As Second-Quarter Net Jumps, Aetna Contracts With CVS Caremark for 12 Years

As Aetna Inc. posted a 42% increase in second-quarter profit, the health insurer said it entered a 12-year contract with CVS Caremark, which will provide pharmacy benefit management services to 9.7 million of Aetna's pharmacy members.

Net income jumped to $491 million, helped by a higher underwriting profit in Aetna's commercial business on favorable prior-period reserve development.

Earnings "reflect strong underlying operating results" and are a continuation of the strong performance in the first quarter, said Ronald A. Williams, chairman and chief executive officer of Aetna (NYSE: AET) during a conference call.

Results reflect "enhanced management processes" that improved the underwriting margin of Aetna's businesses, he said. These include providing decision support to help customers "better informed health decisions."

Profit was offset, however, by lower membership in Aetna's insured commercial health plans. Enrollment in these plans dropped to 5.1 million from nearly 5.7 million the same period a year ago. Total enrollment -- including commercial, Medicare and Medicaid plans -- declined to 18.6 million from 19.1 million.

Under the pharmacy deal, Aetna said CVS Caremark will administer about $9.5 billion in drug benefits annually. CVS Caremark will manage purchasing and prescription fulfillment for Aetna's mail-order and specialty pharmacy operations, while Aetna is keeping its PBM when the deal closes.

The deal will improve Aetna's financial and operating profile by creating a lower cost structure to drive future earnings growth, Williams said.

Carl McDonald, an equity analyst with Citigroup Investment Research, said in an e-mail that Aetna is outsourcing the business to Caremark, but retaining ownership of the PBM, and will continue to perform many of the PBM functions.

PBMs act as intermediaries among patients, health insurers and drug manufacturers, with the goal of lowering drug costs through drug-utilization review, substitution of generic drugs, mail-order and developing and managing approved drug lists, or formularies.

Last year, rival health insurer WellPoint Inc. (NYSE: WLP) completed the sale of its PBM units to Express Scripts Inc. in a transaction valued at nearly $4.7 billion (BestWire, Dec. 2, 2009).

In a research note, McDonald wrote that WellPoint sold its PBM in return for the 10-year contract and access to the better drug pricing offered by Express.

Aetna gets no up-front payment, but keeps its PBM, and gets access to Caremark's better unit cost for the next 12 years, McDonald wrote. However, "it feels to us like WellPoint got the better deal on its PBM transaction."

"Unless Aetna can explicitly quantify meaningful near-term synergies from this transaction (which could be hard given our understanding that Aetna's unit cost on drugs is relatively competitive), we think the market reaction will be negative," McDonald wrote.

Aetna's commercial medical loss ratio dropped to 83.2% from 84.6% and excluded about $160 million in favorable prior-period reserve development of health care costs in 2010.

Under the minimum MLR requirements in the U.S. health care reform law, individual and small group plans must spend at least 80% of premiums on medical care costs, while large-group plans must spend at least 85%.

Much still needs to be determined regarding how health reform be implemented, Williams said. "As we implement the newly enacted legislation, the more comprehensive benefits required will result in higher costs for American consumers."

Once the regulations are finalized and there's more clarity on implementation, particularly those dealing with the minimum MLRs, Aetna will provide more guidance on its post-reform outlook, he said.

Total revenues, excluding net realized capital gains, fell 2% to $8.5 billion.

On the early afternoon of July 28, Aetna's stock was trading at $27.78, down 2.05% from the previous close.

Aetna Health Inc. (a CT Corp.), a member of Aetna Inc. Group, currently has a Best's Financial Strength Rating of A (Excellent).

(By Fran Matso Lysiak, senior associate editor, BestWeek: [email protected])