It's Off! Aetna and Humana's Merger Is a Bust

After determining that it's a bad deal for patients, a federal judge has dashed Aetna (AET) and Humana's (HUM -0.92%) hopes of merging together to become the nation's biggest Medicare Advantage health insurer. Can these two companies succeed on their own?

In this clip from The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and Todd Campbell explain why this deal was blocked, and what it means to investors.

A full transcript follows the video.

This podcast was recorded on Jan. 25, 2017.

Kristine Harjes: Last story of the day was something that just came out earlier this week, which is that the Humana-Aetna merger was blocked by a district court. This was a $37 billion merger within the health insurance industry that a lot of people had their eye on.

Todd Campbell: We talked earlier about how the Dow Jones was eclipsing 20,000 partly because of deregulation. Apparently, the Department of Justice, the district court judge didn't get that memo. The Department of Justice basically has cried foul on this deal, they cried foul a while back, saying that by combining these two very large players in Medicare Advantage, it would cause a big problem to pricing and access to health insurance within markets where they overlap. These two companies, Aetna and Humana, attempted to try and assuage the judge by agreeing to sell some assets to another company called Molina Health. However, when push came to shove and the judge looked at all the different puts and takes, he determined that the risk was just far too great in that Medicare Advantage segment to go ahead and approve the combination of these two big companies.

Harjes: Right. When you look at the Medicare Advantage market, these are two of the three largest players, with UnitedHealthcare being the other one. This is a huge market. Thirty-one percent of people on Medicare are enrolled in Medicare Advantage. And it's growing, the number of people enrolled in these private plans has tripled between 2004 and 2016. So the thinking is, with these companies combining, there's nothing that could happen, no new competitors, no divestitures, nothing that would avoid the competitive issues that would come up. Essentially, the verdict came down to, no matter what happens here, they should have just completed independently to win more customers rather than try to get together to have that bigger negotiating power and win that way.

Campbell: Right. Kristine, it's not like we're talking about a product that you can buy on [Amazon.com], regardless of what county you live in or what state or what town or whatever. These insurance programs do not offer plans the same in every community. They can be very different, and different companies can participate in those different communities. So, you have very different competitive marketplaces within each specific county or town throughout the nation. And I think the big risk was, OK, you consolidate power, but these two very large players turning it into the biggest player in Medicare Advantage, what happens in those communities that, say, are under-served? Where, maybe, UnitedHealthcare isn't currently participating in, or there aren't any other options. If you have that kind of a situation and give that much pricing power over something as important as health insurance to these insurers, who's to say that they're going to act in the best interest of the patient, and compete and drive those prices down?

Harjes: Exactly. Moving forward with these companies, Aetna will owe Humana a $1 billion breakup fee. Interestingly, neither stock really moved a ton. What I think will be the key thing to watch here, after we've already seen this news report, is what happens with the merger between Cigna and Anthem? There will be a ruling on that one soon. These are another two health insurance companies. It's an even bigger deal, it's $48 billion. And they have even more national overlap. So, you definitely want to keep your eyes on that one.

Campbell: Yeah. I don't think there's a very good shot of that deal going through. I think Cigna and Anthem haven't even put forward as good a united front as Humana and Aetna did. I'll be surprised if they go ahead and approve this. Listen, the Medicare Advantage Market specifically is growing and it's big. It's growing by about a million new subscribers annually. So, this is a lucrative business that is still attractive for these companies independently. Obviously, Humana is the most pure play of all four of these insurers, they get the majority of their sales from their Medicare Advantage business. So if you're interested in a stock idea that would allow you to benefit from the fact that you have aging baby boomers who are going to be increasingly going into the marketplace and looking at their different Medicare options, maybe Humana is a name that should be back on your radar.

Harjes: Looking more broadly at the healthcare insurance industry, do you think that Humana and the Medicare Advantage market would be the way to play this? If you could only buy one health insurer, is that what it would be?

Campbell: Well, the thing that's nice about that is you don't have the risk of what's going on with the ACA. Yes, Humana has some participation in the ACA programs. But it gets the bulk of its sales through Medicare Advantage. Medicare Advantage is not impacted by the reform that's the repeal and replace of Obamacare or the ACA. So, you could look at it and say, the demographics support it, it's not as exposed to the risk of what could come in the future of this industry. So, it's definitely one of the more intriguing plays now that it's going to be on its own.