Corporate Research Group’s Weblog

In this week’s installment of Healthcare Week in Review, Oppenheimer analyst Carl McDonald and I discuss the prospects for Medicaid health plans.  As bad as things look for Medicare plans, McDonald says, that’s how good they look for Medicaid plans.  From the Nasdaq Market Site in New York.

Let’s assume, for argument’s sake, that a government-run health insurance option is part of the healthcare reform package that ultimately gets enacted (note: this also assumes that any healthcare reform package gets enacted).  The health insurance industry is worried that the government plan will siphon off business.  Well, I know four things health insurers can start doing right now to ensure they win big even in the face of a government option. 

1. “Developing products and services that improve the quality of health care and help control rising benefits costs.” 
 
2. “Providing members with access to convenient tools and easy-to-understand information that can help them make better-informed decisions about their health and financial wellbeing.”

3. “Introducing new levels of transparency to the health care system.”

4. “Pioneering new ways to focus on wellness and prevention programs.”

Coincidentally, these four quotes appeared in Congressional testimony given this week by Aetna chairman Ron Williams, pointing to investments his company is making to positively impact the physical and financial health of its customers.

Williams, like the rest of the insurance industry, is still against the government-run option.  But he has mapped the road to success: it’s called innovation.

Health insurers opposed to the Obama Administration’s plan for a government-run health insurance exchange for individuals and small businesses should give a careful read to this month’s Congressional testimony by Karen Davis, president of The Commonwealth Fund.

Davis cites research suggesting that a healthcare exchange, along with other reforms, “could slow the growth in national health spending from a 6.7% annual rate of growth over the 2010–2020 period to 5.5%.”

The result would be $3 trillion in savings through 2020.  Employers alone would save $231 billion, state and local governments $1 trillion, and households $2.3 trillion (or $2300 per family in the year 2020 alone).  Furthermore, she notes, the number of uninsured would drop to less than 1% of the population by 2012.

These are the kind of numbers that get people’s attention. 

I spoke to Davis this week, and the challenge she threw down to the health insurance industry was basically as follows: Can you get to 5.5%?  In other words, can the insurance industry control costs?  Considering that managing costs is supposed to be among the industry’s reasons for being, you’d think it would have a ready answer.

What exactly would a government-run insurance option look like?  Below is a chart included in Davis’ testimony showing what the benefit design might include.  Also below, a couple of additional Commonwealth Fund charts on projections for healthcare costs and the uninsured before and after reform.

In our weekly video with Carl McDonald of Oppenheimer, we discuss the rumors that Aetna might be interested in acquiring Humana.  From the Nasdaq Market Site in New York.

This is the battle we knew the health insurance industry would fight, so it’s no surprise to see it in black and white. 

“Creating a new government-run plan would thwart the ability of the health care sector to implement meaningful delivery system reforms, exacerbate the cost-shift from public programs to consumers and employers in the private market, and destabilize the employer-based system. In fact, studies show that more than 100 million people who currently have private coverage would move to the new government-run plan.”

So writes Karen Ignagni, chief executive of America’s Health Insurance Plans, and Scott Serota, chief executive of the Blue Cross Blue Shield Assn., in a joint letter March 24, 2009, to ranking members of the Senate Finance and the Health, Education, Labor and Pension committees.

The government-run plan in question is part of Obama’s healthcare reform package to reduce the number of uninsured in America.  Health insurers oppose it because, well, 100 million people might pick it over a private health plan.  Instead, the industry favors tax credits to help people buy insurance along with Medicaid and the expansion of SCHIP.

In exchange for no government plan, the industry is willing to guarantee it will provide insurance to anyone regardless of health status.  It will also “phase out the practice of varying premiums based on health status in the individual market.” 

The industry only asks for a mandate requiring every individual to purchase health insurance.  It also wants to reserve the right to vary premiums based on age, geography, family size and benefit design, and to provide discounts for people who don’t smoke and participate in wellness and disease management programs.

Of course, I’m willing to bet the insurance industry would cave in on nearly all these conditions if it could vanquish the government-run option for the uninsured.  The problem is, I also think the government-run option is as close to non-negotiable as you can get for the Obama Administration.

