When two large and similar health care companies merge, the economic story tends to be pretty simple: They use their added power in the market to increase prices and profits. Consumers come out behind. At least this is true of horizontal mergers, like when an insurer buys an insurer or a hospital system buys a hospital system.
But vertical mergers between companies that make up different links along the health-care chain — like the just-approved merger between the pharmacy retailer CVS and the insurer Aetna — are more likely, under the right conditions, to produce benefits for consumers.
“I think the biggest source of optimism is on the cost side,” says Austin Frakt, an associate professor at the Boston University School of Public Health. “There have been, in other settings, places where the management of pharmacy benefits and the rest of the health-care benefit — when they’re bundled together, it does produce more value for consumers.”
Combining many different health-care functions under one roof can help address one of the persistent problems with the American health-care system: the disconnect between payments and outcomes.
As the system works now, you pay (or your employer pays, or the government pays) a variety of companies that provide different parts of the health care you need. And those companies get paid based on what services they provide, regardless of whether you get healthier.
Your pharmacy makes money if it sells you drugs. Your doctor makes money if he runs tests. Your hospital makes money if you have surgery. None of these service providers is likely to be focused enough on your integrated care. In theory, your health insurer does have good incentives to take the 30,000-foot view of your health — if you get good outpatient care today, it won’t have to pay to hospitalize you later — but it has limited control over what the other players in the system do.
The idea behind a merger like CVS and Aetna is to bring more of these functions under one roof. Aetna sells you a health plan, and then when you receive care at a CVS Minute Clinic, their focus should be on maintaining your health so Aetna doesn’t have to pay extra claims in the long run — instead of just focusing on what services they can bill your insurer for today.
The merger also helps address one of the costly oddities of American health care: Pharmacy benefit-management companies that operate separately from insurers. Insurers contract with these companies to determine drug formularies and negotiate prices with pharmaceutical companies and pharmacy retailers.
There are three big PBMs that dominate the market: Caremark, owned by CVS; Optum, owned by the insurer UnitedHealthcare; and Express Scripts.
In recent years, PBMs have developed a reputation for being a bit of a scam. They are supposed to represent the interests of insurers — and therefore, at least in theory, the customers who pay the insurance premiums that ultimately cover the cost of drugs — but in practice it’s hard even for the insurers to figure out how much the PBMs are doing to hold down costs, and how much of whatever cost savings they generate they’re keeping as profits.
“In a world of really small insurers, you want scale to negotiate with the pharmaceutical companies, so you saw PBMs emerge because they aggregate scale across the insurers,” said Craig Garthwaite, a health-care economist at the Kellogg School of Management at Northwestern. “But if you’re a big insurer you can do that on your own.”
By merging with CVS, and therefore acquiring Caremark, Aetna will begin doing that on its own. That’s increasingly looking like the norm for large insurers: UnitedHealthcare already owns Optum; Cigna will soon be merging with Express Scripts; and Humana has its own, smaller PBM.
In fact, despite all the attention to the merger, CVS-Aetna won’t have that unusual a business structure once they are merged.
The combined company will be in the health insurance, retail pharmacy, specialty pharmacy, pharmacy benefit mangement, and outpatient care businesses. UnitedHealthcare is already in all those lines of business (did you know they employ tens of thousands of doctors?) and Cigna and Express Scripts will be in most of them once their merger is completed. Humana has a growing partnership with Walmart; the two companies have been rumored as possible merger partners.
The big question for consumers is: Even if these vertically integrated companies are more efficient because make better care choices, or because they no longer have to pay a cut to PBMs, will they pass those improvements on to consumers in the form of lower prices?
“They might,” said Martin Gaynor, an economics professor at Carnegie Mellon and founder of the Health Care Cost Institute. “That’s going to depend on how competitive those insurance markets are. We know there are issues with competition in some health insurance markets.”
But there are some reasons for optimism. For one, “medical loss ratio” rules in the Affordable Care Act limit what fraction of premium revenue insurers can keep as profit from many plans. If they save enough through merger efficiencies, they’ll hit the cap and have no choice but to rebate the savings to customers.
Garthwaite is more confident the merger’s benefits will flow through to consumers. But he also leaves open the possibility that they might not materialize at all. He notes that improving value-for-money in health care is hard, and a lot of previous efforts have failed, even when incentives have been aligned correctly.
Kaiser Permanente’s managed care model is often cited as the holy grail of the benefits of vertical integration in health care. Oakland-based Kaiser sells the insurance, owns the hospitals, employs the doctors, dispenses the medication, and seems to produce superior results at better prices. People love the Kaiser model. Yet nobody has done a good job replicating it; even Kaiser has had limited success expanding it outside California.
Garthwaite chalks that up to the extreme complexity of running inpatient hospitals — and he’s eager to see more companies adopt the UnitedHealthcare approach of uniting most of the elements of care, without getting into the messy hospital business.
If that model is producing superior results, United may have been enjoying most of the benefits to itself as profit, since it’s setting prices in competition against companies that don’t share its business model. But with Aetna and Cigna and Humana copying the approach in their own ways, competitive pressures could force more of those financial returns back into the wallets of consumers — starting with this merger.