Making Sense of the Health Care Merger Scene   


In the past 12 months, there has been a raft of multi-billion-dollar mergers in health care. What do these deals tell us about the emerging health care landscape, and what will they mean for patients/consumers and the incumbent actors in the health system?

Health Systems

There have been a few large health system mergers in the past year, notably the $11 billion multi-market combinations of Aurora Health Care and Advocate Health Care Network in Milwaukee and suburban Chicago, as well as the proposed (but not yet consummated) $28 billion merger of Catholic Health Initiatives and Dignity Health. However, the bigger news may be the several mega-mergers that failed to happen, notably Atrium (Carolinas) and UNC Health Care and Providence St. Joseph Health and Ascension. In the latter case, which would have created a $45 billion colossus the size of HCA, both parties (and Ascension publicly) seemed to disavow their intention to grow further in hospital operations. Ascension has been quietly pruning back their operations in markets where their hospital is isolated, or the market is too small. Providence St. Joseph has been gradually working its way back from a $500 million drop in its net operating income from 2015 to 2016.

Another notable instance of caution flags flying was the combination of University of Pittsburgh Medical Center (UPMC) and PinnacleHealth, in central PA, which was completed in 2017.   Moody’s downgraded UPMC’s debt on the grounds of UPMC’s deteriorating core market performance and integration risks with PinnacleHealth. As Moody’s action indicates, investor skepticism about hospital mega-mergers is escalating. Federal regulators remain vigilant about anti-competitive effects, having scotched an earlier Advocate combination with NorthShore University HealthSystem in suburban Chicago. The seemingly inevitable post-Obamacare march to hospital consolidation seems to have slowed markedly.

However, the most noteworthy hospital deal of the last five years was a much smaller one: this spring’s acquisition of $1.7 billion non-profit Mission Health of Asheville, NC, by HCA. This was remarkable in several respects. First, it was the first significant non-profit acquisition by HCA in 15 years (since Kansas City’s Health Midwest in 2003) and HCA’s first holdings in North Carolina.  While Mission’s search for partnerships may have been catalyzed by a fear of being isolated in North Carolina by the Atrium/UNC combination, Mission Health certainly controlled its own destiny in its core market, with a 50% share of western North Carolina. Mission was not only well managed, clinically strong and solidly profitable, but its profits rose from 2016 to 2017, both from operations and in total.

Precisely because it was not a distress sale, and because Mission was in an unassailable market position, this deal should have sent shockwaves through the non-profit hospital industry. Yet, there was remarkably little public discussion of its significance. There was no burning platform here. Rather, the ability of HCA to lower Mission’s operating expenses with its austere management culture and break even on Medicare may have been viewed as a key to long-term sustainability by Mission’s board, as well as access to HCA’s more-or–less bottomless capital pool.

HCA’s willingness to be patient and wait for the right deals, and crucially, its ability to break even at Medicare rates, are the real sources of its long-term strength. It may well be that HCA’s ability NOT to follow the herd, and to decide which assets, markets, and relationships make sense long term is more valuable than mass and scale. The Rick Scott Columbia HCA had 360 hospitals at “peak roll-up.” The present, better focused HCA is a much stronger company at half the number of hospitals.


So many large non-profit and investor-owned health systems formed as roll-ups of smaller enterprises are struggling to generate operating earnings just now, including many prominent market leading systems. For this reason, many other potential roll-ups in the vein of Ascension-Providence and Atrium-UNC might not survive the courtship stage. Those roll-ups might actually weaken the combined enterprise by burdening them with hospitals that could not have survived on their own and which probably should close.  Bigger may no longer equal stronger in hospital management.

It has never been clear how actual patients would benefit from vastly greater scale of hospital operations. The burden of proof is on the industry that patients will notice a difference in service quality or lower prices from further consolidation of hospital systems. It is not clear that benefits to patients or their physicians has played any meaningful role in the flurry of post-Obamacare deals.

Physicians – Is Vertical Integration Inevitable?

