Why the Justice Department Waved Through the CVS-Aetna Merger

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A CVS Pharmacy in Pittsburgh

This week, Judge Richard Leon of the U.S. District Court for the District of Columbia is holding a Tunney Act hearing, which allows courts to scrutinize merger approvals by the Department of Justice (DoJ), on the CVS-Aetna merger. Judge Leon’s evidentiary hearing with testimony from concerned parties is a first of its kind

In sharp contrast to the AT&T/Time Warner deal, another vertical merger that the DoJ sought to block, the antitrust agency waved through CVS-Aetna, with a modest requirement to spin off Aetna’s Medicare Part D prescription drug plan. Now, the DoJ is being forced to defend itself in court. Why did the antitrust division engage in a seeming double standard, when the cases share particular similarities? 

By happenstance, Judge Leon also adjudicated—and eventually rejected—the DoJ’s attempt to block the AT&T/Time Warner merger. In that case, the vertical stacking involved two layers: the distribution unit that delivers cable programming to subscribers (AT&T); and the content division that produces cable programming (Time Warner). By comparison, the vertical stacking in CVS-Aetna involves three layers: the health plan takes premium dollars from the member and provides insurance in return (Aetna); the pharmacy benefit manager (PBM) negotiates with pharmaceutical companies and pharmacies, administers the pharmacy network, and designs the formulary for the health plan (Caremark); and the pharmacies serve as the physical interface between patient and pharmacist (CVS). 

The pharmacy was already integrated into PBM services via the CVS/Caremark merger; the fresh integration here is the pharmacy/PBM into a health plan, yielding control of the entire stack. It would form the only vertically integrated pharmacy/PBM/health plan currently in the U.S. marketplace. 

As the D.C. Circuit explained in its decision in AT&T/Time Warner, “Vertical mergers can create harms beyond higher prices for consumers, including decreased product quality and reduced innovation.” However, most plaintiffs aim to show concrete and measurable harms such as higher prices, using what are called “foreclosure” theories. For example, a vertically integrated firm may foreclose rivals from access to its content (“input foreclosure”) or from access to customers (“customer foreclosure”). As I have shown in prior research, along with Kevin Caves and Chris Holt, regional sports networks affiliated with cable companies can credibly threaten to withhold content from a rival distributor, because lack of local sports would mean defection to cable provider with access. 

This is the theory of harm that the DoJ pursued (unsuccessfully) in its attempt to block the AT&T/Time Warner merger. The DoJ believed that the newly merged entity would withhold Time Warner content from distribution rivals, or extract a higher price for said content. Judge Leon concluded that Time Warner content was not must-have; he found no compelling evidence to suggest that customers of rival cable operators would leave to follow Time Warner content like CNN or TNT or TBS. So the threat to withhold content from rivals wouldn’t be as powerful as withholding sports or some other must-have input.


ALTHOUGH FORECLOSURE is most frequently studied and litigated in cable television, healthcare economists are starting to focus on the same phenomenon. For example, Professor Neeraj Sood of the University of Southern California estimates that for a vertically integrated healthcare provider, each insurance customer is worth $300 in margins, each PBM customer is worth $23 in margins, and each retail pharmacy customer is worth $40. It follows that a vertically integrated insurer/PBM/pharmacy such as CVS/Aetna might be willing to engage in certain tradeoffs in order to advantage its affiliated (high margin) insurer at the expense of its (low margin) PBM or retail pharmacy division.

Vertical foreclosure strategies in concentrated markets with high barriers to entry are more likely to generate anti-competitive effects than the same strategies employed by firms that lack market power. And the supply of health insurance in the United States is highly concentrated. Data from Kaiser indicate that in most states the market share of the three largest insurance companies—UnitedHealth, Anthem, and Aetna—is more than 50 percent, and in some states the market share of the three largest insurance companies is around 90 percent. Local geographic markets are similarly highly concentrated. There are high barriers to entry in health insurance, including market expertise: how to build networks, knowing how to file products, and meeting compliance burdens. 

