Mergers between insurers and hospitals expected to accelerate

Analysts say the trend may be pushed further by health system reform and greater access to financing the acquisitions.

By Emily Berry — Posted Oct. 25, 2010

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Health system reform, in combination with economic factors and trends in play, is expected to speed consolidation of health insurers and hospitals, leaving physicians to figure out how they should adapt.

The prospect for mergers and acquisitions throughout the industry is high thanks not only to health system reform, but also more access to financing to buy up other companies. In addition, a change in the 2011 capital gains tax means privately held companies will do better to sell this year, said Bill Baker, a Dallas-based health care transaction consultant. He is a partner at the consulting firm KPMG, where he leads the health care sector transaction advisory group.

"The overall outcome of the health care bill across numerous sectors is that it creates models that incentivize health care companies to be very large -- larger for the sake of driving efficiency," Baker said. "There is going to be less reimbursement available, less cash, and you're going to have to have scale."

Analysts expect to see the major health plans buy small regional health insurers rather than try blockbuster mergers of large companies. They said small insurers might want out of the business because of the capital needed to update technology and otherwise comply with minimum coverage and spending rules under health system reform. For large insurers, such deals can pass antitrust muster much more easily than mergers with big plans, analysts said.

One model for these deals is Coventry Health Care's purchases in 2010 of two Midwestern plans owned by small Catholic hospital systems. Analysts said that while the Coventry deals were not expressly driven by health reform, they are indicative of how mergers will go.

WellPoint executives have told investors they expect consolidation because of health reform. UnitedHealth Group executives have expressed the same sentiment to their investors.

Mike Mikan, executive vice president and chief financial officer at UnitedHealth Group, speaking to investors at a Morgan Stanley investors conference Sept. 14, said he sees not only mergers but also large plans taking on membership from companies that drop their health business or pull out of a market. The model he cited was United's deal to acquire the membership of Health Net when it pulled out of the Northeast in 2009.

A few weeks after Mikan's comments, United announced a similar arrangement with Principal Financial Group, which announced Sept. 30 that it would leave the health insurance market.

Larry Zimpleman, Principal's chair, president and CEO, said the company's medical business had diminished in comparison with its retirement and asset management business.

"The medical business continues to be one that undergoes rapid change, which would mean investing additional capital into the business to be able to offer competitive products," he said in a company news release. "For us, that just does not make sense."

When Principal's 14,000 employer clients' policies, representing 840,000 employees, expire during the next three years, United will get first rights to match them with similar coverage and "renew" those policies.

Effect on doctors

For physicians, an increasingly consolidated insurance market is generally bad news, experts say.

Even before health reform, insurance companies argued in favor of consolidation by promising efficiency of scale, but the resulting efficiencies typically lead only to better profits, not lower premiums, said J. James Rohack, MD, immediate past president of the American Medical Association.

Dr. Rohack is a cardiologist from Bryan, Texas, who practices at Scott & White, a physician-led health system that also operates a health plan. He is director of Scott & White's Center for Healthcare Policy and medical director for system improvement of the Scott & White Health Plan.

He said the AMA has been disappointed in federal authorities' recent failure to block deals, but there are signs federal regulators are looking more closely at proposed health plan mergers.

Advocates of stricter antitrust enforcement were heartened when Christine A. Varney, assistant attorney general in the Justice Dept.'s Antitrust Division, said this year that the department would "not hesitate to block the merger or to require the settlement concessions necessary to protect consumers" if the deal would diminish competition.

But some of the policy meant to improve the health care system will serve to further consolidate markets that the administration wants to see less concentrated. said John Callahan, a partner at the Chicago law firm McDermott Will & Emery who focuses on transactions in the health sector.

"Health care reform policies are driving consolidation, and at the same time antitrust enforcement is scrutinizing consolidation," he said.

Reform is triggering further hospital consolidation, analysts said.

Bigger health plans with greater market share carry a bigger stick when it comes to negotiating with hospitals. Hospitals are driven to consolidate so they can go head-to-head with payers, but also because of the demands of health system reform, analysts said.

For example, two single-hospital systems in Chicago's western suburbs, Central DuPage Hospital and Delnor Hospitals, announced Oct. 5 that they plan to combine.

"Further collaboration will strengthen our ability to provide exceptional levels of clinical care and become more responsive to the new requirements of health care reform, while also delivering an extraordinary patient experience," Thomas L. Wright, Delnor's president and chief executive officer, said in a statement.

Physician practices face the same challenges small hospitals do in making the investments necessary to comply with health system reform, Callahan said. "Not only do you have to provide a higher-quality service, you have to be able to prove that you did so. Right now hospitals don't have the infrastructure to meet those reporting requirements, and certainly very few physicians offices do."

Analysts said that could intensify pressure on some practices to combine with others, or ally with a hospital -- trends that were apparent before health system reform was enacted.

An example of the kind of transaction Callahan predicted was announced Oct. 6, when multispecialty physician group IHA, which is made up of 150 physicians at 32 locations, announced it would merge with St. Joseph Mercy Health Systems, a seven-hospital system based in Ann Arbor, Mich.

"Hospitals and physicians together are facing future expectations for rapid improvements in quality of care and value as accountable health networks that would be difficult to achieve independently," Mary Durfee, MD, quality medical director and president of IHA, said in a statement.

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