In December 2017, United HealthGroup’s $100 billion subsidiary Optum purchased the troubled DaVita Medical Group for $4.9 billion. This deal set off a frenzy of speculation that United was positioning itself to become the next Kaiser. Industry pundits opined that Optum and United will transform itself into a closed panel vertically integrated care system that would enable United to sell a comprehensive exclusive care system product. I believe this is not a strong likelihood.

Optum’s first entry into the physician group business was opportunistic, obtaining a captive physician delivery system in Nevada as part of United’s 2008 acquisition of Sierra Health Plan.  The physician group asset did not belong in the health plan part of United and was therefore lodged in Optum as a one-off. Subsequent Optum acquisitions in California, Texas and Florida consisted of successful risk contracting Independent Practice Associations with significant and diverse (e.g. non-United) contracts. Some of those IPAs had a core multi-specialty employed medical group at its core. Optum’s early strategy was not a “physician employment” strategy, but rather not dissimilar to that of MedPartners or Phycor in the 1990’s: buying risk-bearing contracts through the acquisition of physician enterprises that had negotiated them.

Obamacare was expected to catalyze a wave of capitation. Owning risk-bearing physician groups was an asset-light way of playing this presumed shift to capitation. However, the expected post-ACA surge in delegated risk contracting did not materialize. Optum ceased buying care system assets in 2012 because the bidding for physician groups, particularly from health systems, had gotten out of hand. They resumed buying in 2016, adding urgent care centers and ambulatory surgical centers to the portfolio, in addition to the DaVita deal.

While some have claimed that Optum now employs 47,000 physicians, this number seems more likely to be the sum of its IPA networks.  The actual employed physician cadre is probably more like 15 thousand, a number smaller than the combined Permanente Medical Groups inside Kaiser.  There are roughly a million licensed physicians in the United States.

Presently, Optum has care system assets in markets which contain 70% of the US population, but there is limited “integration” among the care system assets, or between Optum and United’s Health Insurance operations. Obviously, United’s health insurance subscribers can use Optum’s group physicians. But Optum patients are not required to or even encouraged to use United’s health insurance products. It would damage the Optum care system asset value to exclude other insurers from paying Optum for a physician or ambulatory care.

Despite its large footprint, I believe that Optum’s strategy in the physician space is disciplined but opportunistic “conglomerate” style diversification. In only two markets, greater Los Angeles and San Antonio, does Optum have a significant local market share in the risk-bearing care system market? Optum has not shown any interest in canceling the substantial number of non-United network contracts and going “closed panel.” Nor is there yet evidence of a backlash from non-United insurers in anticipation of a closed panel strategy that would cause United’s health insurance competitors to shun contracting with Optum care system assets. United/Optum has more to lose than to gain in contracting advantage by closing their panels.

Optum is also unlikely to diversify into the slow growing hospital business. Despite a “buyers’ market” for hospital-based physician enterprises like Envision, Team Health, and MedNax, Optum has thus far studiously avoided acquiring hospital-linked assets. Rather, it is capable of surrounding hospitals with low-cost alternatives and stepping in front of them where possible as risk bearing physician-based care systems, leaving hospitals in those markets, as one analyst put it, as “stranded assets.” We will be watching the “integration” of these diverse Optum assets closely but are skeptical that “integration” will yield significant earnings or growth potential.


Regardless of who owns their physicians, a significant fraction of Americans will need to use the hospital as they age, and an increasing percentage will be publicly funded. Though successfully organized physicians can rigorously minimize the use of the hospital by substituting lower cost non-hospital alternatives (e.g. in surgery and imaging), the residual demand for hospital care related to complex conditions and for the fragile elderly seems likely to grow, not shrink, in years ahead.

The challenge hospitals face is making money at publicly funded rates and driving out the unnecessary or inappropriate use of its services. Hospitals can learn from Optum’s long time horizons, its market-by-market pragmatism about organizational models and insistence on deals being “accretive” rather than “mission driven.” Strategic discipline is the best response to the threat posed by Optum and other organizers of physician care.

Consumers may or may not be willing to “bond” with a corporate giant like Optum. They are likely to make their decisions about where they get their physician care based on responsiveness to their needs and the strength of the physician relationships that develop.

