Health Insurers Face Headwinds in Tough Economy; Premiums May Rise

Major U.S. health insurers and managed care companies earned sharply lower profits in 2008, some nearly half of 2007 results, as poor stock market performance and lower interest rates chiseled away at their investment portfolios.

The downturn in results may lead some insurers to try to increase premiums, though they will likely meet stiff resistance from employers, some analysts say.

Insurers also were hurt by a shrinking commercial market, while underestimation of the cost stung those that dived headlong into the Medicare Advantage plan business, analysts said.

If U.S. unemployment continues to rise, health insurers are likely to see group enrollment fall further, even after taking into consideration the effects of the 65 percent COBRA subsidy made available under the American Recovery and Reinvestment Act of 2009, analysts said. Despite help from the federal government, COBRA premiums may be too expensive for the jobless who are living solely on unemployment insurance benefits, they noted.

Meanwhile, planned cuts in federal funding of Medicare Advantage programs will affect the performance of insurers with a sizable portion of that market after 2010, analysts warned.

While health insurer profit margins hovered in the 9 to 10 percent range in 2007 after several prior years of similar good performance, margins of the top 10 health insurers dropped to about 5 to 6 percent in 2008, where they are expected to remain for the near future.

“We typically look at the sector as being fairly strong. But we had said for several years the 9 percent and 10 percent margins weren’t sustainable,” said Bradley Ellis, a director at Fitch Ratings in Chicago.

Poor investment results were a major contributor to the lower margins.

“Interest rates are down. Since health insurers have a shorter duration in their investment portfolios than life insurers, they’re replacing higher-returning investments with lower-returning investments,” Ellis said.

The decline of the financial markets was particularly problematic for Oakland, California-based Kaiser Foundation Health Plan Inc., which reported a net loss of $794 million for 2008, compared with a net gain of $2.2 billion in 2007.

Although Kaiser was the only one of the top 10 managed care companies to post a net loss for 2008, Stephen Zaharuk, vice president and senior credit officer at New York-based Moody’s Investors Service Inc., said the rating agency has placed a negative outlook on the entire sector.

“A number of things happening in the health care space are unsettled,” Zaharuk said, pointing to the Obama administration’s call for national health reform, cuts in federal funding of the Medicare Advantage program and enrollment losses due to increasing layoffs.

“Earnings were not as good in 2008,” said Sally Rosen, managing senior financial analyst with Oldwick, New Jersey-based A.M. Best Co. Inc. “But there were other issues besides investment returns. Each one of the companies seemed to have independent issues.”

For example, “in the winter of 2007 going into 2008, the flu season was worse in several areas of the country than it had been in several years,” she said. “There does not seem to be an increase in medical cost trend, but there is an increase in utilization. We’re also seeing an increase in high-dollar claims and claim severity.”

Minnetonka, Minnesota-based UnitedHealth Group Inc., for example, cut its full-year 2008 outlook by 10 percent due to unusually high flu costs and reduced investment income. For the year, UnitedHealth’s net income fell 36 percent to $2.97 billion from $4.65 billion in 2007.

Indianapolis-based WellPoint Inc., which reported net income of $2.5 billion in 2008 versus $3.3 billion in 2007, changed its financial forecast several times last year.
“They had an issue with systems migration,” said Wayne Kaminski, a financial analyst at A.M. Best.

Rosen said WellPoint had several legacy claims systems that had to be merged after a string of acquisitions in 2007 and 2008.

Other insurers “had issues with product design and pricing, mostly Medicare-related. The way it was priced and designed allowed several companies to be selected against,” Rosen said.

For example, Bethesda, Maryland-based Coventry Health Care Inc. restated its 2008 forecast twice last year because of Medicare Advantage issues, she said.

“In the first quarter of 2008, they realized their claims turnaround on the Medicare Advantage fee-for-service product was much longer than on their traditional business,” Rosen said.

As a result, “their reserving for 2007 was lower than expected.” Underreserving affected mostly plans covering large groups enrolled in employer-sponsored retiree benefits plans, she said.

Similarly, Louisville, Kentucky-based Humana Inc. “had a pricing issue with one of their Part D plans,” Rosen said. In addition to having underpriced the product, “they ended up having adverse selection” because the plan attracted more sick seniors because it was designed to protect them from exceeding their out-of-pocket maximum spending on prescription drugs.

Although they corrected the pricing for 2009, “they had to ride it out” for all of 2008, Rosen said.

As a result of its missteps and other issues, Coventry’s net income fell nearly 40 percent to $381.9 million in 2008 from $626.1 million in 2007. Humana’s profits fell 22 percent to $647.2 million in 2008 from $833.7 million in 2007.

Planned cuts in Medicare funding as Congress attempts to balance the budget likely will exacerbate insurer challenges in that business, Zaharuk said.

“Because of the deficits, the government is going to be looking for every penny,” Zaharuk said. “Quite possibly we’re seeing a repeat of what happened to Medicare before,” he added, referring to the Medicare+Choice program in the mid-1990s. After the government cut funding, insurers began withdrawing from the market.

To address expected revenue shortfalls, some analysts expect health insurers to try to raise premiums on fully insured business and administrative service fees on self-insured accounts.

“I think you’re going to see a more rational pricing environment,” said Bridget Maehr, senior financial analyst at A.M. Best.

But she doesn’t think employers will be willing to just sit back and accept price increases in the current economic environment.

The economy is likely to have a significant effect on health insurers’ group business, Zaharuk and Ellis predicted.

“In 2008, growth in the group market was flat,” Zaharuk said. “Aetna gained membership, but a lot of other companies lost membership. There’s also a loss in the market itself” as a result of layoffs and small employers dropping coverage for their employees due to the cost, he said.

Despite its enrollment gains, Aetna’s profits fell in 2008 to $1.38 billion from $1.83 billion in 2007.

“You’re seeing a lot of issues with regards to enrollment,” said Fitch Ratings’ Ellis. “Growth has shifted to state-run programs like Medicaid.”

Filed by Joanne Wojcik of Business Insurance, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.