A back-alley brawl is breaking out in Washington between insurers and regulators.

In July, Aetna (AET) told regulators that a blocking of its planned merger with Humana (HUM -0.83%) would imperil its participation in the Obamacare exchanges. The Justice Department ignored the warning and sued to block the merger anyway, prompting Aetna to announce it will cut its participation in the exchanges by 70%. Is Aetna's decision to pull the plug a direct response to the Justice Department's throwing a red flag over its merger? Or is something else at play?

Healthcare analyst Kristine Harjes is joined by contributor Todd Campbell to discuss insurers' Obamacare exodus in this clip from The Motley Fool's Industry Focus: Healthcare podcast.

A full transcript follows the video.

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This podcast was recorded on Aug. 17, 2016.

Kristine Harjes: Aetna, which is one of the major health insurers, announced yesterday that it plans to cut its Obamacare exchange presence by about 70%-ish. It was present in 778 counties, and now it's cutting back to just 242 counties. What does that mean for Aetna and for Obamacare?

Todd Campbell: We have a good old-fashioned back-alley brawl here between insurance companies and Washington. And there's a lot of backstory, Kristine, that you and I are going to talk about for our listeners that I think is pretty fascinating. The nuts and bolts of this is that you've got insurers participating on the exchanges through Obamacare that are losing money. And, obviously, that's not what companies are in the business to do. So, as a response to that, Aetna is the latest company of these insurers to say, "You know what? We're going to reign in significantly our participation." -- as you noted before -- "significantly reducing the number of counties that we participate in, and significantly reducing the number of states that we're going to be doing business in." Aetna's taking their exposure to the exchanges down to four states from, I think, 15.

Harjes: Right. And that's because they reported ... Well, there are kind of two reasons here. The first that you touched on is because they just haven't been profitable, these exchanges. Aetna reported a loss of $230 million on Obamacare in the second quarter. They cite rising utilization, which, really, what that gets at is, Obamacare patients are just more expensive than anybody was anticipating. None of these health insurers realized just how difficult it would be to price these plans properly in order to actually make money on the exchanges. So, what you're seeing now is this mass exodus from them, where they're throwing their hands up and saying, "We don't want to keep losing money on this." 

When you look at a company that's losing money, it boils down to two options: you can either cut your costs or bring in more money. If you're going to bring in more money, you need to actually raise the prices of your plans. But the other option there, with the other issue at heart here, is what happens if these companies decide to try to team up and maybe lower their costs via some synergies, via some mergers? And that is the other really interesting side of this story.

Campbell: Right. You have Aetna, specifically, looking to combine with Humana. Humana is another insurer, they have a huge Medicare business, but they were also participating in 19 states' exchanges for Obamacare. And the thinking was, "OK, if we leverage all of this size against fixed costs, get rid of overlapping positions and the like, then we're able to turn more easily a profit." Aetna had said previously earlier this year that it expected to break even on its Obamacare of business. It even actually indicated that it could expand into more states, going from 15 states -- I think it was -- to 20. So, this is a fairly rapid deterioration in their risk pool. 

You talked about, how do you price these plans and charge the premiums so that you can turn a profit if you don't really know how healthy your members are going to be? And it's been very much struggle trying to get healthier younger patients to sign up for Obamacare. Obviously, people who signed up originally were those who were the sickest, because, you know, they needed insurance. And that's great. And I don't think that's what these companies are saying, that these people don't deserve to have access to care. I think what they're trying to say is, "Listen, we need to find a way to be able to make this profitable for ourselves and our investors." No one's going to cry any tears, though, Kristine, for these companies over their lack of profitability in the bigger picture, right?

Harjes: Shareholders might.

Campbell: Yeah. Investors will always look at it from the perspective of -- or they have a tendency, sometimes, to look at it from the perspective of -- "What have you done for me lately?" And they look at the profitability of each of these companies on a quarter-to-quarter basis. I think an argument could be made for long-term investors to look at it and say, "Isn't it better for you to continue to participate in these exchanges, even if they're operating at manageable losses, as long as the end game suggests that you'll reach that scale where you've got the right premium for whatever care those patients are going to need."

So, there's two ways of looking at that: the short-term view of saying, "OK, yeah, but if we stop participating in these programs, right away, I can add $300 million to my bottom line in 2017," versus, "OK, well, now I'm no longer getting the experience of operating in these markets, experience that could be beneficial if these turn out to be very profitable markets -- say, five years from now -- because of policy changes or anything else."

Harjes: I mean, I think Aetna did have that kind of long-term view. They wouldn't have continued to be in these markets, and they wouldn't have planned on expanding their presence on the exchanges, if they didn't have that sort of long-term mentality.

Campbell: Which begs the question, right, Kristine -- what's changed?

Harjes: Exactly. That's your big "but... " here. So, the Department of Justice sued recently to block Aetna's proposed merger with Humana, which was a key part of Aetna's strategy. I'm quoting right from Aetna's CEO here. He says -- and before, he had been talking about how they had been on the public exchanges since the beginning of 2014, they had been losing money, blah blah blah -- and he goes on to say: "Our ability to withstand these losses is dependent on our achieving anticipated synergies in the Humana acquisition." And then, he goes on to say, essentially, if the DOJ blocks this transaction, their hands are tied, they're going to be forced to reduce their exchange footprint. Which might be true, but, I think the even more interesting reason behind this is, that's them playing this strategic game with the Department of Justice, saying, "You know, you don't really want to block this merger."

Campbell: Yeah, it's throwing the gauntlet down, almost, and saying, "Listen, we actually will consider expanding into more markets, if you OK this deal, because we think we can better afford to operate within the exchanges as a combined entity. But if you block it, then who knows how this is all going to play out? I think there's a little bit of gamesmanship going on here. You have to remember that, even despite the drag on earnings from the exchanges last quarter, Aetna remains nicely profitable. I think their net income was about $800 million. Actually, if you look at United, Humana, and Aetna, and combined their net income over the course of the second quarter, it comes out to about $2.8 billion, despite the ACA headwinds.