Optum seems unlikely to noticeably lower the cost of physician care to patients, as there are yet no demonstrable economies of scale in physician services.

Pharma Distribution: The “Amazon is Coming” Freak-out

In December 2017, CVS, the nation’s largest drugstore chain, and Aetna, the nation’s fifth largest health insurer, announced a $69 billion merger. Aetna had been blocked from its planned acquisition of rival Humana over anti-trust concerns. But CVS, the acquirer, had a much larger and more urgent concern – the mooted entry of Amazon into the pharmaceutical supply chain, either through wholesale distribution, direct-to-consumer strategy or both.

As its retail sales have slowed, CVS has become increasingly dependent on their CVS-Caremark pharmaceutical benefits management (PBM) business both for revenue and earnings growth. The entire complex and costly US pharmaceutical supply chain is buckling under the financial pressure created by rising drug spending. The PBM business model has come under increasing regulatory scrutiny over concerns over lack of transparency and that PBM rebates negotiated with pharmaceutical firms do not seem to be reaching consumers. In the Aetna transaction, CVS looked to diversify out of its two main businesses to re-establish growth and establish closer and more comprehensive relationships with corporate customers.

Of course, retail in all its forms is being disrupted by Amazon. That Amazon might disrupt the pharmaceutical market by selling directly to consumers became a good deal less speculative with Amazon’s recent $1 billion acquisition of PillPack. BOTH of CVS’s current businesses may be in Jeff Bezos’ crosshairs.

Having said this, the CVS Aetna combination is an “out of the frying pan-into the fire” merger. CVS will discover that the health plan business is actually an extremely fragile web of short-term contracts between the insurer and employers, as well as between the insurer and its care networks. Many of these latter contracts may not be renewed under their present terms, which have been highly favorable to and profitable for insurers. This is because many care systems have been bitterly disappointed by the lack of return to them from the deep front-end discounts made in those contracts in anticipation of rapid growth in “narrow network” lives which have not materialized.

Health insurance is nearing the end of an exceptional profit cycle begun during the roll-out of Obamacare. The creation of health exchanges and the new narrow network contracts designed for them catalyzed a 2010-2014 hospital pricing panic similar to that which ensued on the rollout of PPOs in the mid-1990s. This pricing panic has damaged hospital system earnings and prevented them from recouping escalating losses from Obamacare Medicare rate concessions and the 2012 federal budget “sequester,” which cut Medicare rates by 2% annually going forward.

As with the Optum-DaVita combination, much has been made of the “vertical integration” aspect of Aetna having access to CVS’ network of instore clinics. CVS’s clinical assets – its 1,100 Minute Clinics – are more “nurse in a broom closet” than “doc in the box.” Fully loaded with CVS’s hefty corporate overhead, the Minute Clinics probably lose $20 a visit, with the fond hope of making some of it up on shampoo sales. Despite outgoing Aetna CEO Mark Bertolini’s vision of the CVS clinics as a health care equivalent of Apple’s Genius Bar, CVS/Aetna won’t be a credible player in disease management or anything else complicated by relying on a spindly network of nurse-driven instore clinics. As they did before the deal, consumers will find in CVS’s clinics a great place to get flu shots and back to school physicals, though.

It is also not clear how either business will grow as a result of the combination. CVS Aetna’s consolidation won’t lower the cost of health care for Aetna’s members or corporate clients, nor bring Aetna new health benefits customers.  Though Aetna has a number of large national accounts, it remains a marginal player in most large geographical markets, the venue where bargaining clout really matters. Having a bunch of drugstores and a PBM will not increase Aetna’s leverage with its care networks, hospital or physician. It will also not materially lower Aetna’s drug spend.

On the CVS side, merging with Aetna won’t drive more customers into CVS’s stores, or bring them any additional PBM business, because CVS/Caremark already managed Aetna’s pharmacy claims. And it might lose CVS the recently announced pharmacy benefits management deal with Aetna’s competitor, Anthem, that looked for a new PBM after dumping Express Scripts. There are no good reasons why Anthem would want to contract with a PBM owned by a competitor to their core business.