The supply of PBM services in the United States is also highly concentrated. The three large PBMs—Express Scripts, CVS Health Caremark, and Optum Rx—account for almost 70 percent of the entire market. Pharmacies habitually complain that they have no alternative but to contract with specific PBMs. Again, there are natural barriers to entry in PBM services, including economies of scale in negotiating favorable discounts from manufacturers, operational expertise, and regulatory barriers, as well as artificial barriers, such as vertical integration with a health plan or a pharmacy network or both, which makes competition by a standalone health insurer more daunting. 

Finally, the supply of pharmacy services in the United States is highly concentrated. The largest three pharmacies account for more than 50 percent of prescription revenues. Local markets are similarly highly concentrated; according to Business Insider, CVS and Walgreens together control between 50 and 75 percent of the drugstore market in each of the country’s 14 largest metro areas. Barriers to entry also prevent new pharmacy firms. For example,CVS chief executive officer Larry Merlo is not afraid of Amazon’s entry into the pharmacy business because “there’s a migration to more value-based care, those clinical capabilities are going to continue to grow in importance. It’s highly regulated, so the barriers to entry are high.”

What would input foreclosure mean in this setting? The vertically integrated firm could deny an input—here, CVS pharmacy services—to a rival health plan such as UnitedHealth. The DoJ’s vertical theory fell apart in its challenge of AT&T/Time Warner because the merging parties lacked a must-have input. In this case, would CVS’s network of pharmacies be considered must-have for rival health plans?

CVS is uniquely positioned in the pharmacy marketplace due to its ubiquitous coverage of the U.S. population. According to comments filed by the AMA, “CVS pharmacy chains may be considered ‘must have’ pharmacies. They are ‘must have’ because health plan sponsors prefer geographically comprehensive networks—pharmacies located in close proximity to their patient population.” Indeed, CVS claims to cover 76 percent of the population in the United States within a five-mile drive.

If a rival health plan lost access to CVS’s network of pharmacies, it could find itself unable to patch together other pharmacies to serve customers, and could even lose its license to serve certain areas as a health provider. The Centers for Medicare and Medicaid Services (CMS) will not contract with a Medicare plan unless it can meet certain time-and-distance requirements. For non-Medicare plans, local state agencies such as California’s Department of Health Care Services and Florida’s Agency for Health Care Administration review a plan’s network adequacy using their own time-and-distance requirements. 

Using mapping data of all U.S. pharmacy locations from Healthcare Ready, Augustus Urschel, Omer Gold and I identified several areas of the country in which a rival plan would not be able to meet CMS’s coverage requirement without access to CVS’s network of pharmacies. CMS’s Medicare Part D Manual, states: “In urban areas, at least 90 percent of Medicare beneficiaries in the Part D sponsor’s service area, on average, live within 2 miles of a retail pharmacy participating in the sponsor’s network. In suburban areas, at least 90 percent of Medicare beneficiaries in the Part D sponsor’s service areas, on average, live within 5 miles of a retail pharmacy participating in the sponsor’s network.” Using those constraints, we conservatively identified localities where CVS was the only pharmacy within a ten-mile radius. 

The first figure shows the area immediately south of Chicago, spanning parts of Illinois and Indiana. Ten localities appear beholden to CVS for pharmacy services.

The second figure shows the area outside of Tallahassee, spanning parts of Florida and Tennessee. Two localities appear beholden to CVS. 

For rival health plans seeking to serve those areas, CVS would easily qualify as a must-have input. Without access to CVS’s pharmacy in that area, the rival health plan likely could not contract with CMS (for a Medicare plan); similarly, the rival plan likely would not meet the coverage requirements of state licensing agencies (for non-Medicare plans).

