Aetna's plans announced Monday to acquire Coventry Health Care Inc. for $5.6 billion could catapult the insurance giant to the front of an industry race to capitalize on Obamacare and the health needs of aging baby boomers.
The deal, subject to approval by Coventry stockholders and industry regulators, is expected to be completed in mid-2013.
Aetna said it would pay about $5.6 billion to acquire Bethesda-based Coventry and will take on the company's debt, driving up the total value of the transaction to $7.3 billion.
The move is the latest development in a trend that has the nation's largest health insurers buying up smaller health plans to get a larger part of the ballooning Medicare and Medicaid markets.
Medicare enrollment will expand in the next two decades as more and more baby boomers reach the eligibility age of 65. Medicaid, too, is set for massive expansion. In 2014, federal health care reform under the Affordable Care Act — often called Obamacare — expands the market for insurance companies to administer government-funded Medicaid plans for the poor and disabled.
Additionally, federal reform is squeezing insurers' profits, which has driven managed care companies such as Aetna to expand by buying out competitors, said David H. Windley, an analyst at Jefferies & Co. in Nashville, Tenn.
"A lot of this is driven by regulatory compliance under the Affordable Care Act," Windley said. "There are limits on profitability through underwriting; the growth comes through acquisitions."
In Coventry, Aetna would get a company that has a reputation for being well-run with a strong management team. The deal would increase its business in government programs and enable Aetna to better compete with WellPoint and UnitedHealth over the next decade, analysts said.
In a statement announcing Aetna's plans, Chairman and CEO Mark T. Bertolini said: "Integrating Coventry into Aetna will complement our strategy to expand our core insurance business, increase our presence in the fast-growing government sector and expand our relationships with providers in local geographies.
"Coventry has distinct capabilities and a local market focus that will accelerate our efforts to bring simpler, more affordable products to consumer insurance exchanges in 2014 and beyond," Bertolini said.
Health insurers' profits are squeezed as never before. Starting last year, under federal regulations, all health insurers must spend a minimum amount of revenue on medical expenses for customers — 85 cents of every premium dollar for people in large-group plans, and 80 cents of each premium dollar in small-group and individual-market health plans.
In the past, a health insurer's shareholders benefited when the insurer spent the least amount of every premium dollar on medical expenses. With federal constraints on profit, insurers are looking for better profits by serving more members through acquisitions and then reducing administrative costs, including jobs.
With the purchase of Coventry, Aetna expects to eliminate $400 million annually from expenses by 2015.
"These cost efficiencies will support our efforts to drive costs out of the system and offer products at a lower price point in the marketplace," said Aetna's chief financial officer, Joseph M. Zubretsky.
Windley, the Jefferies & Co. analyst, said the acquisition allows for the cutting of corporate overhead even as new members are added.
"A good chunk of that comes from employment," Windley said. "Not much on the Aetna side; most on the Coventry side."
How, exactly, the cost cutting might affect jobs remains unclear.
"While we are constantly focused on managing our staff levels to align with membership, we do not anticipate any immediate impact as a result of this pending acquisition," said Aetna spokeswoman Cynthia Michener. "Until the acquisition closes, Aetna and Coventry will continue to operate as two separate companies. After that, we will begin a staged integration process that will involve employees of both companies. We expect to address any overlap in similar functions over time."
The offer is 65 percent cash and 35 percent stock, with Coventry stockholders receiving $27.30 in cash and a fraction of Aetna common shares for each Coventry share. In total, the acquisition value is $42.08 per share of Coventry — about 20 percent higher than Friday's closing price of $34.94.
The purchase would boost Hartford, Conn.-based Aetna's total medical membership in health plans from 18 million to 23.3 million in an industry dominated by five major players.
The acquisition keeps Aetna squarely in position as the nation's third-largest insurer. UnitedHealth Group has 35.9 million members and WellPoint has 33.5 million. Aetna, however, jumped ahead of Cigna Corp., which has 12.6 million members, and Humana, which has 12 million.
Thomas A. Carroll, an analyst at Stifel, Nicolaus & Co. in St. Louis, said, in a note to investors that Coventry's former chief financial officer Shawn Guertin, is now a senior financial officer at Aetna.
Carroll wrote, "As such, the due diligence and integration process is likely well informed and may increase the probability of a successful deal."
The deal will increase Aetna's negotiating power with providers, something larger diversified peers such as WellPoint have already done through acquisitions.
"The market, in general, thought that Aetna needed to match that," Windley said. "They are doing that with this transaction."
Similarly, Cigna bought HealthSpring in November 2011 for $3.8 billion to boost its Medicare business.