Hospitals ought not to be threatened by the CVS-Aetna combination, nor the copycat CIGNA-Express Scripts deal that followed it. Neither is likely to affect the prices paid for the specialty IV drugs that have pressured hospitals in the past several years.

Amazon’s core strengths – merchandising clout, logistics and cloud computing – are minimally relevant to health care provision. Amazon has no significant presence in any service business at the present time, other than cloud computing. But as suggested earlier, the pharmaceutical supply chain is ripe for disruption. Anything that lowers the cost of drugs to patients or care givers will help both cope with tightening cash flows and be welcomed by all.

While Amazon’s future incursion into health care remains “notional” at this point, the spate of deals that have been spawned by the mere potential of its entry into the pharmaceutical business resembles nothing so much as one of those chain reaction freeway collisions, where the first driver was distracted by the sight of a large moose walking out of the woods and up to the roadway. It is worth noting that other tech company invasions of the so-called “health care vertical”- Apple, IBM, Microsoft, Google – have not gone very well.

The Future of Mega-Medicine

In his 2012 book Anti-Fragile: Things that Gain from Disorder, finance guru Nassim Taleb makes a convincing argument that scale and the search for security in the corporate and financial world actually increased those institutions’ fragility and exposure to franchise risk. The reciprocal drive of health systems and health insurers, in particular, to become larger and more “unavoidable” may, ironically, have made them more, rather than less, vulnerable to economic shocks. This includes the effects of the inevitable economic downturn that awaits the American economy in the next year or two.  Larger health care organizations are inevitably more bureaucratic and take far longer to make decisions.

On the narrower issue of “integration,” the economic literature on the effectiveness or economic benefits of vertical integration in health care is remarkably devoid of evidence of consumer or societal benefits, or even benefits to the organizations themselves.

Health care remains the most intimate personal service in the US economy. Health care organizations that wish to consolidate are increasingly constrained by the legal and political consequences of their actions. They are also increasingly tempting targets for the hostile populist sentiments accumulating on both the left and right sides of the political spectrum.

The lack of evidence of measurable consumer benefits and the rising risks haven’t yet stopped the wave of consolidation in health care. Despite the pro-merger puffery of prominent strategy consulting firms and bankers, it remains to be seen if $50 billion-plus mega-corporations can connect with real people on a consistent basis and deliver measurable benefits that meaningfully affect their health.

Jeff Goldsmith is the national adviser to Navigant Consulting and President of Health Futures, Inc. He is a veteran health care industry analyst and forecaster.

11 replies »

  1. If a hospital’s average occupancy rate falls below a profitable threshold and stays there, it will eventually have to downsize or close. It’s not a voluntary budget cut. It’s a rational response driven by economic necessity.

    In NYC, Beth Israel Hospital (now Mount Sinai Beth Israel), which first opened in 1888, will close its 825 bed hospital by 2020 and replace it with a 70 bed hospital nearby. My understanding is that at least half of the beds have already been taken out of service. After World War II, the U.S. had roughly 10 licensed inpatient beds per 1,000 of population. Now the number is approximately 2.9 and the long term secular trend is down.

    Everything from less invasive surgical techniques which speed recovery to better drugs that help to keep people out of the hospital in the first place to ambulatory surgical centers are reducing the need for expensive inpatient hospital beds. That should be a good thing on balance. Shouldn’t it?

  2. I’m far from convinced that the surgicenter versus hospital arithmetic works. “The more care we can push out of hospitals, the more potential there will be to mitigate healthcare cost growth” will only be true if the resultant reduction in hospital costs (many of which are fixed or semi-fixed) is at least as large as the costs of the surgicenters that hijack the hospitals’ patients. Has anyone seen a hospital’s budget shrink when a surgicenter is built next door?

  3. Your last point is really important: we are probably in year four of a string of annual declines in US life expectancy, caused by your long list of problems.
    We are spending $3.6 trillion on healthcare in the US annually AND OUR LIFE EXPECTANCY IS DECLINING! Between 2014 and 2016, we lost over three months- 0.3 years (a season!). Multiply that times 327 million people and you have, what?, a hundred million lost life years, in just two years time.

