US-based health insurer Aetna on Friday said it would buy smaller rival Humana for about $37 billion in cash and stock, in the largest ever deal in the insurance industry.

The combination will push Aetna close to Anthem’s No.2 insurer spot by membership, and would nearly triple Aetna's Medicare Advantage business.

The deal will face antitrust scrutiny but if it goes through it would dwarf the previous largest insurance deal announced just this week, where Swiss property and casualty giant ACE announced it was buying Chubb Corp for $28 billion. It would also dwarf Anthem Inc's purchase of WellPoint in 2004 for $16.6 billion.

Analysts have said that M&A activity in the healthcare sector had been waiting for last week's Supreme Court ruling on Obamacare, which upheld key subsidies that underpin the reform and thus gave more certainty to healthcare insurers.

The bigger the insurer, the more power it has negotiating prices and improving its doctor networks.

Anthem has offered to buy Cigna Corp to create the largest insurer in the country, toppling UnitedHealth Group.

Media reports have also said UnitedHealth could be eyeing Cigna and Aetna. On Thursday, Centene Corp said it would buy smaller rival Health Net for $6.3 billion.

ANTITRUST ISSUES

Antitrust authorities, who were aggressive in their review of the failed deal between Comcast) and Time Warner Cable, are expected to scrutinize how the combination of insurers will affect competition for each line of insurance: Medicare, Medicaid for the poor, individual insurance, commercial insurance for small and large businesses and the large employer business.

Aetna and Humana are in nine of the same states in Medicare Advantage. Combined, they would have market share of 88 per cent in Kansas, 80 per cent in West Virginia, 58 per cent in Iowa and 51 per cent in Missouri.

Wall Street analysts and some antitrust experts have said they expect the combination will be approved, although regulators may ask for some divestitures.

Others have said it is unclear that this group of regulators will stick to the usual review playbook for such a large deal and may add other restrictions.

The Justice Department, which reviews insurance mergers, will scrutinize deals city-by-city to see if the combination would have a monopoly in any metropolitan area, said Andre Barlow, a veteran of the department who is now at Washington law firm Doyle, Barlow and Mazard PLLC.

Aetna said the combined company is projected to have over 33 million medical members, based on memberships as of March 31. Operating revenue is expected to be about $115 billion this year, with approximately 56 per cent from government-sponsored programs including Medicare and Medicaid.

Last week, the US Supreme Court upheld subsidies for individuals under President Barack Obama's signature healthcare law, keeping a large chunk of patients intact under the Medicare and Medicaid programs.

Insurers have said subsidies are key to bringing in new customers and the ruling has removed uncertainty for insurers looking for acquisitions. It could also spur more deal making in the health insurance sector, which has already seen a blitz of merger activity this year.

US Senate Majority Leader Mitch McConnell, of Kentucky, praised Humana's presence in his home state but also noted the role of the healthcare law in the merger.

"This morning's announcement, as I predicted during the debate five years ago, is the inevitable result of Obamacare’s push toward consolidation as doctors, hospitals, and insurers merge in response to an ever-growing government," the Republican said in a statement.

The deal includes a $1 billion break-up fee payable by Aetna to Humana, should the deal fail because of antitrust concerns, an Aetna spokeswoman confirmed. The fee was first reported by the Wall Street Journal.

CASH AND SHARES

Hartford, Conn.-based Aetna said it would pay Humana shareholders $125 in cash and 0.8375 Aetna shares for each share held. The offer of about $230 per share is a 23 per cent premium to Humana's closing price on Thursday.

Following the deal, Aetna shareholders would own about 74 per cent of the combined company with Humana shareholders owning the rest. Aetna Chief Executive Mark Bertolini will serve as chairman and CEO of the combined company.

The deal is expected to close in the second half of 2016 and add to operating earnings per share from 2017.

Humana's sale has been anticipated since May when it was first reported that Cigna Corp (CI.N) and Aetna were interested, and multiple sources confirmed to Reuters that the company was entertaining offers.

Humana, based in Louisville, Kentucky, has been under pressure for more than a year from investors, which include activist fund Glenview Capital Management, to produce higher returns.

Last year Humana hired a CFO from investment bank Goldman Sachs and went through a strategic review that included asset sales. But it missed several quarters of earnings targets and struggled with profits in its individual business, disappointing Wall Street.

Aetna said it has received commitments from Citi and UBS Investment Bank to finance the deal.

Citi and Lazard are financial advisers for Aetna and Davis Polk & Wardwell LLP is its legal adviser. Goldman Sachs is the financial adviser to Humana, while Fried, Frank, Harris, Shriver & Jacobson is its legal adviser. –Reuters