So it’s going to be interesting to see who wins this showdown.  Right now, it’s advantage Obama.  The very fact that the industry keeps suggesting compromises suggests it’s nervous.  But I wouldn’t count out the insurance lobby; it’s pretty savvy.

My take on the government-run option is “why not?”  As I wrote in an opinion piece in 2007: “Managed care plans have always maintained that their products are better than government-run programs (e.g., the industry has long argued that Medicare HMOs are superior to traditional Medicare).  So the industry should welcome an opportunity to go head-to-head with any public plan.  Health plans that can’t compete on a level playing field deserve to be shown the door.”

Caution is the watchword as Leerink Swan initiated coverage on the managed care industry with a buy rating for Aetna and a sell rating for WellPoint.  Leerink was neutral on a handful other other managed care companies, including Cigna, Coventry, Humana and UnitedHealth.  Here are some key quotes from the Leerink research report by analysts Jason Gurda and Nell Bhalodkar. 

“We are cautious on the outlook for managed care stocks over the next year as we believe a deepening recession will increase concerns about commercial enrollment trends, investment portfolios, and hospital cost shifting.” 

“While we anticipate continued near-term stabilization in underwriting margins, we are cautious longer-term as we believe commercial utilization rates are unlikely to change…and that it will be difficult for the managed care industry to remain disciplined on pricing.”

“Near term we believe potential compromises on healthcare reform could be a positive for Medicare Advantage.  However, as the year progresses, we believe rapidly widening deficit projections will raise the threat of broad Medicare and Medicaid cuts in 2010.”

“The outlook for Medicaid plans is mixed…On a positive note, we anticipate significant increases in membership as a result of the recessions and the stimulus package. However, state finances remain extremely fragile, and we believe that the outlook for pricing is uncertain.”

Aetna “has demonstrated better execution in gaining market share and growing operating earnings than most of its peers….Aetna is the only company in the group that we believe will increase its commercial enrollment growth during 2009.”

“WellPoint has experienced several issues related to the integration of previous acquisitions, including inadequate pricing in 2008….We
are somewhat concerned about the company’s ability to rapidly identify and respond to new cost trend developments.”

Answer: Probably not too well.

Now that Jon Stewart of the Daily Show has (quite fairly) stuck it to CNBC and Mad Money host Jim Cramer for among other things failing to predict the market implosion (see video here), I’ve been doing a little soul-searching myself. 

The team here at CRG (i.e., mostly me) had projected that managed care profits would rise about 20% in 2008.  Instead, they fell off a cliff.   There were indeed signs that a downturn was overdue, as I pointed out in a 2007 opinion piece (see below). 

Countering these signs, state insurance department data continued to show strong profit growth among HMOs.  Furthermore, our annual nationwide survey of employers and health plans showed that premium rate increases were steady and mirrored historical cost trends.

Only higher-than-expected increases in medical costs coupled with some poor forecasting on the part of health plans could turn things sour.  Throw in investment losses tied to falling markets and some other unexpected blow-ups….well, you get the idea.

Bottom line: There was enough evidence to suggest managed care plans would have another good year and enough to suggest as I did in my 2007 opinion piece that there were concerns. 

Too bad I went with ”another good year” of 20% profit growth.   ”I coulda been a contender, instead of a bum, which is what I am!”

***

When Is a Trend a Trend?  Thoughts on the Insurance Cycle

by Carl Mercurio (Originally published, May 3, 2007)

The 2007 managed care earnings season officially began on April 17 when UnitedHealth Group (Minnetonka, MN) released first-quarter financial results.  Since then, managed care stocks are down 5.5%. 

The only winners over the period from April 17-May 1 were Aetna Inc. (Hartford, CT) and Cigna Corp. (Philadelphia), two companies with something in common.  Both reported declines in medical costs as a percentage of premiums (i.e., medical cost ratio) for the first quarter.  That means premiums generally speaking rose faster than medical costs—the single most important measure of a health plan’s financial success.

