Recent press reports are speculating that CVS Health Corporation is seeking to acquire the health insurer Aetna.  The rumored transaction would create a new type of health care company that doesn’t currently exist:  one that combines a commercial health insurer with a retail pharmacy chain and a pharmacy benefit manager (PBM).  According to most reports, CVS would pay $66 – $70 billion to acquire Aetna (with Aetna stockholders receiving cash and CVS stock).  It’s said that the parties are trying to enter into a definitive agreement by year-end.    

Business Strategy for the Transaction   

To understand the transaction from CVS’s perspective, it’s helpful to first identify the components of the drug supply chain.  At the top of the chain is the drug manufacturer, followed by the wholesale distributor, the dispensing pharmacy, the PBM, the insurer, and finally the patient.  Currently, CVS participates in two of the five non-patient segments of the chain:  the pharmacy and PBM segments.

The Aetna acquisition will expand CVS’s service line offerings by adding a commercial insurance component.  The company currently operates an insurance business line through its SilverScript division, but that business is limited to Medicare Part D Prescription Drug Plans.  Acquiring Aetna will expand CVS’s insurance offerings to commercial health plans, Medicare Advantage plans, and other plan types to make CVS the third largest health insurer in the country.  The deal would effectively give CVS control over more of the chain between the manufacturer and the patient.  As a result, the deal could potentially allow CVS to keep a greater portion of the revenue from the various transactions that occur within the chain.

The acquisition is also consistent with CVS’s business philosophy, which is to be viewed as an integrated healthcare organization.  The acquisition follows a pattern of other acquisitions by the company over the last 12 years that were designed to broaden the company’s service line offerings outside of the retail pharmacy industry.  Examples of this include the Caremark merger in 2006 and, most recently, the Omnicare acquisition in 2015.

Amazon’s Rumored Entry into the Drug Supply Chain

The proposed transaction can also be seen as a defensive response by CVS to Amazon’s rumored entry into the drug supply chain.  Amazon could become a significant purchaser and distributer of drugs (relying upon its next day fulfillment capabilities).  If that were to occur, pharmacies and PBMs might lose market share as a result of providers and consumers preferring Amazon for the delivery of prescription drugs and other items.

It remains unclear what role (if any) Amazon will choose to play in the drug supply chain.  It was reported in October that Amazon successfully obtained wholesale distributor licenses in at least 12 states.  These licenses will allow Amazon to act as a wholesale distributor of drugs, medical supplies and durable medical equipment in those states.  This means that Amazon will be able to ship these items from the 12 states to hospitals, pharmacies, physicians and other providers.  However, these licenses are not the same as pharmacy licenses, which permit direct-to-consumer dispensing of prescription drugs.  Consequently, by obtaining these licenses first, it suggests that Amazon may seek to compete initially with other wholesale distributors like Cardinal Health and McKesson.

Of course, it’s possible (and perhaps even likely) that Amazon will eventually seek pharmacy licenses in some states in order to operate online or mail order pharmacies.  Since Amazon could face significant regulatory hurdles in obtaining the pharmacy licenses, Amazon may instead seek to acquire an existing pharmacy or PBM with mail order capabilities.  Given Amazon’s potential entry into the pharmacy marketplace, it’s understandable how a deal with Aetna might be viewed by CVS as a preemptive defensive measure.

Although CVS has served as Aetna’s PBM for several years, the acquisition could allow CVS to more closely manage Aetna enrollees if Amazon does enter the pharmacy marketplace.  Any potential threat to market share could be addressed through CVS gaining full control of the pharmacy benefit for the Aetna plan members, which will allow it to create stronger incentives for Aetna members to utilize CVS pharmacies.  Notwithstanding the advantages of Amazon’s next day delivery service, CVS would be able to structure the pharmacy benefit for Aetna plan members so it’s potentially less expensive for those plan members to fill their prescriptions through CVS retail or mail order pharmacies than if the members filled the prescriptions through Amazon.  This might be done through, among other things, offering lower priced drugs or reduced co-payments for prescriptions filled at CVS pharmacies.  What may be lost in discounted price can potentially be made up by increased volume given Aetna’s approximately 50 million members.

Potential Synergies for Cost-Savings and Care Efficiencies

The CVS – Aetna deal seems premised on a belief that certain cost-savings and care efficiencies can be realized where pharmacy benefit management and insurer functions are combined within one organization.  An insurer effectively has a captive membership (which it can control through its design of the medical and drug benefits).  A PBM negotiates with drug manufacturers and pharmacies for the delivery and reimbursement of prescription drugs to an insurer’s members pursuant to the insurer’s drug benefit design.

