure thing? The current bet is it will be approved with some possible changes in their overlapping Part D prescription drug programs.

Are other mega-deals likely? Speculation is already swirling around other mega-deals as consultants and investment bankers circle around potential deals.

Is it Armageddon for the traditional incumbents in the system? No, but it should spark boards and senior managers to think outside the box and refresh strategic plans replacing narrow assumptions that are sector specific with thoughtful assumptions about the entire system.

The CVS-Aetna deal is a wake-up call for incumbents. How each responds and their pace of change is worth watching.

Paul
 
Fact File

Key Stats: CVS-Aetna Scale:

  • Retail pharmacy: 9700 retail sites (includes Brazil, Puerto Rico)
  • Access: 70% of U.S. population lives within 3 miles of a CVS Pharmacy; 50% of U.S. population lives within 10 miles of a Minute Clinic
  • Fulfillment: 65 million unique patients filled at least one script at CVS in 2016; 1.1 billion scripts annually including 144 million auto fills via ReadyFill/ScriptSync (telephonic/text messaging connectivity with 95%)
  • Pharmacy benefits management: Via Caremark, 90 million members with 97% retention including 40% of revenues from infusion therapies through Coram
  • Medicare: 5.5 million members in Silver Script
  • Retail clinics: 1100 locations, 30,000 clinical professionals, 37 million annual visits plus 140 million consultations with pharmacists
  • Members: (Aetna) 22.2 million members
  • Combined financials: $221.4 billion in revenue and $18.5 billion in operating income in the 12 months ending Sept. 30, 2017.

December 3-5, 2017 Headlines about Aetna acquisition by CVS

  • “CVS to Buy Aetna for $69 Billion in a Deal that May Reshape the Healthcare Industry” (Michael de la Merced, Reed Abelson New York Times December 3, 2017)
  • “The CVS-Aetna deal is actually all about Amazon” (Sarah Todd Quartz Media December 3, 2017)
  • “CVS-Aetna deal to change how big employers buy health benefits” (Caroline Hummer Reuters December 3, 2017)
  • “Why Wall Street is Skeptical of the CVS-Aetna Deal” (Bloomberg December 4, 2017)
  • “Five questions for the CVS-Aetna deal” (Nathaniel Weixel The Hill December 4, 2017)
  • “With Aetna Deal, CVS Looks To Turn Stores Into Health Care Hubs” (Alison Kodjak National Public Radio December 4, 2017)
  • “CVS-Aetna deal could spur a wave of changes on how Americans get treatment” (Martha C. White NBC News December 4, 2017)   
  • “3 Takeaways from the CVS-Aetna Merger” (Steve Brozak, Forbes December 4, 2017)
  • “CVS buys Aetna: How the deal will affect you” (Nathan Bomey, USA TODAY December 4, 2017)
  • “What the CVS-Aetna deal means for you” (Jacob Passy MarketWatch Dec 4, 2017)
  • “CVS-Aetna Is More Tortoise Than Hare” (Charley Grant Wall Street Journal December 4, 2017)
  • “Aetna-CVS behemoth would nudge patients toward drug store” (Darius Tahir, Paul Demko Politico December 4, 2017)
  • “CVS and Aetna stocks slide on news of merger deal” (Samantha Masunaga Los Angeles Times December 4, 2017)
  • “How the CVS-Aetna Deal Could Change your Visit to your Neighborhood Drugstore” (Dallas Morning News December 4, 2017)
  • “CVS and Aetna seek community-based care model in giant healthcare deal” (Shelby Livingston Modern Healthcare December 4, 2017)
  • “Allina doesn't see CVS' blockbuster deal upending its venture with Aetna” (Joe Carlson Minneapolis Star Tribune)
  • “CVS-Aetna Merger a Bid to Bring Down Costs, Gain Competitive Edge” (California Healthline December 4, 2017)
  •  “CVS and Aetna Say Merger Will Improve your Healthcare. Can they Deliver?” (Reed Abelson, Katie Thomas New York Times December 4, 2017)
  • “CVS-Aetna deal may hinge on antitrust approach under Trump” (Robert Langreth, David Mclaughlin, Zachary Tracer Chicago Tribune December 4, 2017)
  • “The CVS-Aetna Gamble: A Health-Care Giant Not Built Around Doctors" (Anna Wilde Matthews, Jane Terlop Wall Street Journal December 4, 2017)
  • “CVS-Aetna Deal Could Start a Health Takeover Run" (Robert Langreth Bloomberg Markets December 4, 2017)
  • “Aetna’s Outgoing CEO Set to Reap About $500 Million if CVS Deal Closes” (Dana Mattioli, Anna Wilde Mathews, Nathan Becker Wall Street Journal December 5, 2017)
  • “What the CVS-Aetna deal means for consumers” (Paul R. La Monica Money/CNN December 5, 2017)
  • “CVS likely wants FTC antitrust review, not Justice Department, of Aetna deal” (Reuters Staff December 5, 2017)
  • “3 Takeaways from the CVS-Aetna Merger” (Steve Brozak, Forbes December 4, 2017)
  • “What the CVS-Aetna deal means for consumers” (Paul R. La Monica Money/CNN  December 5, 2017)
  • “With Aetna Deal, CVS Looks To Turn Stores Into Health Care Hubs” (Alison Kodjak National Public Radio December 5, 2017)
  • “CVS buying Aetna: transformative or intrusive?” (Harold Brubaker Philadelphia Inquirer December 5, 2017)

Other Sources:

Claxton G, Levitt L, Long M, et al. Increases in cost-sharing payments have far outpaced wage growth. Peterson-Kaiser Health System Tracker. October 4, 2017.

PhRMA. Commercially-insured patients pay undiscounted list prices for one in five brand prescriptions, accounting for half of out-of-pocket spending on brand medicines. March 2017.

QuintilesIMS. Medicine use and spending in the U.S.: a review of 2016 and outlook to 2021.

Fein AJ; Drug Channels Institute. The 2017 economic report on U.S. pharmacies and pharmacy benefit managers. Exhibit 72. February 2017.