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What the CVS-Aetna merger could mean for health care deals, drug prices, and Amazon

“This is a watershed event. The entire health care system is about to converge.”

CVS Pharmacy Justin Sullivan/Getty Images
Emily Stewart covers business and economics for Vox and writes the newsletter The Big Squeeze, examining the ways ordinary people are being squeezed under capitalism. Before joining Vox, she worked for TheStreet.

CVS Health has agreed to buy Aetna for about $69 billion. The merger, if completed, would be the largest health insurance deal on record and would combine the biggest US drugstore chain with the third-largest health insurer. It represents a new type of experiment in health care industry consolidation.

The agreement between CVS and Aetna, first reported by the Wall Street Journal, has reportedly been in the works for some time. The combined business would push some of Aetna’s 22 million customers into CVS drugstores to fill prescriptions through CVS’s drug plans, which could help the company’s brick-and-mortar stores as retail is struggling. Aetna’s insurance plans, meanwhile, would get greater access to the place their customers go for care.

And this could be the first of a coming wave of health care mergers that could affect what you pay for prescription drugs, how businesses buy health insurance, and how health care companies are structured.

“Your retail pharmacy wants to be a bigger piece of your health care and is buying greater access to you by purchasing an insurer,” Leemore Dafny, an economist at Harvard Business School, told me. “And they’re betting that they’ll be able to drive more revenue through that storefront, and the insurer would presumably be betting that they could lower total spend or raise quality through that integration in a way that they can’t just through an arm’s-length relationship.”

Managing pharmacy benefits is a big business

Pharmacy benefits managers — which include companies like CVS and Express Scripts— are the sort of middlemen between insurers and drug companies. They are contracted by health plans, employers, unions, and government entities to manage prescription drug programs and, over time, have taken advantage of their position to play a bigger role in negotiating the drug prices patients and their insurers ultimately end up paying. Many industry experts say these benefits managers increase prescription drug prices to raise their own profits.

CVS and Aetna say the merger would drive down drug prices by giving the combined company more leverage in negotiations with drug manufacturers and cutting out the middlemen between insurers and drug companies. In the long term, though, experts say patients could end up paying more.

Eliminating profit-taking middlemen could bring down prices in the short term but could ultimately drive them up over time, Craig Garthwaite, a health economist with Northwestern University’s Kellogg School of Management, told the New York Times.

That’s because eventually these mergers will make it harder for new insurers to enter the market since they won’t be able to negotiate lower drug prices than larger firms. That reduces competition, and having fewer competitors often leads to prices going up.

“Given how concentrated the pharmacy business is in terms of these really two extraordinarily dominating companies of Walgreens and CVS, I think it ought to be a concern,” said Linda Blumberg, senior fellow at the Health Policy Center at the Urban Institute, about the prospect of higher prices.

“This deal is not being done for the average consumer,” David Friend, managing director at BDO's Center for Healthcare Excellence & Innovation, said. “It’s likely being done because both organizations have weaknesses.”

CVS has been managing Aetna’s pharmacy benefits since 2010 and recently announced a deal to help Anthem start its own pharmacy benefits management business. The insurer UnitedHealth already has its own internal pharmacy benefit manager, OptumRx.

“While it’s still early, the moves by Anthem and Aetna have the feeling of the beginning of the end of the standalone pharmacy benefits manager business,” Garthwaite said.

The merger could also change how companies buy benefits and drive customers to CVS’s stores

There are also questions over how the CVS-Aetna deal could impact the way major employers buy health benefits. Most national companies employing more than 20,000 people keep their prescription drug benefits separate from medical coverage, Reuters pointed out, under the belief that they pay less by shopping contracts around.

Aetna CEO Mark Bertolini told Reuters the tie-up would “lower overall” the cost of health benefits, but not everyone is so convinced. So far, they are taking a “wait-and-see attitude as to whether there is a direct favorable impact on their pricing” of a CVS-Aetna combination, Jim Winkler, senior vice president for health at Aon, told the publication.

The CVS-Aetna merger could also save money for the company in other ways by giving Aetna a closer relationship with consumers and access to CVS’s consumer data. It will help the combined company better identify which drugs work better than others (and which drugs don’t work at all) because they’ll have greater access to health data and potentially give them an opportunity to offer more efficient health plans.

