This deal is being driven by cost-cutting
The possible merger of Anthem (ANTM) and Cigna (CI) is all about extracting synergies and driving down costs. As the Affordable Care Act puts pressure on health insurers, they need to cut costs in order to maintain margins. Since much of health insurance is technology-driven, increased scale matters a lot.
Anthem expects this transaction to be more than 10% accretive to earnings per share in the first year and double that after year two. Anthem is guiding more than $2 billion in synergies after year two. Pro forma EPS (earnings per share) in 2018 is expected to be $17 per share.
The industry is ripe for consolidation
We’ve had numerous press reports of merger activity in the managed care space. In late May, there were press reports that Humana (HUM) was in merger discussions with Cigna (CI), Aetna (AET), or Anthem (ANTM). Over the weekend, another report claimed that Aetna made an offer for Humana. Note that Cigna could go after Humana as a way to defend itself from Anthem. We’ve seen a lot of M&A (merger and acquisition) activity already in the healthcare sector but very little in the managed care space.
Another big reason for managed care M&A is negotiating power. Bigger companies can negotiate better prices with pharmaceutical companies and doctors. This dynamic will undoubtedly affect the regulatory review at various state levels. Hospital merger activity has outstripped managed care activity since the Affordable Care Act was passed.
Regulators will want a piece of the action
Given the large synergies involved, state regulators may well demand that the companies offer rate cuts in order to gain approval. Keep in mind that this sort of negotiation happens all the time in utility mergers, and insurance companies are as regulated as utilities. State regulators are going to demand at a minimum that service levels are kept up. The companies could find their synergy estimates overstated as the government grabs its piece of the action.