    WTF? We should be gauging both policy interventions and institutional strategy, including mergers, by whether it affects this really troubling macro trend. It is embarrassing evidence that our society is unraveling.

    And you are also right that it will be community based strategies that eventually turn it around.

  4. Steve2, thanks for the feedback. It’s very helpful.

    Regarding the peaks and valleys in hospital occupancy being greater than I might think and the need for surge capacity should there be a pandemic, perhaps the best way to address that is a taxpayer funded approach similar to the national petroleum reserve. Maybe some hospitals could be paid enough to cover their underlying costs for a certain number of licensed beds even if they are empty most of the time so they will be available when and if they’re needed with the funds coming from a separate taxpayer funded source unrelated to patient billing.

    While I hear you about money vs. safety being a tough call, surgical centers have a financial advantage by not doing the low margin stuff like psychiatric care, pneumonia treatment, labor and delivery, etc. and they don’t have nearly as much structural overhead relative to their size and as a percentage of revenue that most hospitals have. They also presumably don’t have intensive care units but I don’t know if those are pretty good moneymakers for hospitals or not.

    To the extent that urgent care centers can reduce more expensive ER visits, that should be a good thing. If most colonoscopies can be safely done in a surgical center instead of a hospital outpatient department or same day surgery suite, that’s a good thing too. In the end, one of our goals should be to ensure that patients get the right care in the right place at the right time to the maximum extent possible. That should prove to be more cost-effective than having too many patients who don’t need to be in a hospital wind up being admitted to one.

  5. Your general train of thought her is good I think, but a few issues need to be pointed out just so you are aware.

    ” If it turns out that the U.S. still has significantly more hospital capacity than it needs the number of licensed inpatient beds should continue to shrink”

    There are more peaks and valleys than you would think in admissions, so what looks like excess capacity may be needed. You should also think about how much excess you want to allow in the case of a true pandemic. Finally, it is not only the total number but also the distribution.

    “The more care we can push out of hospitals, the more potential there will be to mitigate healthcare cost growth.”

    I wouldn’t be so definite about that. We are now doing a lot of stuff as outpatients w/o being really sure that it is safe or that outcomes are just as good. It makes a lot of money for the surgicenter, but maybe not the right thing to do. Remember that it is hard to set bright lines on where you do a case as an in or out patient. Money vs safety is a tough call, in many ways. Remember that the bigger and sicker the case you do at an outpatient center, the more you need that place to look like a hospital, and you stop losing that financial advantage. Please be aware that if every pt in the hospital is incredibly sick, it wears on staff and costs in the hospital may increase. Enough to offset the savings from out patient care? I doubt it, but would like to see at least a couple of studies on it.


  6. We shouldn’t deliberately WANT oligopolies or oligopsonies in health care because they decrease societal total welfare. Hence, too much M&A activity is not good. See any Micro text. Maybe there are natural monopolies and monopsonies in certain areas and maybe there are scientific advances coming along that may require huge firms like these–like genomic medicine–but these natural mono’s are not obvious, at least to me, at this time.

    We don’t need any more firms that can affect prices (have market power).

  7. OR, the latest Wall Street, Ponzi scheme.
    Health spending as a portion of our economy has increased by 5.0% compounded annually between 1960 (5.0%) through 2016 (18.0%), as corrected for economic growth and inflation. The increase is perfectly explained by the dimension’s of Parkinson’s Law…”work expands to use the resources available.”
    In the meantime, we have no national consensus about a national strategy to mitigate obesity, adolescent suicide/homicide, substance addiction, mid-life depression, worsening maternal mortality, mass shootings and, not OR, entrenched poverty. Its unlikely that the national economics of healthcare will improve without a community by community driven strategy to mitigate the continuing disruptive processes that adversely affect each person’s HEALTH every day. The words of Eleanor Roosevelt apply.

  8. Wow! I wish I shared your optimism about the economy. I think a recession is one bear stock market away. We had an eleven percent “correction” in February, but a real trade war or an “accidental” war with a foreign power and we are off to the races.