It would also be an opportunity for CVS to get consumers in the door in an environment where brick-and-mortar retailers are seriously struggling. Whereas in the past it may have previously been cost-efficient for insurers to drive patients to mail-order prescriptions, the combined company will likely want to drive more customers to retail pickup so they buy items CVS carries — beauty products, greeting cards, snacks — and stop by the walk-in clinic.

Beyond its storefront pharmacies and pharmacy benefit management arm, CVS also operates one of the country’s biggest specialty pharmacies and runs walk-in MinuteClinics in its pharmacies and Target stores.

According to WSJ, CVS will use its nearly 10,000 US pharmacy locations to provide consumers with “more local care options” and convert it some of its pharmacies to community health centers where consumers can get answers about their health and coverage.

Lurking in the background, meanwhile, is the looming threat of Amazon’s potential entry into the pharmacy business.

CNBC reported in May that Amazon was hiring a new manager to help figure out how to help the e-commerce giant break into the pharmacy market. Amazon in October was reported to have acquired wholesale pharmacy licenses in 12 states. Amazon most recently dove head first into the grocery space with the acquisition of Whole Foods.

The threat of Amazon entering the pharmacy market likely spurred CVS’s move on Aetna. The deal “feels more defense than offense,” Ana Gupte, an analyst Leerink Partners, recently said.

“What I really think this merger means for consumers, on some level, is that Amazon is coming,” Friend said. “If CVS buys an insurance company, why couldn’t Amazon buy an insurance company tomorrow?”

This could be just the beginning for health care mergers

CVS’s bid to buy Aetna marks a new era in health care industry consolidation where insurers, drug distributors, and retailers buy each other up, leading to a health market with fewer, more vertically integrated players. If CVS-Aetna works, it could have some systemic cost-saving effects other companies might seek to emulate.

“This is a watershed event. The entire health care system is about to converge,” Friend said.

The CEO of Express Scripts, the largest pharmacy benefits management company in the United States, said recently that he would be “open to” a deal with an insurer at the right price. It recently ended its relationship with Anthem over a dispute about drug prices and rebates.

“I would expect some kind of frenzy to ensue, just as we saw with the health insurance mergers,” Dafny said. “It seems like the big health care companies, cash is burning a hole in their pocket and they’re looking for where to spend it.”

“It’s building on what we’ve already seen when you see insurers integrating with hospital systems, they’re doing that in order to make sure that their insurance company is getting the best rates from those providers,” Blumberg said. “I think this is taking that one step further and saying, okay, we’ve seen it work successfully in some areas between the insurers and medical systems, now let’s take a look and see how it works with drugs.”

Aetna in February called off its proposed $34 billion bid to buy fellow insurer Humana after a federal judge blocked the deal on antitrust grounds. Insurers Cigna and Anthem called off their $54 billion merger the same month after being blocked by the courts as well. Under scrutiny from regulators, Walgreens in June scrapped its $9.4 billion bid for Rite Aid and announced that it would buy half of the company’s stores instead.

Those were horizontal mergers, meaning they were proposed between companies operating in the same space and competing directly (think McDonald’s-Burger King). And the CVS-Aetna deal would be a vertical one, meaning they operate in separate stages along the business value chain (like if General Motors were to buy Goodyear Tire).

The sheer size of the CVS-Aetna deal would likely subject it to antitrust scrutiny, but it’s unclear how regulators might approach it. One possible issue could be the companies’ business activities in Medicare Part D, a government program to subsidize prescription drug costs. CVS has 5.5 million members, or a 23 percent market share, and Aetna has 2.1 million, or a 9.9 percent market share.

Bloomberg Intelligence analyst Jennifer Rie said it may depend on which federal regulatory agency is tasked with reviewing the deal — the Federal Trade Commission has been less critical of vertical consolidation, whereas the Justice Department just sued to block a major vertical deal, AT&T’s proposed merger with Time Warner.

More broadly, the CVS-Aetna tie-up will be a test case for other potential vertical mergers in the health care space. “The question is, is [CVS] paying the right price to Aetna?” Dafny said. “It depends on your projections. How much new business does this drive to CVS and Aetna?”