The recent hit HMO stocks have taken in the market has come because Wall Street has the jitters over revised earnings outlooks. Many health plan stocks have fallen by 50% in recent weeks.
The Street is right to worry that the health plans are going to have difficulty pumping out more of the great and predictable earnings we've seen from them in recent years. But they also continue to miss a very large political risk that still looms as the Congress looks to trim private Medicare payments.
Health plan profit expectations are going to be harder to make in the next few quarters. The health care trend rate has stopped its five-year deceleration and the easy days are over. Now, a health plan has to hit its numbers on the head without the help of falling trend rates and the good things that result like "positive reserve development."
Wellpoint upset the market when it said it missed its health care cost trend assumptions by half a percentage point--that's little more than the margin for error in this business. I've missed it by multiples of that! Management reports that the fundamentals in the Wellpoint businesses continue to be strong even if the business is getting harder.
Universal American and Humana announced they miscalculated on their Part D pricing--Universal American because of mistakes in a health plan they later acquired and Humana because they once again blew their anti-selection assumptions. The other parts of the business for these companies--they tell us--continue to perform as expected.
We are at a point in the underwriting cycle where profit windfalls from a five year deceleration in the medical trend rate are gone. Growth in Medicare Advantage and Part D plans are both slowing as the low hanging fruit in those markets are gone. A slowing economy makes growth in the commercial health insurance market all but impossible unless you steal someone else's business.
So, the easy money days are over. But the wheels are not coming off. Margins continue to be at historically high levels.
If medical cost trend picks up the business will get even tougher. Two things would cause that to happen--an increase in underlying health care price inflation and/or cuts in Medicare and Medicaid payments to providers that force them to shift costs to the private sector. Cost shifting can assert itself both in higher prices and higher utilization. Both may be on the way, but neither has happened yet.
So, the health plan business is at a point where there is neither any profit windfall from decelerating health care cost trends nor is there a real pick-up in costs. The current environment isn't helping or hurting health plan results much--but we are at a place where a health plan has to hit its marks perfectly to come in on expected results.
So, the recent HMO sell-off was probably overdone--but with the easy results past us not entirely wrong.
But on top of legitimate earnings concerns there is still a pretty big political risk the stock market seems to be ignoring. That is the risk that payments to private Medicare plans--particularly Private Fee-For-Service plans--will be cut in the next year.
A recent article in Forbes.com by David Whelan has it about right. He points out that the health plans have made a lot of money on private Medicare and that is their real risk these days.
As David points out, Clinton and Obama would waste little time trying to kill private Medicare--and would have plenty of allies in a presumably Democratic Congress.
The only reason the Congressional Democrats haven't clipped that program's wings so far is that President Bush would veto any attempt. But this President is out of a job on January 20, 2009. Bush hopes John McCain will succeed him.
Will John McCain defend the terrific private payments the 2003 Medicare Act has given the health plans?
Well, McCain was one of the only Republicans to vote against the private Medicare legislation calling it a big boondoggle.
United, Wellpoint, and Aetna have only a single digit percentage of their profits tied up in the private Medicare Advantage business. Good for them.
Humana and Universal American have a whole lot more--Humana about half it its profits.
Humana and Universal American have both lost about half of their market cap in recent weeks because of earnings worries in the wake of disappointing news from both. But what about the political risk they are taking?
Doesn't look like John McCain has the same attachment to the 2003 Medicare Act George Bush has had.
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