Corporate Research Group’s Weblog

Can managed care plans consistently increase membership without sacrificing profits — or conversely increase profits without sacrificing membership?  The recent example of Aetna (solid membership growth followed by profit shortfalls) and others before suggests the answer is no, as noted by Oppenheimer analyst Carl McDonald.

While it was intellectually stimulating to consider why Aetna might be different from its managed care peers, and better able to manage through the more difficult fundamental environment, it turns out at the end of the day that Aetna was no more immune to the situation than either UnitedHealth or WellPoint. With Aetna’s operating earnings guidance now down almost 30% for the year, it seems safe to say that none of the larger plans in the group can really stake a claim to having any kind of sustainable competitive advantage over their peers. Aetna had the responsibility for awhile, but as it turns out, the ability to grow commercial risk enrollment profitability was just a façade that couldn’t be maintained for very long. 

One of the things this reality suggests — despite claims of differentiation among leading plans — is the notion of health insurance as commodity.  Healthcare reform featuring insurance exchanges offering plans with standard benefit packages would only make it more so.

Aetna may (or may not) be looking to sell its PBM operation (see prior post).  But that doesn’t mean it’s giving up on integration. 

Aetna announced today that it was acquiring the employee assistance program business of Psychiatric Solutions for $70 million in cash.  The operation, called Horizon Behavioral Services (Lewisville, TX), has about 5 million EAP members and generated revenues of about $22.6 million through six months of 2009.

Aetna already has about 7 million EAP members (14 million total behavioral lives), so the acquisition will nearly double its EAP business.  The deal also expands Aetna’s EAP presence in the mid-sized group market (300 to 3000 employees), a strong segment for Horizon.  Most of Aetna’s current EAP business is national accounts (3000+ employees).

Cigna has been cutting costs to boost profits, and while the company has made progress, it still has a ways to go.  Per member costs at Cigna are still about 10% higher than key managed care competitors.  It plans more job cuts, vendor consolidation, administrative efficiencies through technology, outsourcing and real estate sales.  In the second quarter alone, the company cut 465 jobs.  Second-quarter operating expenses at Cigna’s healthcare segment fell 3% or $25 million from a year earlier. 

Cigna has been struggling to get its costs in line given hefty membership losses.  Total medical membership fell 7% in the second quarter, compared to a year earlier, with at-risk down 13%, experience-rated 17% and ASO 6%. 

In some ways, Cigna is an extreme example of a problem potentially facing other managed care plans: how to boost margins without losing so much membership that overall cost structures get out of line.  What was it the Pointy-Haired Boss said in Dilbert?  Imagine how much money we’d save if we fired everybody.

I suppose you can blame pretty much anything on the economy.  But WellPoint Inc. really does seem to be susceptible to downturns — in part because of its exposure to the small group and individual markets.

Shares in the company had fallen 7% by early afternoon today, with investors spooked by a cloudy outlook in the face of high unemployment. Here are some bullet points, as reported by the company in its second-quarter earnings call this morning.

• WellPoint lowered its 2009 profit forecast, blaming the impact of the economy on the company’s commercial business.  Overall, profits fell nearly 8% in the second quarter, which still topped Wall Street expectations. 
• Medical membership fell by 1.1 million or 3% to 34.2 million as of June 30, compared to a year earlier.  Small group membership alone fell by 734,000.  Compared to the first quarter, total medical membership was down 338,000, almost entirely from commercial; about 75% of the loss came from job attrition among existing clients. 
• Commercial medical cost ratio rose nearly 200 basis points in the second quarter, compared to a year earlier.  The company said that markets hit hard by the recession, such as California and Ohio, fared worst.  It also said layoffs have been mostly among lower utilizers of healthcare services.  Exactly why isn’t clear. 
• COBRA membership — with its high medical cost ratio — has increased to 2.2% of WellPoint’s fully funded membership, compared to 1.6% as of year-end 2008.

So basically what started as a good day (Hey, they beat 2Q09 consensus!), turned into a downer really fast.

