A merger between CVS Health and Aetna could be what the doctor ordered

STANLEY and Sidney Goldstein would scarcely recognise their creation. In 1963 the brothers opened a humble storefront in Lowell, Massachusetts, selling health and beauty products. Determined to put customers first, they named their enterprise Consumer Value Stores. Today the Goldsteins’ startup, soon afterwards sold to a bigger firm, is nothing short of a health-care Goliath.

Revenues at CVS Health reached $177bn last year, riches which come from 9,700 retail pharmacies and from its operations in mail-order drugs and sales of more expensive speciality medicines. The firm commands nearly a quarter of the American market for prescription drug sales (see chart). It is also the biggest pharmacy-benefit manager (PBM) in America, a type of middleman that negotiates bulk discounts on drugs with large pharmaceutical firms on behalf of employers and insurers.

Yet even that formidable position is not enough. CVS is reported to have made a bid for Aetna, a big American health insurer (both firms have refused to comment publicly). Aetna, which had revenues last year of about $63bn, is in a different business, serving mainly corporate clients by providing health insurance for their employees. The two companies already have a relationship, however, since CVS has a contract to serve as Aetna’s PBM. If consummated, the transaction would be one of the biggest ever in American health care (and a tie-up between the two would doubtless encourage other transactions of a similar nature). That raises two questions. Why would the two be contemplating a deal? And crucially, given the tendency of prior mergers to fatten profit margins rather than lower prices, would such consolidation yield benefits to consumers?

Start with the reasons for a deal. Health care is becoming increasingly unaffordable for American consumers. Since 2014, total health-care cost inflation has been 6-7%, owing to growth in the cost of everything from doctors and hospitals to medical devices and drugs. Such large rises cannot continue indefinitely.

Drug retailers in particular fear the prospect of Amazon entering their business. The e-commerce titan was recently reported to have sought regulatory approval to distribute pharmaceutical products in a dozen or so states. That news, which broke in October, prompted sharp falls in the shares of several firms in the pharmaceutical supply chain.

Selling drugs would be harder for Amazon than out-competing department stores, in part because consumers do not typically pay much of the cost of drugs (insurers do). If it has serious ambitions in health care, it might even be forced to build or buy a PBM. Even so, history suggests that the firm’s relentless focus on consumers and willingness to forgo profits for years make it a huge potential threat to incumbent pharmacies.

PBMs, once seen as cash cows, also face an uncertain future. These middlemen took off in the 2000s by promising to cut drug prices through aggregating demand and negotiating discounts with Big Pharma. Pembroke, an industry consultancy, estimates that the total value of drug rebates and discounts soared from $39bn in 2008 to $125bn in 2015. Some PBMs used questionable practices, including secret rebates (in addition to the discounts negotiated upfront on drug prices, that were passed on to PBM customers), which allowed them to pocket much of the savings rather than pass them on to insurers and employers and in turn, to consumers.

Anthem, a big health insurer, sued Express Scripts, which it fired as its PBM, for $15bn last year, alleging that the latter firm had withheld savings and overcharged it by huge sums (Express Scripts denies the allegations). In October Anthem unveiled plans to launch its own in-house PBM with help from CVS. UnitedHealth, another giant health insurer, acquired Catamaran, a big PBM, in 2015, and merged it into OptumRx, its in-house PBM.

Greater transparency in pricing is coming, argues Viren Mehta of Mehta Partners, an industry consultancy, be that through vertical integration (as in the purported deal between CVS and Aetna) or via the entry of a titan like Amazon. “If opacity is reduced, the PBMs lose market power and profits,” he says.

This combination of forces explains why a CVS-Aetna merger might make sense: to make CVS a more formidable competitor against possible new entrants, such as Amazon, into the bit of the business started by the Goldsteins, and to extract efficiencies by cutting out the middlemen in the health-care supply chain. Other such deals are easy to imagine. Analysts reckon that insurance firms including WellCare, Centene and Humana are potential targets for acquisition. As the biggest stand-alone PBM, Express Scripts is thought to be a potential target, too. Anthem, which may lose CVS as a partner if antitrust authorities prise the two firms apart as a condition of approving a CVS-Aetna deal, may soon be shopping for a new PBM.

The specific nature of these sorts of tie-up offers some reason to hope that the answer to the second question—whether consolidation will benefit consumers—will turn out to be positive. In the past, firms have typically joined horizontally within a market segment. This has generally led to oligopolies that enjoy fat profits but do little to lower prices and lift quality for patients. Such horizontal mergers have been increasingly frowned upon by regulators in recent years.

Up and down, not across

The CVS-Aetna deal is an effort at vertical integration, which by removing rent-seeking middlemen can, in theory at least, lead to more choice, better health outcomes and lower prices for consumers. If this seems far-fetched, consider the example of United’s pioneering use of data analytics and artificial intelligence at its in-house PBM. As costs spiral upwards, insurers’ interest in ensuring the good health of consumers deepens. Because United can now analyse both a patient’s medical files and her pharmacy records, it can track how medications are taken and whether or not they work well. A small group of integrated health-care systems in America, such as Kaiser Permanente, Intermountain and the Mayo Clinic, has been shown to have delivered better care and lower costs.

By creating a much more integrated firm, the CVS-Aetna deal could do the same. CVS already has more than a thousand MinuteClinics (cheap and cheerful health centres) at its pharmacies offering affordable medical care seven days a week. The combined firm would offer everything from basic health services to diagnostics to drug-infusion centres. It would have a strong incentive to make sure that customers have good access to primary care, including vaccinations, medical information, prescriptions, and follow-ups. “Consumers would save through lower premiums, lower out-of-pocket spending at preferred CVS outlets, or both,” reckons Adam Fein of Pembroke. Moreover, the accumulation of data on what interventions work best in similar patients would speed the personalisation of medicine.

In truth, no one knows how a CVS-Aetna deal would affect consumers of health care, as this structure of transaction, at this scale, has not been tried. The concern for patients—and for trustbusters—is what would happen if customers of a combined firm wanted to receive care from other clinics or buy drugs from other pharmacies, perhaps because it was restricting choice or increasing co-payments. The reason for hope is that this vertical deal could become a template for a new sort of health-care firm, which offers a lower-cost ecosystem of quality health care. That could be a boon to consumers; it would have pleased the Goldstein brothers, too.