    And when it happens, the present trillion dollar budget deficit goes to $1.6 to $1.8 trillion in a New York minute. Healthcare spending is 28% of the federal budget. If hospitals are losing, as they are, $49 billion a year on regular Medicare patients at the top of the economic cycle. they are highly vulnerable at the bottom. Pharma dodged a bullet with the present administration, which threatened them during the election, then pulled its punches and nominated a former (apparently competent) former pharma exec as HHS Secretary. Haven’t heard much about a Medicare formulary since. A Democratic administration will probably not mess around.

    So two big “consolidated” industries are really vulnerable in an economic downturn or change of control in DC. That is why Taleb’s thesis about fragility is so relevant. Large health care systems are really struggling to earn money on operations at the top of the cycle, and are making it up in investment earnings (untaxed because non-profit). If you are right about “six to eight more years” of prosperity, they have time to get their acts together. If not, and those investment earnings disappear, they’ve got some issues. . . .

    Every time I hear someone talk about the federal government “taking over” healthcare, I
    cannot help thinking about the VA. . .

  9. The next recession will tell the tale. The currently, over-due character of recurring recessions may have been “reset” by the election of President Trump. As a result, we are probably 6-8 years away from the next one. The surprising level of the current economic growth spurt has all sorts of unknowns. So, whenever it occurs, the evolving growth of the mega-enterprises in the healthcare industry may be severely unraveled by the next recession.
    Most unpredictable is the status of our nation’s health spending as a portion of the national economy (its high cost) and our nation’s decline in longevity (its quality). There currently are no new options to manage the horizon for the improvement of our nation’s HEALTH and its healthcare. With the next recession and the likelihood of hospital failures, its likely that the Federal government will finally arrive at the threshold of a take-over. I am not sure that any of us is likely to be too happy about what that will look like, especially with the currently worsening level of chaos within the beltway.
    So, who’s on First! The Abbott & Costello routine always cheers me up…just thinking about it. Its easy to find on U-Tube.

  10. Here’s what I like about UnitedHealth Group’s strategy. Optum’s ownership of physician practices, urgent care centers and, most recently, ambulatory surgical centers should give it a robust understanding of how much it actually costs to deliver various types of care including surgical procedures outside of a hospital setting. At the same time, United Healthcare obviously knows how much it’s paying hospitals for similar work. Management stated a few months ago on an earnings conference call that it costs about half as much to perform some surgical procedures in an ASC as compared to a hospital.

    So, on one level, payers should be trying to push as much care out of hospitals as they can on cost-effectiveness grounds. Hospital consolidation, as far as I can tell, is primarily about maximizing market power in negotiating payment rates with commercial payers. The more care we can push out of hospitals, the more potential there will be to mitigate healthcare cost growth.

    Hospitals are inherently high cost businesses with much of their cost base fixed over the short to intermediate term. Building codes are getting ever more stringent. There are rules around minimum nurse staffing ratios. There is a trend toward more single patient rooms because it’s thought that it promotes healing and reduces the probability of mistakes, especially giving medication to the wrong patient but single rooms are more expensive to build than double rooms are. Hospitals also have to operate around the clock whereas ASC’s and independent imaging centers don’t have to. Finally, hospitals need a pretty high average occupancy rate to sustain their business model which many currently don’t have and can’t achieve.

    Of all surgical procedures done in hospital settings, both inpatient and outpatient, I wonder what percentage are trauma cases and other true emergencies that must be done immediately or close to it after the patient presents at the ER, how many are done on high risk patients, especially elderly patients, where it’s most appropriate to perform the procedure in a hospital for safety reasons, and how many are very sophisticated procedures like organ transplants and neurosurgery that can’t be done in an ASC. If it turns out that the U.S. still has significantly more hospital capacity than it needs the number of licensed inpatient beds should continue to shrink and outpatient surgical capacity may need to shrink as well.

    As for prescription drugs, payers, including Medicare and Medicaid, need to develop the backbone to just refuse to pay for drugs that are deemed too expensive for the value they provide especially if there are competing drugs that are as good or at least almost as good.