The return of Allen Wise to the chief executive slot at Coventry Health Care earlier this year (see prior post) already appears to be paying off. 

Mostly, the company seems to be making progress toward getting pricing in line with costs, stabilizing margins, exiting certain businesses (like Medicare PFFS and Medicaid ASO), and zeroing in on others (like Medicaid risk, individual and Medicare CCP).  Commercial medical cost ratio in the second quarter fell 100 basis points to 81.7% — and that’s important given that the company got whacked in 2008 by soaring MCRs.

The bad news is that the focus on margin improvement is expected to drive commercial risk membership down about 9% in 2009, said Wise on a conference call with Wall Street analysts to announce second-quarter 2009 financials.  (Group risk is expected to fall 12%, with about half the decline coming from price increases on renewals and half from other types of attrition, such as layoffs, small business failures, etc.). 

Wise said that in the past, customers were usually willing to absorb 500 basis points of price increase, assuming they were happy with a particular plan’s benefits and service.  “They’ll change for 100 basis points in today’s economy,” he said, adding,  “We paid a bigger price than would be ideal in membership.”

All of which makes you wonder what kind of member attrition Aetna will have now that it also appears to be firmly committed to margin improvement (see prior post).  When it comes to balancing growth and profit margins, MCOs are really boxed in.

Two news items concerning Aetna today.  Neither surprising. 

First, The Wall Street Journal reports that Aetna is considering the sale of its pharmacy benefit management unit.  After WellPoint sold its PBM for a hefty $4.7 billion, several industry observers (myself included) figured others would follow.

How much is the Aetna PBM unit worth?  Lisa Gill of J.P. Morgan says Aetna could get anywhere from $1.6 billion to $1.8 billion for its PBM unit.  Glen Santangelo of Credit Suisse puts the value at $2.4 billion.  Both seem high to me, but the ultimate price-tag will depend on which assets Aetna sells and the terms of the PBM contract between Aetna and the acquiring entity.

Whatever you think of integration in managed care — i.e., the notion that a health plan can better manage overall medical costs by owning PBM, vision, dental and behavioral plans — Aetna’s PBM appears to lack a compelling offering in the eyes of the marketplace. 

Plus, it’s pretty hard to make a case that owning a PBM helps with overall medical cost management when you keep reporting medical costs are rising faster than you predicted — which brings us to news item number two: 

Aetna has — yet again — cut its 2009 earnings projections, this time to a range of $2.75 to $2.90 per share.  The company — yet again — blamed higher than expected medical costs in its commercial health plans.  I’ve written before (see prior post) about the potential bind Aetna was in concerning pricing, membership growth and profits.  The only question now is whether the company finally has its pricing and costs in line.  (Addition, July 28, 2009: Wall Street analysts believe the answer is yes, according to several research notes that passed our desk yesterday afternoon and this morning).

Shares in Aetna were down nearly 5% in midday trading on the revised 2009 forecast.

Imagine how profitable Health Net would be if it got rid of all its businesses.  O.K., that’s a joke.  But the company has lost its lucrative Tricare business and now — at long last and after much ado — has struck a deal to sell its Northeast operations to UnitedHealth. 

The sale price appears to be a good one for Health Net.  It includes $60 million in up-front cash, plus another potential $120 million in incentive payouts tied to commercial member retention, plus access to $450 million in previously restricted assets — a total potential value of $630 million.

Health Net serves 578,000 members in Connecticut, New York and New Jersey: 437,000 commercial risk, 35,000 self-funded, 55,000 Medicare Advantage and 51,000 Medicaid members.  The company expects 2009 revenues from these operations of about $2.7 billion.
 
I still think Health Net will sell off the rest of the company at some point, which includes its operations in California and Arizona.  So the good news — i.e., the successful sale of the northeast business at a decent price — is overshadowed by the prospect that this is just another step in the dismantling of an organization that has been floundering for most of the decade.

