Plans post bigger profits as weak demand for health care services continues

The country's largest shareholder-owned health plans reported mostly better-than-expected profits for the first quarter of 2011, gains in many cases attributed to members spending less than projected on health care. The results were somewhat familiar to investors, who have heard a similar story for the last four quarters.

A new factor added to some plans' unexpectedly high profits in the most recent quarter were young adults who are now covered dependents on their parents' plan, thanks to a provision in the Patient Protection and Affordable Care Act that expanded their eligibility to age 26. The rules took effect in September 2010. When they announced earnings, some health plans for the first time reported medical costs for the newly eligible population.

At WellPoint, the country's largest health plan by membership with 34.2 million members, the company built in an anticipated rise in medical spending when it priced insurance after September 2010, but that turned out to be overly cautious, Chief Accounting Officer Marty Miller said at an investors conference in May.

"We had a much more pessimistic outlook in terms of the risk associated with the 26-and-under dependents than actually materialized," he said.

During WellPoint's first-quarter earnings call April 27, President and CEO Angela Braly said about a third -- or 291,000 -- of the company's 875,000 new members added in 2011 was attributable to the eligibility rules.

Wayne DeVeydt, WellPoint's chief financial officer, said during the call that the newly eligible dependent group tends to have a low medical-spending ratio compared with the overall population.

"The claims experience is very low from this group. The majority of these lives are healthy lives," he said.

Aetna President and CEO Mark Bertolini said during the company's earnings call April 28 that fewer than 100,000 young adults joined their parents' Aetna policies since the eligibility change took effect.

"It's a little early to look at the impact of cost, but we have projected that to be a relatively small amount," he said.

The new young adult members were a small part of another quarter of profit growth for the seven biggest publicly traded health plans. The first quarter usually brings lower health care expenses than the latter part of the year. But even taking that into account, nearly all the big publicly traded health plans saw growth in profits in the first three months of 2011 that exceeded Wall Street expectations and the companies' projections.

With the exception of Health Net, which saw a drop in net earnings due to one-time litigation costs, the largest shareholder-owned plans saw a double-digit increase in quarterly per-share earnings compared with the first quarter of 2010. Health Net still saw a 3% increase in revenue, to $3.5 billion from $3.4 billion in the first quarter of 2010.

Cigna had the most dramatic increase, with $430 million in net earnings, up more than 50% from 2010. Coventry Health Care's earnings growth was the most modest, up 12% to $110 million from $97 million the same period a year ago.

In announcing their results to investment analysts, health plan executives said lower-than-expected medical expenses were a source of profit growth. They invariably said they expect results to be tempered within a few quarters with a return to "normal" patterns of medical utilization.

Miller, of WellPoint, reiterated the company's expectations in a presentation at the investment conference hosted by Deutsche Bank on May 2, but conceded that there are few signs of a rebound.

"The fact is there is no doubt we have not yet seen a lot of very, very hard signs about what's happening and utilization picking up," he said.

But he said that eventually the company expects the economic recovery to translate into a more rapid growth in elective care.

Investment analysts have been hearing comments like that for the last year, and they aren't so sure that even insured workers will have the confidence to schedule hip replacements or other elective care this year.

Commenting on WellPoint's earnings April 27, investment analyst Dave Shove of BMO Capital Markets wrote in a note to investors: "Outperformance driven by lower-than-expected medical expense has become a familiar story line. We suspect that utilization (and therefore medical costs) will remain below expectation for the duration of the year."

Analysts are keen on tracking how much plans spend on health care because of new government rules that require them to spend at least 80% of the premiums they collect for individual and small-group policies, and 85% of what they collect for large-group plans, on patient care and quality improvement.

The rules took effect for their 2011 spending, so they will be required to pay rebates in 2012 if they spend too little on care this year. Insurers and their investors want to hit as close as they can to the minimum to avoid a rebate but expand their profit margins. Plans reported overall medical-loss ratios of 79.2% (Aetna) to 87.4% (Health Net), though no plan broke down ratios by specific policies. Cigna does not report an overall medical-loss ratio.

To get a better sense of the likely recovery timeline, Goldman Sachs investment analyst Matthew Borsch cross-referenced the story line he heard from health plans with what hospitals, medical device makers and physician services companies were saying.

He found that while more people were insured and have been using health care services, the growth in health care spending on a per-member basis has continued to grow at a slower pace than it had been before the recession.

Borsch looked at recovery patterns following past recessions and found that the rebound in health care use takes a few years. Like Shove, he expects health plans to continue to benefit from weak demand for health care.