In addition to the ten-mile radii used in the two figures, a radius of five miles was drawn around each CVS location nationwide to identify must-have inputs; in 93 locations, CVS is the only pharmacy within a five-mile radius. CVS could simply refuse rival plans access to these (or any) CVS pharmacies, impairing the reach of those health plans and forcing patients to sign up with CVS/Aetna. Less extreme forms of input foreclosure would include CVS Caremark developing formularies for health plan rivals that do not include important drugs that are in demand by their subscribers; offering pharmacy networks that do not provide important options (for example, independent specialty pharmacies) or forcing rival insurers into CVS mail-order pharmacy services; or charging rival plans higher administrative fees to provide services like formulary maintenance or claims processing. For example, CVS currently charges PBMs to fill prescriptions; CVS could demand, post-merger, a higher dispensing fee for performing the same task. 


OF THE FOUR POTENTIAL input-foreclosure strategies outlined above, the DoJ failed to address anyin its complaint. In its Questions and Answers for the General Public, the DoJ stated it “thoroughly considered whether the merger would raise the costof (i) CVS/Caremark’s PBM services or (ii) retail pharmacy services to Aetna’s health insurance rivals.” So it appears most foreclosure strategies were ignored completely, or considered and dismissed.

If the merged firm found it profitable to engage in input foreclosure against rival health plans, the anti-competitive effects would be straightforward under antitrust law. This could diminish competition in the market for health plans, as rival plans lose access to CVS pharmacies or incur a higher cost for such access, which could lead to higher premiums or higher deductibles or less coverage. 

The DoJ could have assured prevention of the harms from input foreclosure. In particular, the merging parties could have been subject to a non-discrimination regime, as Georgia and New York imposed in their merger reviews. That would mean that no health plan could be prevented from accessing CVS’s pharmacy network, or forced to pay an exorbitant fee for access. This kind of non-discrimination regime actually appears in the 2011 DoJ Policy Guide to Merger Remedies. 

The DoJ and Federal Trade Commission have a history of using behavioral remedies to address potential harms in vertical mergers: the Anheuser-Busch InBev-SABMiller and AOL-Time Warner mergers, for example, or Ticketmaster-Live Nation, which bans Ticketmaster from using the threat of withholding shows from venues in retaliation for their signing with a competing ticketing service. The DoJ also employed a non-discrimination remedy in Comcast-NBCUniversal.

Yet in October 2018, Assistant Attorney General for Antitrust Makan Delrahim announced that DoJ would withdraw its 2011 Policy Guide. The guidelines prescribed behavioral remedies in vertical mergers to police discriminatory conduct. Delrahim announced his lack of faith in behavioral remedies, calling them “regulatory” in nature, and embracing structural approaches. 

As an expert for an online video distributor (OVD) that brought one of the first challenges under the NBCU Order, I am professionally familiar with the efficacy of behavioral remedies in the context of vertical merger enforcement. Bloomberg was the first to sue Comcast under the NBCU protections, and it secured better placement on Comcast’s dial. Per the DoJ’s annual reports monitoring the merger conditions, an unnamed OVD also sued and settled with Comcast. Finally, my OVD client sued and we prevailed before an independent arbitrator, who ruled that our estimate of fair market value was closer than Comcast’s (that case is pending appeal). Based on these three cases, it is fair to say that the behavioral remedies under the NBCU were largely effective in constraining Comcast’s worst impulses.

The DoJ was attempting to block the AT&T-Time Warner merger at the time it retracted the Policy Guide to Merger Remedies. By disavowing behavioral remedies in general, the DoJ must now choose between approving the merger without behavioral conditions (as it did in CVS/Aetna) or blocking it outright (as it tried and failed in AT&T/Time Warner). Even if waving through the merger is slightly preferred to blocking the merger outright, losing the flexibility to deal directly with input foreclosure was a loss from a public policy perspective. Instead of preventing discrimination against rival health plans in CVS-Aetna, the DoJ did basically nothing to address the potential harm. Judge Leon could right this wrong and fix the DoJ’s error.

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