UnitedHealth Group will release its second-quarter earnings tomorrow, marking the start of 2Q09 earnings season for the managed care industry.  The problem is that with healthcare reform looming, investors aren’t likely to be paying much attention.  Notes Matt Perry of Wachovia:

Fundamentals are less important in 2Q09 than at any other time in recent memory. Health care reform is, and will continue to be, the dominant issue. Based on that view, we think it would take material EPS beats or misses to change valuations in meaningful ways.

Here’s an interesting analysis from Justin Lake of UBS suggesting that growing COBRA uptake is cutting into managed care profits — but not too badly.

With concerns around impact of increasing COBRA membership to plans post introduction of 65% gov’t subsidy in Feb ‘09, we worked with Hewitt to develop proprietary data feeds illustrating increasing election rates post-subsidy. Data indicates that election rates have more than doubled for the subsidy eligible population to roughly 40%, with higher MLR membership pressuring earnings.

Est. manageable impact w/‘09 EPS range -1 to -3% and decelerates in 2010….While not immaterial, it is apparent that ex significant further increase in election rates or changes to current subsidy program, plans should be able to manage thru impact. We leave EPS estimates intact given our MLR estimates were already conservatively set at or above the high end of company guidance to account for COBRA pressure.

As our elected officials consider sweeping healthcare reform legislation, healthcare costs increase apace.  A survey from benefits consultant Hewitt Associates projects 2010 HMO premiums will rise 11.8%.  After benefit buydowns, figure on a final increase of about 8.3%.  That’s on par with 2009 when HMO premiums rose 9% after benefit buydowns. 

Not surprisingly, Hewitt says, employers are “continuing to look for ways to shift a greater portion of healthcare costs to employees.”  Notes Hewitt:

An increasing number of employers are shifting from a copay to a coinsurance model by, for example, moving from a $15 office copay and $250 hospital copay to a $200 plan deductible followed by 90 percent coinsurance for all services. Between 2007 and 2009, Hewitt’s data shows that out-of-pocket costs for large employer HMO offerings increased by 11 to 12 percent per year….

Companies are also looking at reducing their dependent subsidy dollars and focusing more on the subsidies provided to employees. This reduction is happening through increased payroll contributions for dependent health care coverage and/or by applying surcharges to encourage dependent spouses to take coverage under their own employer’s plans.

There’s a good chance that healthcare reform is going to mean big membership gains for individual health plans (Medicaid and small group plans too, but that’s another story).  How much growth can be expected in the individual market?  I’ll tell you, but first you have to tell me exactly how many individual lives there are currently.

According to the Census Bureau, there are about 17 million members of individual health plans, representing nearly 7% of the insured market.  A Kaiser Family Foundation analysis of Census data puts the number at 14.5 million.

Both seem high to me.  A recent CRG tally of individual plan membership at 23 leading managed care organizations added up to about 8.4 million lives.  Applying the 80/20 rule, the intrepid analyst would arrive at a nationwide individual membership estimate of 10 million to 11 million. 

So where are the other several million individual lives?  Census basically admits that its individual number might be overstated.  Here are two possible reasons why.  1. Misconceptions among Census survey respondents over the definition of individual or “direct-purchase” insurance; 2. The survey question is phrased to include anyone who had individual coverage at any point during the year. 

Can the number be overstated by that much?  Who knows.  A Census analyst offered little comfort in characterizing the 17 million number by stating: “It is what it is.” 

Now on to the growth potential.  There are nearly 50 million uninsured.  Expanding Medicaid eligibility could cover 15 million to 20 million.  Figure another 5 million (a guess) will remain uninsured for one reason or another. 

Of the remaining 25 million to 30 million, most would end up in a group health plan, according to a scenario laid out by the Commonwealth Fund.  Individual membership under the CWF scenario would increase about 40%.  Using CRG’s 10 million to 11 million baseline, individual membership would grow to nearly 15 million.

All of which is strictly a back-of-the-envelope projection that could change dramatically depending on the details of the final reform package.  That’s another way of saying your guess is as good as mine. 

