Change in Tricare contractors disappointing news for Humana, Health Net

Multibillion-dollar military contracts that Humana and Health Net have relied on for years of predictable profit are changing hands next year, leaving the two companies facing the loss of steady business when they can least afford it.

The change in Tricare contractors left industry analysts wondering how badly Humana and Health Net would be hurt by the loss of that business, and if it would precipitate the sale of one or both companies -- sales frequently rumored but never discussed by the plans themselves. Both plans, like their competitors, have lost commercial membership as the economy has deteriorated.

Tricare is the Dept. of Defense's health care program for members of the armed services, their families and survivors. Aetna and UnitedHealth Group won the contracts, triggering a shakeup that took some industry onlookers by surprise. Both Health Net and Humana released statements saying they were "disappointed" with the decision.

The new contracts are set to last five years beginning in 2010, following a 10-month transition period. Tricare is administered inside the U.S. in three regions, each with nearly 3 million enrollees. Health Net and Humana had each been contracted to administer Tricare benefits since 1996 -- Humana in the South and Health Net in the North.

TriWest Healthcare Alliance, a group of nonprofit Blues plans and hospital systems, won its bid to continue managing care in the West region as it has for the last 13 years.

The Tricare contracts are worth $16.7 billion for the North region and $21.8 billion for the South region over five years, according to the government's figures.

Humana and Health Net have the option to protest the contract award, but neither company was immediately ready to say whether it had plans to do so. First, the Dept. of Defense will meet with Humana and Health Net representatives separately to discuss the reasons for the contract awards. Those meetings weren't scheduled as of mid-July.

Industry analysts saw the loss of the Tricare business as particularly damaging to Health Net, which has seen dropping profits and a steady stream of regulatory fines over the past two years. Goldman Sachs analyst Matthew Borsch said that Tricare represented more than 30% of Health Net's 2009 earnings.

"The loss of Tricare is a major blow to Health Net, since this business has been the company's most consistent performer over the past decade," Deutsche Bank analyst Scott Fidel wrote in a note to investors.

Seeking to centralize its operations in California, Health Net has openly sought a buyer for its business in the Northeast and in Arizona. A deal with New York-based EmblemHealth to buy the Northeast business is rumored to be all but final, with the Medical Society of the State of New York already issuing a statement protesting the sale. But neither company will discuss it.

For Humana, the loss of Tricare means a less-diverse business, one heavily dependent on Medicare Advantage.

In a note to investors, Borsch estimated that after losing Tricare, Humana's business would be about 80% Medicare and 20% commercial. With expected changes to Medicare Advantage that are expected to diminish its profitability, as well as a declining commercial membership, the company is left with an uncertain outlook.

Health Net's stock price closed at $14.13 on July 13 just before the awards were announced. The stock fell to a low of $11.32 the next day. Humana's stock price dropped from $30.59 to a low of $27.96 over the same period.

If one or both of the companies founder and become the target of an acquisition by a bigger insurer, there would likely be a battle to win approval from state and federal officials.

The AMA and others in organized medicine oppose any further health plan consolidation, and early signs point to increased scrutiny of such deals from the Dept. of Justice under the Obama administration.