By integrating these functions, a number of synergies can potentially be achieved that impact cost and care delivery.  For example, there is the potential for gaining greater negotiating leverage with drug manufacturers.  This would come from a manufacturer being more willing to offer greater rebates for formulary placement knowing that the PBM with which it is negotiating actually controls the patients and drug benefit design.  There is also the potential for reduced medical and drug costs from better clinical management of patients.  A combination of Aetna’s insurance claims data with CVS’s pharmacy data could give the merged company greater insight into controlling overall health costs through more integrated management of patients.  Furthermore, since CVS has numerous touch-points with the consumer as a retailer, it can possibly influence consumers and manage outcomes in a way that traditional insurers can’t from having to rely upon a network of unaffiliated providers.  For example Aetna members could capitalize on the growing number of simple health services offered in CVS stores through MinuteClinic retail clinics, such as flu shots and testing services.  CVS could structure the medical benefit for Aetna members to incentivize them to use MinuteClinic over other more costly outpatient settings.

CVS Business Risk

One potential business risk that CVS may face with the deal involves the perception of CVS’s Caremark PBM by other health insurers.  In October, it was announced that Anthem (the country’s second largest health insurer) was developing its own PBM (IngenioRx).  This PBM will become operational in 2020 and be operated as a partnership with CVS.  The move comes as Anthem’s contract with PBM Express Scripts expires at the end of 2019.  Rather than renew with Express Scripts or contract with another PBM, Anthem decided to partner with CVS to form its own PBM in order to give the insurer greater control over the drug benefit design for its members.  Can CVS acquire Aetna and still be viewed by Anthem as a good business partner?  Anthem may question a partnership with CVS since CVS will simultaneously own one of Anthem’s chief competitors.  This illustrates a potentially broader issue that CVS may face.  How will other insurers now view CVS when considering what PBM to contract with for purposes of managing the prescription drug benefit for the insurer’s members?

Antitrust Scrutiny Likely 

The proposed CVS – Aetna transaction will likely undergo an antitrust review by the Department of Justice and the Federal Trade Commission.  Such a review will focus on concerns that regulators may have about the merged company lessening competition and increasing costs for consumers.

Over the last year, the federal government has shown a willingness to challenge large scale acquisitions within the healthcare industry.  Some recently proposed consolidations that the government has either opposed or sought to restructure have included Walgreens acquisition of Rite Aid, Anthem’s acquisition of Cigna, and Aetna’s acquisition of Humana.  These particular transactions involved horizontal mergers within a healthcare industry segment.  In the case of the insurer transactions, the government opposed the transactions, which resulted in both deals being abandoned by the parties.  In the case of the Walgreens – Rite Aid transaction, the government expressed significant concerns which resulted in a restructuring of the deal (with Walgreens agreeing to divest several hundred stores that were part of the original transaction).

The proposed CVS – Aetna transaction involves a vertical merger across industries (between an insurer, a retail pharmacy chain and a PBM).  A possible precedent for approving such a deal is the UnitedHealth acquisition of Catamaran.  In 2015, UnitedHealth acquired the independent PBM Catamaran without government opposition.  This PBM now operates as OptumRx (one of UnitedHealth’s Optum subsidiaries).  The CVS – Aetna transaction is similar to the UnitedHealth – Catamaran deal in that it will result in the combination of an insurer with a PBM.  Notwithstanding the UnitedHealth – Catamaran precedent, the CVS – Aetna deal will likely result in some level of antitrust review given the scope of the deal – it involves the #3 insurer, the #2 retail pharmacy chain and #2 PBM.  Moreover, the recent announcement that the government is opposing the proposed AT&T – Time Warner merger demonstrates that the government is currently not reluctant to challenge large scale vertical consolidations.

Future Industry Integration?

It’s unlikely that the CVS – Aetna deal will prompt a greater move toward more horizontal integration within the PBM industry, the retail pharmacy industry or the health insurance industry.  However, the deal could prompt further consolidations that result in vertical expansions.  Other insurers, retail pharmacies, PBMs, and drug manufacturers could look for partners across industry segments to protect market share and increase negotiating leverage.  Companies might see such integrations as necessary in order to stay competitive by matching CVS’s expanded service line offerings.  For example, could a CVS – Aetna merger prompt Walgreens to explore acquiring an insurer or a PBM?  Will other insurers seek to bring PBM operations in-house similar to UnitedHealth and Anthem?  Only time will tell.