With the exception of shares in Sierra Health Services (Las Vegas, NV), which were flat, shares in all the other major managed care plans are down since April 17.  Shares in Medicaid plans like Amerigroup Corp. (Virginia Beach, VA), Centene Corp. (St. Louis, MO) and Molina Healthcare (Long Beach, CA) were the hardest hit, but the fallout included industry giants UnitedHealth and WellPoint Inc. (Indianapolis) as well. 

And in most cases the culprit was an unexpectedly high medical cost ratio.  It’s a pretty safe bet that a rising medical cost ratio—short of a change in business mix or other factors that explain the increase—will put a damper on a health plan’s stock.  When the increase is unexpected, Wall Street freaks.

The $64,000 question is whether the recent MCR run-ups are limited to company-specific issues, or whether they indicate an industry-wide increase in the price and/or utilization of medical services.  The former means the problem is isolated—a one-time or short-term aberration.  The later means the entire health insurance industry may be sucking wind.

Ebbs and flows in industry-wide MCRs used to be called the insurance or underwriting cycle.  Prices rise to cover costs (an up cycle) and then fall as plans price to win share (a down cycle).  The concept has fallen out of favor.  Industry executives and Wall Street analysts have declared the underwriting cycle dead.  One of my favorite analysts—and a hell of a good writer—Carl McDonald of CIBC postulates the following:

“Mountains of evidence suggest managed care is a cyclical business, with regular patterns of rising and falling margins….The historical evidence looks indisputable, but the question remains: will it be this way going forward?  Is there still an underwriting cycle?  We think the answer is no.”

He goes onto the say that health plans will still have ups and downs.  But the ups and downs will be less pronounced because health plans have a better handle on cost trends then ever before (technology has speeded up reporting) enabling plans to adjust prices more quickly than before.

I admit that I’ve never been much of a visionary.  I tend to look at history as a predictor the future.  If the price-to-earnings ratio of the stock market is above historical averages, I look for stock prices to fall.  If Yankee shortstop Derek Jeter has a high batting average against a particular pitcher, I expect him to get a hit when he faces that pitcher.  

In short, I’m not ready to declare the insurance cycle dead. I’ll agree, however, that future cycles will likely be less pronounced.  So if McDonald and I disagree, it may more semantics than substance—which is another way of saying we’re both hedging. 

Meanwhile, here’s a look at some of the first-quarter MCR troubles of top health plans, along with the various explanations of plan executives.  You be the judge if the worm is turning.

*Stephen Hemsley, chief executive of UnitedHealth Group (Minnetonka, MN), basically admitted the company got sloppy in its forecasting of medical costs—failing to adequately project the prices it would have to pay for out-of-network medical services and guessing wrong on cost trends for high-deductible and consumer-directed products.  United officials said HDHP/CDHP costs tend to soar in December when members rush to get treatment before the deductible resets for the next year.  Why this should suddenly be news to a company that has been a big player in the consumer-directed market for some time wasn’t clear. 

*David Colby, chief financial officer of WellPoint Inc. (Indianapolis) said the company was waiting for a Medicaid reimbursement rate hike that never came—resulting in “unacceptably high” Medicaid MCRs in two states.  One of the states was California, where the company is negotiating for higher reimbursements.  The company has also initiated other cost-control efforts, including recontracting with labs, reducing physician fees, closing drug formularies, and restructuring hospital networks.

*The red flag raised by WellPoint over Medicaid MCRs put the spotlight on Medicaid health plans in general—pushing down shares in Amerigroup, Centene and Molina.  Amerigroup said medical costs in Georgia were higher than expected, driven by dental, drug and in some case in-patient expenses.  Centene also reported higher-than-expected physician costs in Georgia.  Molina saw its stock bounce back after it reported no first-quarter MCR problems.

*By the time Humana Inc. (Louisville, KY) reported an increase in first quarter 2007 MCR, the market was already sufficiently spooked to drive down the company’s stock—despite the fact that Humana reported better-than-expected profits.  Wall Street analysts estimate that Humana’s Medicare Advantage product line alone drove the increase in MCR.  Shares in Humana are also susceptible to investor concerns that Congress will scale back Medicare HMO payments. 

