(Reuters) - Health insurer Cigna Corp will buy HealthSpring Inc for $3.8 billion to jump-start its business selling Medicare plans as more elderly Americans become eligible for the U.S. government program.
Medicare is an enticing market for U.S. health insurers, even as Congress weighs cuts to the program to rein in the country’s debt.
In particular, the entry of the postwar baby boom generation into retirement is expected to swell the ranks of privately run Medicare Advantage plans, which now account for 25 percent of Medicare enrollment, compared with 75 percent for government-run plans. Medicare beneficiaries can choose to receive their benefits through private health insurance plans.
“The expectation is that that 25 percent rate will increase,” Jefferies & Co analyst David Windley said. “There’s some increasing view that the political pendulum has swung in favor of Medicare Advantage plans in recognition that they are the one group out there doing something to reduce Medicare costs.”
Wedbush Securities analyst Sarah James projects private insurance plans could comprise about half of Medicare over the next five years.
Medicare contractors receive payments from the government and then market their plans directly to seniors. Compared to government-run plans, they have narrower networks of physicians that allow them to keep their costs lower. The companies also try to limit medical claims by driving members to seek preventive care so they avoid costly hospitalizations.
“The basic proposition to the beneficiary has always been ... by going into a narrower network, we will provide you with richer benefits,” said John Gorman, head of the Gorman Health Group, a consulting firm focused on government-sponsored plans.
UnitedHealth Group Inc and Humana Inc are the largest private players in Medicare Advantage, with 2.2 million and 1.6 million members respectively. Large insurers WellPoint Inc and Aetna Inc have also struck deals to expand their presence in Medicare, but Cigna’s purchase of HealthSpring is by far the biggest single bet.
(For a graphic on major health insurance deals, see: link.reuters.com/sak64s.)
HealthSpring has about 340,000 Medicare Advantage members in 11 states and the District of Columbia, making it the sixth-biggest player, according to Susquehanna Financial Group analyst Chris Rigg. Cigna has 46,000 Medicare Advantage members. HealthSpring also has more than 800,000 enrollees in stand-alone Medicare prescription drug plans.
The deal represents a major diversification for Cigna and the most significant move by Chief Executive David Cordani since he took the helm nearly two years ago. Cigna had focused its U.S. health insurance plans on businesses, though Cordani sought more international expansion.
While overall merger activity has slowed in the last few months, transactions such as the HealthSpring buy are happening as companies look to expand into new businesses or cut costs.
Recent deals include Kinder Morgan’s $21 billion deal for El Paso Corp and Google’s planned $12.5 billion buy of Motorola Mobility Holdings Inc.
Cigna plans to buy HealthSpring for $55 a share, a 37 percent premium over Friday’s closing price, the companies said in a statement on Monday. HealthSpring shares closed up 33.7 percent at $53.71, while Cigna rose 1.4 percent to $45.34.
Cigna said it would issue new equity to cover about 20 percent of the purchase price, with the rest funded by additional debt and cash. It expects the deal to add to its earnings per share in the first full year of operations.
Shares of other health insurers that specialize in Medicare rose after the deal was announced. Humana rose 4.7 percent, Universal American Corp gained 3.9 percent, and WellCare Health Plans jumped 8.8 percent.
“There are still a few larger plans in the industry that want to become bigger Medicare players, and the number of plans out there ... with more than 50,000 lives is relatively small,” Citigroup analyst Carl McDonald said in a research note.
Shares of Canadian pharmacy benefit manager SXC Health Solutions Corp, which counts HealthSpring as a major client, fell 23 percent on fears the business may go to Cigna.
Investors have expected consolidation in the health insurance industry as a U.S. healthcare overhaul enacted last year squeezes smaller companies and creates incentives for larger companies to take advantage of scale.
The lack of major deals to date may stem from concerns that the Obama administration and state insurance regulators could push back against transactions that threaten competition or drive premiums higher.
Asked whether the HealthSpring deal would face regulatory hurdles, Cordani told reporters on a conference call that it was a “segment expansion” into an area where the company is not a large player and therefore should not meet opposition.
“It’s not a scale-based consolidation,” Cordani said. “We’re obviously aware of the environment around scale-based consolidation.”
The deal is expected to close in the first half of 2012.
The deal values HealthSpring at a “relatively rich” $3,200 per member, compared with the current industry average of about $869, Wells Fargo analyst Peter Costa said.
Medicare Advantage members bring in about three times as much revenue as commercial members, according to Susquehanna’s Rigg. Because Medicare members are older, they typically have more need to see doctors and pay higher premiums than younger people who receive insurance through their employers.
“The person who is 70 years old uses a lot more healthcare,” Rigg said. “It’s lower margins, but higher overall dollars.”
Profit margins for Medicare Advantage plans tend to range from 3 percent to 5 percent, Gorman said.
HealthSpring’s management, headed by CEO Herb Fritch, will now lead Cigna’s Medicare expansion.
Separately, Cigna raised its forecast for 2011 adjusted earnings to a range of $5.05 to $5.30 per share from a previous view of $4.95 to $5.25.
Cigna’s financial adviser is Morgan Stanley and its legal adviser is Davis Polk. Moelis & Co advised on the deal financing. Goldman Sachs & Co was the financial adviser to HealthSpring, whose legal advisers were Skadden, Arps, Slate, Meagher & Flom LLP and Bass, Berry & Sims Plc.
Reporting by Lewis Krauskopf in New York; additional reporting by Toni Clarke in Boston; Editing by Michele Gershberg, John Wallace and Tim Dobbyn