(Bloomberg View) — Health care consolidation is not a sexy issue. It’s not the sort of thing you want to bring up at a dinner party, unless you’ve already completely exhausted proposed changes to the local noise ordinances, the weather, and the best way to get from LA to Newport Beach without enduring the 405. And yet, this is a topic you ought to pay attention to, because the mergers creating mega-insurers and mega-providers are going to have a big impact on your life in the near future.
Why do I bring this up now, when we’ve hardly begun to plumb the possibilities inherent in taking Route 1 to the 710? Well, because Anthem is inking a deal to buy Cigna for $48 billion. As my Bloomberg colleagues noted yesterday, “An acquisition would add to a wave of consolidation sweeping over the health-insurance industry.” This, coming close on the heels of an Aetna merger, is of some concern to antitrust people, according to the Wall Street Journal: “Antitrust regulators are expected to closely examine the implications of the two tandem deals and a third, smaller transaction announced earlier this month.”
Consolidation in the health care industry is not new. It’s been consolidating ever since the days of the proverbial country doctor, trotting down the back roads to house calls. But it is becoming critical now, because we’ve got a vast new health care entitlement, and both the cost and the performance of that program are going to be affected by this trend. Obamacare is also going to drive further consolidation.
There can be a few factors behind consolidation. For example, massive economies of scale. Or … well, I’m afraid this is a bit delicate, but I can’t let it go unmentioned: Industries consolidate to reduce the number of players in the market, giving the remaining players more pricing power. Antitrust regulators tend to put on their big frowny face if companies cite the latter reason, so the public statements made by companies in consolidating industries tend to focus on more superficially attractive reasons like cost savings and “broader industry reach,” or more ethereally vague words like “synergies.”
True to form, Anthem is claiming that nearly $2 billion in synergy savings will be realized by the merged entities. This is probably true, to some extent. But you should keep in mind that mergers are themselves extremely costly. And I don’t just mean the fabulous fees that investment bankers and consultants collect to facilitate them. Joining two entities into one is really difficult: corporate cultures clash, turf wars damage morale and profits, IT systems never do work right together, key employees leave, customers are alienated. So in general, these sorts of statements should be taken, not just with a grain of salt, but while sitting next to a salt lick with a big bag of Mr. Salty Pretzels and some cocktail peanuts to wash the whole thing down.
So why is the insurance industry consolidating? Lots of reasons. First of all, heavily regulated industries thrive on consolidation. These companies have a lot of regulatory overhead, first of all for compliance, and second of all for lobbying. The bigger you are, the easier it is to afford a team of experts to make sure that you understand all the pertinent regulations, and a second team of experts to prevent legislators and bureaucrats from burdening you with a lot more pertinent regulations. These are largely fixed costs, and merging reduces them. Getting bigger also makes it harder for legislators to refuse to return your phone calls.
Second of all, Obamacare’s new exchanges may play at least a small role. Not all of it, by a long shot — the individual market for health insurance is a small and not particularly well-loved part of insurers’ overall business. However, that piece may get larger, if Obamacare succeeds in restructuring the market for health care, as employers convert more positions to part-time jobs without benefits, or decide it’s easier to give people money to shop on the exchanges than to keep dealing with the hassle of providing health insurance. And thanks to the exchanges, that individual market is now competing on price more than it did in the past, because prices are now completely transparent and roughly comparable. Pricing power suddenly matters more, not so much the power to charge consumers more, but the power to pay suppliers less.
Which brings us to the third big reason for merging: They are under pressure from other parts of the industry that are also consolidating. Hospital networks have gotten bigger and more powerful. Physicians are increasingly going to work for hospitals or large practices. This could put insurers at a disadvantage to negotiate prices. If your suppliers are highly fragmented, you can walk into the meeting and say “here’s what we’re offering; take it or leave it.” But if there are only two or three big hospital networks in your area, they can say the same thing to you. This has produced something of an arms race between insurers and providers trying to get bigger so they will better be able to crush the other. When Mothra and Godzilla are battling over the city, you don’t want to be the tiny human standing on the ground between them.