One thing is certain, however.  If health plans want to capitalize on these individual opportunities, they’ll need to figure out how to make money in what’s likely to be a highly regulated, community rated, guaranteed issue market in which benefit levels are standardized by the government.

Humana chief executive Mike McCallister once told me if investors are concerned about exposure to government-related business they shouldn’t invest in his company.

Shares in Humana were down 8% as of 2:00 p.m. today after the company announced it had lost the contract to provide health benefits to 2.9 million Tricare South Region members.  Instead, the Dept. of Defense awarded the $21.8 billion contract to UnitedHealth.  The value is based on a 22-month initial award of $3.7 billion, plus four more one-year option periods.

Things were even worse for Health Net, which saw its shares plummet 14% as of 2:00 p.m. today after it lost the $16.7 billion Tricare North Region contract to Aetna.  The North Region contract has a 22-month initial award of $2.8 billion, plus four more one-year option periods.

Health Net was hit harder because the Tricare contract accounts for 25% to 30% of its profits, compared to a smaller percentage for Humana, according estimates from Wall Street analysts.  Still, it’s painful for Humana, which also has a lot of exposure to looming Medicare Advantage cuts.  I expect both Humana and Health Net will challenge the awards, but to no avail.

What’s interesting is while the business was important to Health Net and Humana, it appears to add very little to Aetna and UnitedHealth — raising the question of whether the winners simply bought the business.  The risk may be offset by the new contracts’ cost-plus features.

Notes Christine Arnold of Cowen: “The annualized, estimated net income gain for United and Aetna is less than half the estimated loss in earnings of Humana and Health Net, implying aggressive bidding by the victors relative to the incumbents. It is unclear if the risk sharing elements of the new contracts will leave the contract winners exposed to losses if costs come in over those assumed in the bids.”

Finally, the Triwest Healthcare Alliance Corp. consortium of Blue Cross Blue Shield plans retained the $17 billion Tricare West Region contract, which has a 22-month initial award of $2.9 billion, plus four more one-year option periods.

All of which suggests how brutally competitive it is out there in managed care land as plans stuggle to find ways to grow.

In short, they never ran. 

Blue Cross Blue Shield of North Carolina took a lot of heat a couple of months ago for its involvement in a series of planned Harry and Louise-like online videos slamming Obama’s proposed government-run health plan.

The videos were supposed to run on the company’s NChealthreform web site, according to the Washington Post, which had obtained copies of the video storyboards.  NChealthreform was launched in June to provide a platform for BCBS-NC’s views on healthcare reform.

But according to a BCBS-NC spokesman, the videos never made it past the planning stage and were never vetted by senior management, including company chief executive Bob Grezcyn.  The question is whether the videos were killed because of the negative press?  No, says the spokesman, adding that the company had already moved on when the storyboards were leaked.

So where does BCBS-NC stand on the government-run plan?  Like the rest of the managed care industry, it’s opposed, as Grezcyn explains in a video that did get released on NChealthreform.  It’s a softer sell than the videos that never happened, but the point is essentially the same.

The whole ugly episode was the second big black eye for BCBS-NC this year — the other being its involvement in the North Carolina State Health Plan fiasco (see prior post).

But I’m going to give BCBS-NC a pass on the videos that never ran.  I’ve known Greczyn for some time, and he’s always struck me as a straight-shooter.  Btw, he’s been pulling for universal coverage of the uninsured and a role for government for some time (see video). 

The Harry and Louise-esque videos were a bad idea (like Bob’s tie), and one way or another (on its own if you believe the spokesman or because of a backlash) the company realized its mistake before it did something uncalled for.

A decade ago, then Kaiser CEO David Lawrence joked that “managed care has gone from being a communist conspiracy to a capitalist conspiracy.”  Given the ongoing debate over how to reduce healthcare costs and improve quality, I’m wondering how you would finish the following sentence: Managed care is ….. a communist conspiracy?  a capitalist conspiracy?  the future of healthcare?  doomed?