Big MCO Earnings Growth in ’11 Likely Won’t Be Repeated This Year

Reprinted from HEALTH PLAN WEEK, the most reliable source of objective business, financial and regulatory news of the health insurance industry.

By Steve Davis, Managing Editor
January 23, 2012 Volume 22 Issue 3

While health plan stocks enjoyed a banner year in 2011, it’s highly unlikely that earnings will continue to grow at the same pace in 2012. However, continued low medical utilization could mean profits will continue to exceed expectations this year, according to equities analysts who offered their 2012 earnings predictions during a Jan. 18 webinar hosted by AIS.

“I don’t think things are going to be as good as they were last year” for health insurers, said Carl McDonald, an equities analyst at Citigroup Global Markets. Premium rates in 2011, he explained, increased about 7.5% from the previous year, while the medical cost trend grew by about 5.5%. This year, he anticipates that pricing will increase between 6% and 6.5%. If the medical cost trend grows at the same rate as last year, the sector still will experience earnings growth — “it just won’t be as big as it was” in 2011, he explained.

Matthew Coffina, a health care analyst at Morningstar, Inc., agreed that moderate health spending put the managed care sector on “a good trajectory in 2011 and into 2012.” But he predicted that headwinds such as increased regulatory oversight and heightened competition would pressure health plans in the long term.

Federal regulators, as well as some state insurance commissioners, have taken an increasingly tough stance against rate hikes they see as unjustified, particularly in the individual market. Coffina suggested that health plans might try to counter that rate pressure with more aggressive negotiations with providers.

Republican Sweep Would Be Good for Plans

If President Obama is re-elected in November, McDonald anticipates a 10% to 15% earnings decline in 2014 when many of the key reform law provisions kick in. But if a Republican wins the White House, and Republicans gain control of the Senate and maintain a majority in the House, publicly traded health plans could see earnings growth of 5% to 10%, he forecasted.

While it’s too early to predict the presidential race, or even determine the Republican candidate, chances are good that Democrats will lose their majority in the Senate, he added. With 47 seats in the Senate now, Republicans need just four victories to reclaim the majority. Sen. Ben Nelson’s (D-Neb.) recent decision not to run leaves the state without a strong Democratic candidate, and the seat is expected to be won easily by a Republican. Of the 33 Senate seats up for grabs in November, only 10 now are held by a Republican.

“But the presidency is what really matters for managed care,” McDonald told attendees. “If you get a Republican president, regardless of what happens in Congress, it would be a pretty big benefit for managed care because the president appoints the HHS secretary. You’d have to imagine that a Republican HHS secretary would have some very different interpretations of the reform law relative to the situation today.”

One of the biggest concerns among investors is uncertainty about how some reform law provisions, such as guaranteed issue and new taxes on health plans, will wind up impacting insurers when they go into effect. “If Republicans sweep, it means either everything [in the reform law] goes away because they repeal it, or, more likely, the Republicans strip down significant pieces of the legislation. There is very little I could see them doing that would be negative relative to existing expectations,” McDonald asserted.

MLRs, M&A and the Supremes

Here’s a look at five factors that could have a significant impact on health insurers in 2012.

(1) The Supreme Court: If the high court strikes down the individual mandate, it also may need to eliminate other reform law provisions such as rating bands and the guaranteed issue requirement. But that would translate to a negative for health plans because they wouldn’t see as much membership growth through the expanded individual market, Coffina said. He added that upholding the entire law would be the most favorable outcome for plans because many of the negative aspects of the law “are in place and here to stay.”

But once people understand how small the penalty is for not having health coverage in 2014, a Supreme Court decision striking down the mandate probably won’t have much impact on health plan stock prices, McDonald said. “The penalty isn’t nearly enough to convince someone who is young and healthy to buy insurance,” he said.

(2) Medical loss ratio (MLR) minimums: A year ago, many industry analysts predicted the reform law, particularly the MLR requirement, would have a negative impact on health plan earnings. But so far, the law has had a minimal effect. Coffina noted that stock prices among the publicly traded health plans he covers are up about 70% since the middle of 2008. During the same period, the S&P 500 is virtually unchanged. “We thought [the MLR rule] was going to be more meaningful for 2011….It turned into a virtual non-issue,” he told attendees. Part of the expected impact was mitigated by the calculation methodology outlined in the regulations, which allows certain administrative costs to be counted as medical costs, he explained. It also allows health plans to exclude taxes and fees from premium revenue.

(3) Medicare Advantage (MA) plans: The 85% MLR minimum for MA plans, which becomes effective in 2014, will mean margin contraction for carriers. And even more cuts are possible, said Coffina. But, he added, there is still some possibility of an upside for MA through some type of privatized Medicare legislation. Several Republican presidential candidates appear supportive of a Medicare strategy being promoted by Rep. Paul Ryan (R-Wis.) and Sen. Ron Wyden (D-Ore.) (see story, p. 1).

(4) Dual eligibles: People who are eligible for both Medicare and Medicaid represent a significant growth opportunity for managed care, according to McDonald. While there are just 9 million dual eligibles nationwide, annual spending on this group tops $300 billion (about $35,000 per member). Fewer than 1 million dual eligibles are now enrolled in an MA Special Needs Plan. With so much money at stake, MA and Medicaid plan sponsors are seeing duals as their best chance for major growth in the next few years. CMS’s newly created Medicare-Medicaid Coordination Office has proposed Medicare-Medicaid financial alignment models that allow states to share in the savings yielded from better management of dual eligibles. McDonald predicts that over the next three to five years, more than half of the money spent on dual eligibles will be in some type of coordinated care.

(5) Mergers and acquisitions (M&A): It’s unlikely there will be major consolidation among large health insurers in 2012, but carriers such as Aetna Inc. and WellPoint, Inc. might try to beef up their MA business by acquiring an existing company. Although WellPoint acquired CareMore Health Group in August, the deal brought in only 55,000 lives (HPW 6/13/11, p. 3). “They might want to get into it further,” McDonald said. However, there are a limited number of MA acquisition targets. Among publicly traded companies, there are WellCare Health Plans, Inc. and Universal American Corp., and only a couple of private insurers that have more than 100,000 MA lives.

Coffina added that WellPoint might be the most undervalued stock in the sector.