Should regulators block CVS from buying Aetna?

Posted by The Economist

Should regulators block CVS from buying Aetna?

A proposed health-care merger raises difficult antitrust questions

AMERICA has a competition problem. Market concentration has risen in more than three-quarters of industries since the late 1990s. Concentration has led to higher profits and higher returns for shareholders at the expense of consumers. Antitrust authorities have become more supine: between 1970 and 1999, regulators brought an average of 16 cases a year in order to prevent big firms from becoming even bigger; between 2000 and 2014, that number fell below three.

Health care is one of the industries that has been marked by bouts of consolidation. The annual number of hospital mergers in America doubled between 2005 and 2015; the national market share of the four largest insurers went from 74% in 2006 to 83% in 2014. Trustbusters have recently showed more teeth. In February a federal judge blocked a proposed tie-up between Aetna and Humana, two health insurers. Antitrust authorities pruned an acquisition by Walgreens of Rite Aid, America’s second- and fifth-largest pharmacies respectively.

They may soon face another big test. CVS Health, the largest pharmacy, is reportedly in talks to buy Aetna for $66bn (see article), in what would be the country’s biggest-ever health-insurance deal. At first glance, it is hard to see why trustbusters would wave through this deal if they have balked at others. But look closer and the picture becomes more complex.

Trustbusters have been clamping down on “horizontal” mergers between direct rivals, such as Aetna and Humana. The CVS-Aetna deal would be a different animal. It is an example of “vertical integration”, in which separate bits of a supply chain are brought together under one roof. This tie-up would reach across three distinct layers of the health-care industry: the retail pharmacies for which CVS is famous; the pharmacy-benefit managers (PBM), intermediaries which negotiate drug prices on behalf of medical plans and whose number again includes CVS; and the insurers, like Aetna. Supporters of the deal argue that aligning the interests of insurers and pharmacies would reduce costs and improve life for consumers. An insurer that could send patients to walk-in clinics of the sort CVS owns would be better placed to monitor and improve results.

Antitrust types are usually less worried by the vertical integration of powerful firms than they are by horizontal mergers between them. The more market power a firm has, the greater its ability to set prices above the level that would prevail in a competitive market. If two such firms exist along a supply chain, prices are inflated at each stage. A tie-up between supplier and customer can solve this problem of “double marginalisation”. As a result, vertical integration can achieve lower prices for consumers.

In the case of CVS-Aetna, the incentive for the pharmacy-benefit manager to fatten its profits would disappear. The question then is would that benefit accrue to the consumer? That depends on whether firms are dominant in their respective markets. The benefits to consumers of a vertical merger disappear if one of the parties has a monopoly. The proposed deal between AT&T and Time Warner, for instance, fails this test. The monopoly that AT&T wields as a broadband provider in many parts of America means that rivals to Time Warner have no simple options for getting their content distributed there. Uncontested markets would have a similar impact on the CVS-Aetna deal: a combined entity would be free to restrict insured customers to CVS medications and clinics, for example, if it had no rivals to fear.

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