3 Reasons Why Health Insurers and PBMs Are Merging

Moody’s Investors Service outlined the strategies underlying the rapid M&A activity driving much of the change underway in healthcare delivery.

UnitedHealth Group is the most vertically integrated health insurer today “by far,” thanks in large part to mergers and acquisitions it began undertaking several years ago, according to a report released Thursday by Moody’s Investors Service.

UnitedHealth picked up Catamaran, a pharmacy benefits manager (PBM), for $13 billion in 2015, before snatching up physician groups, surgery centers, and other businesses in a spree of acquisitions last year, the report notes.

But the clear leader in vertical integration now has competitors nipping at its heels, as fellow insurers have latched onto PBMs of their own.

Related: Verticality of CVS-Aetna Deal Likely Means No Regulatory Challenges

Dean Ungar, a Moody’s vice president and senior analyst, said the uptick in vertical M&A activity in this sector of the healthcare market has been driven primarily by a desire to control costs.

“The growth in medical costs has been a great challenge to the industry,” Ungar said in a statement. “Medical costs are impacted by medical cost inflation, changes in the level of utilization, and the use of inpatient versus outpatient services and pharmacy costs, which are estimated at 20% of total medical costs.”

The report outlined three main reasons for health insurers and PBMs to merge:

1. Cost savings

The desire to keep costs down is a major factor pushing companies to combine forces, but it may not be a good enough reason on its own to justify certain of these vertical mergers, according to Moody’s.

“If a health insurer already contracts with a large PBM as a client, it should already be benefiting from superior purchasing power and scale,” the report states, adding that existing PBM contracts should also be giving insurers an informational advantage.

“That said, there may be incremental value in receiving and owning access to timely and complete data, including data extending beyond their own insureds,” the report states.

2. Freer cash flow

Insurers may also look to PBMs as an attractive way to diversify their business and gain access to additional perhaps less-restricted revenue streams, according to Moody’s.

“The revenue and earnings of a national PBM (as well as provider practices) are not regulated, unlike an insurer’s health plan subsidiaries,” the report states. “The PBMs, therefore, can be a source of significant, unregulated revenue, earnings and cash flow.”

Aetna generated $61 billion in revenue last year. Assuming its acquisition by CVS Health is finalized, it will be part of an organization with $240 billion in revenue, which is more than UnitedHealth has, according to the report.

3. Pressures on PBMs

“The PBM model has been under pressure from increasing demands for more transparency about business practices such as drug manufacturer rebates and volume discounts,” the report states.

“Transparency inevitably reduces margins as clients, in turn, demand a better deal as well.”

It remains unclear, the report adds, whether a standalone business will be able to compete in a future with other organizations that have combined PBMs and insurers into joint operations.