Moving Mount Aetna

What it will take to make the U.S. Healthcare merger pay

Back in April, flush with $4 billion in cash from the sale of his company's property-casualty unit, Aetna Inc. CEO Ronald E. Compton made the biggest gamble of his 40-year career. He shelled out a rich $8.9 billion to buy U.S. Healthcare Inc., the nation's most successful health-maintenance organization, in a move that instantly transformed Aetna, a laggard insurer, into the leading player in the managed-care industry.

It was a bold stroke, but one with considerable risk. Naysayers grumbled that Compton was paying too much at a time when the HMO industry was already chilling from its once feverish growth. And many wondered how "Mother Aetna's" old-line culture would mesh with that of aggressive U.S. Healthcare, whose health-care membership at the time of the merger was one third as large as Aetna's. But Compton, whose five-year tenure as CEO has been marked by relentless and not always productive restructuring, now boasts of the "transformation" of Aetna. "Am I a happy guy, is the question," he says. "The answer is, I am a very happy guy."

Whether his happiness is warranted is far from clear, since the merger only closed in July. Compton must forge a cohesive whole from two radically different cultures while also sharpening Aetna's competitiveness in an increasingly hostile marketplace. Wall Street, at least, seems impressed. Merrill Lynch & Co. analyst Margo L. Vignola is looking for 1997 health-care segment profits of $839 million on $12.06 billion in revenues--34% over anticipated 1996 earnings of $625 million on $9.1 billion. Analysts are projecting 15% earnings growth going forward and have

set a yearend target of $90 for the stock--up 20% from its recent $75.

And Compton has a clear business plan: U.S. Healthcare is now running Aetna's health business, the source of two-thirds of its revenues. The day-to-day reins of the business are in the hands of former U.S. Healthcare execs Michael J. Cardillo and Joseph T. Sebastianelli, now co-presidents of Aetna U.S. Healthcare. And it's the U.S. Healthcare approach to the business, with its cheaper reimbursement to providers, heavy reliance on information technology, and focus on a low cost structure, that is being grafted onto Aetna's larger customer base. "This is like a marriage of Hyatt and Days Inn," says Robert L. Natt, president of Physicians Health Services, the largest HMO in Connecticut. Adds Aetna Vice-Chairman Richard L. Huber, who was brought into the company in 1995 to revamp its strategy: "If we get it halfway right, this is going to be a pretty awesome, major player."

BIG KNIFE. A key to the strategy is cost cutting. Aetna told analysts in mid-January that it is well on its way to a promised $300 million in savings and operating improvements as the two companies merge information systems and personnel. In October, Aetna announced it would lay off 4,400 of its 33,700 workforce over the next 18 months, and took a $275 million restructuring charge.

The biggest savings will come from reducing the number of customer-service centers from 44, 41 of which were Aetna's, to about a dozen. An additional $60 million is expected to be saved annually from converting doctors and hospitals to U.S. Healthcare's lower reimbursement. "There's a lot of overlap between the networks," says Cardillo. Providers are fearing the worst. "U.S. Healthcare generally paid hospitals 25% to 50% less than what Aetna was paying," says Herbert White, who oversees managed-care contracting at Temple University's health center in Philadelphia.

Cardillo and Sebastianelli are also targeting growth. They have boosted Aetna's direct sales force by 36% and are eyeing small acquisitions, such as the one announced on Jan. 27 of Colorado's Frontier Community Health Plans. The aim: to expand Aetna's presence beyond its existing 23-state network. Says Robert Natt: "I am very skeptical these national systems can work."

Aetna also hopes to raise prices to employers by some 3% to 8%. That may not sit well with some companies, which have enjoyed favorable pricing in the past few years. "The marketplace is ultimately going to set the pricing structure," says J. Randall McDonald, senior vice-president for human resources at GTE Corp.

But the U.S. Healthcare team has proven adept at reading the marketplace before. At their previous employer, Cardillo and Sebastianelli led the company away from a limited product offering and increased the number of HMO members while preserving profits. Indeed, in 1995, U.S. Healthcare earned nearly 11 cents on the dollar while Aetna earned barely 4 cents in its health-care business. In the HMO business alone, Aetna's expenses consumed 16 cents of every dollar of revenue, while U.S. Healthcare was under 12 cents. And Aetna's claim losses ran 13% higher.

Cardillo and Sebastianelli believe they can tap U.S. Healthcare's success in extracting the best deals from doctors and hospitals and then using state-of-the-art databases to match patients and their health problems with the most efficient care. But they will have to do this at a time when intense competition is slashing margins in managed care. The industry must also cope with increased legislative oversight because of patient complaints that HMOs are focusing on profits at the expense of the best care.

Nevertheless, Compton insists Aetna can turn itself into a national health-care colossus. Compton will be seen as a hero if he pulls it off. If he doesn't, he'll be remembered as the CEO who did in Mother Aetna.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE