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It isn’t rocket science, or, to use a more fitting analogy, brain surgery. Health insurance is a scale business. Once the infrastructure to process and pay claims has been built, customers can be put on without adding much cost. So when one insurer buys another, and moves the target’s enrollees to its own platform, a pop in margins usually follows. No wonder that in a decade there have been 15 acquisitions, each worth at least $500m, according to Dealogic.
It also explains why Aetna’s shares moved up on Monday after it announced its plan to buy Coventry Health Care for $42 a share in cash and stock, for an enterprise value of $7.3bn. That is a 20 per cent, or about $1bn, premium to Friday’s closing price. Aetna says it expects to cut $400m annually in Coventry’s costs, not terribly aggressive by industry standards. When you get a chance to buy $400m in incremental pre-tax profit for $1bn, you do it.
Aetna may have got a good price because other big players were not bidding. WellPoint and Cigna are digesting recent acquisitions, and UnitedHealth is well positioned in government health plans for the poor, where Coventry is strong.
Given that the consolidation gives the large health insurers a profitable way to invest excess capital, should more growth not be reflected in their valuations? Shares in all the big health insurance companies can be had for well under 10 times forward earnings. Mergers are not the only thing driving profits, however. Average annual premiums for family insurance coverage are up 160 per cent during the past 10 years, according to the Kaiser Family Foundation.
Even if the portion of those premiums that insurers keep for themselves has not increased, the trend has been the insurers’ friend. But if you believe that this pattern can continue indefinitely, you should have your head examined.
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