*And finally, Health Net (Woodland Hills, CA) saw its shares fall 5% on April 30 and then bounce back somewhat the next day as investors tried to make sense of the company’s prospects after it reported solid but hardly spectacular first-quarter results.  Medical cost ratio was up—but mostly that was expected.  And while I couldn’t help but note that commercial medical costs were rising slightly faster than premium yields, the company said yields would end up topping cost trends for the year.

So what’s the bottom line?  Remember Aetna, which took it on a chin a year ago when costs got ahead of premiums.  The company said at the time that the shortfall was related to a few specific accounts and that all had been fixed.  Judging by first-quarter 2007 results, Aetna was right.  So there’s a good chance that all the MCR woes mentioned above are also one-time blips.  There’s a good chance all is being corrected as we speak.  There’s a good chance all is well.  And a cycle runs through it.

***

In the “you’ve got to be kidding me” category, shares of Humana soared last week on rumors that the company was in talks to be acquired by Aetna. 

Whatever Humana’s motivation might be given its battered stock price, I doubt this is the right move for Aetna.  I always get nervous when a company announces a major shift in strategy, especially if the shift is spearheaded by a major acquisition.  Does this approach ever work?

The acquistion of Humana would represent a major shift for Aetna on two fronts:

1. The sheer size of the deal would dwarf anything Aetna has pursued since its ill-conceived mega-merger and acquistions strategy of the 1990s (US Healthcare, Prudential, NYLCare).  Instead, Aetna has since successfully pursued a lot of small, targeted deals aimed at expanding its product portfolio and geographic reach in promising areas.

2. The acquisition of Humana would represent a major expansion for Aetna into Medicare in particular and government business in general—this at a time of heightened regulatory uncertainty and confusion over the future of Medicare health plans.

In short, I’d be surprised if this rumor is well-founded.

I last spoke to Aetna chairman and CEO Ron Williams two months ago, and he told me that the company remains consistent in its approach to M&A.  Granted, this wouldn’t be the first time a CEO told me one thing and did another. 

As for Humana CEO Michael McCallister, I usually interview him every year for the annual outlook for managed care issue of Managed Healthcare Market Report.   This year he never got back to me.  Hmmmm!

Really, really brief comment by Jim Cramer of TheStreet.com on HMO stocks.  Click here to watch the video.

The Financial Times reported today that WellPoint has put its pharmacy benefit management division on the block—or “up for auction” to quote the FT.  The potential price?  “Anywhere from less than $1bn to five times that amount,” the FT says.  WellPoint had no comment.

I suppose you can argue that any company—in whole or in part—is up for sale at the right price.  But barring someone making a mad stupid bid, the main conclusion I would draw from the PBM unit’s sale would be that the pressure to “do something” got to WellPoint CEO Angela Braly and her management team.

Managed care companies that own PBMs pitch a simple concept to employers and other clients: if you let us manage both your medical and drug benefits, we’ll create an integrated program that better controls total healthcare costs. 

The problem is that it’s difficult, if not impossible, to prove that integration works.  Nor do health plan-owned PBMs typically enjoy the same purchasing power as giant standalone companies like Medco, CVS Caremark and Express Scripts.  Furthermore, health plan-owned PBMs struggle to win business from anyone other than their own captive medical members.

But WellPoint’s PBM is different.  It actually has been pretty successful at winning outside clients, which account for nearly a fourth of its membership.  It also has the scale to wield considerable purchasing power.  And most importantly, it fits neatly into WellPoint’s broader corporate strategy around integration. 

So what’s changed?  Shares in WellPoint have fallen 60% since Braly became CEO in June 2007.  In fairness, a lot has happened in the world since June 2007, and other managed care company stocks have been hit even harder. 

But you either believe in your company’s strategy or you don’t.  While there’s nothing wrong about divesting a PBM unit (many analysts argue that it’s in fact the right move), my guess is that the sale of WellPoint’s PBM would be mostly about appeasing weary shareholders.  Whether it leads to a viable new strategic vision remains to be seen.