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Managed Care's Price-Hike Panacea

By Sam Stovall The managed-care group -- companies that operate health-maintenance organizations (HMOs), preferred-provider organizations (PPOs), and point-of-service plans (POSs) -- was recently reenrolled in the list of industries with top Standard & Poor's Relative Strength rankings. These stocks have put in a robust performance thus far in 2002, while the broader market remains under the weather. Year-to-date through Oct. 18, the S&P Managed Care subindex rose 20.8%, vs. a 23.0% drop in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600).

S&P analyst Phillip Seligman maintains a positive investment outlook for the managed-care industry. Although the group still faces a number of potential issues, including patients'-rights legislation, litigation, and medical-cost inflation, Seligman expects earnings to increase by an average of 15% to 20% in 2002. Driving profit growth, according to Seligman, will be premium increases in the mid- to upper-teens percentage range. He sees this outpacing medical-cost inflation, which he believes will be in the low-to-mid teens.

CUTTING COSTS. With the economy remaining sluggish, however, employers have been taking stronger positions against rising premiums. Among their responses: cutting back on expensive options, reducing price increases in favor of higher co-payments (a practice referred to as buydowns), and passing on more increases in premiums to their employees (see BW Online, 10/23/02, "Health-Care Costs: The Painful Truth").

On the legislative front, Seligman notes that President Bush has said he would veto patients'-rights bills being considered by the Senate, because damage awards would be too costly and lead to higher premiums and greater numbers of uninsured. In any event, Congress has put both this issue and managed-care reform on the back burner while it concentrates on the war against terrorism and on rebuilding the economy.

BEST OF THE BUNCH. And while most managed-care organizations (MCOs) have been able to hike premiums at rates greater than those of accelerating medical costs, they're likely to face increases in their medical-cost ratios -- defined as direct costs expended on health-care as a percentage of total premium revenues. In light of buydowns, the premium-rate yields realized by MCOs can be one percentage point to three percentage points lower than the rate hikes. In addition, large-group accounts, which command lower rate increases than small-group and individual accounts, make up a larger percentage of managed-care membership.

To offset rising medical-cost ratios, MCOs have been focusing on reducing their selling, general, and administrative costs as a percentage of revenues. One method is to improve computer systems to further automate paper handling. Some MCOs are also consolidating service operations through workforce reductions.

What distinguishes the best-positioned players in the industry? Seligman still recommends that investors focus on companies with stable medical-cost ratios, minimal exposure to Medicare, a relatively low percentage of capitated provider agreements (where an HMO pays doctors and other health-care providers a fixed monthly fee for performing a range of services for HMO members under their care), and strong management. His top picks in the group are Anthem (ATH), UnitedHealth (UNH), and WellPoint (ATH), each of which is ranked 5 STARS (buy).

S&P Relative Strength Rankings

These industries carry 12-month relative strength rankings of "5" as of Oct. 18, 2002 -- meaning they're in the top 10% of the 114 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior 12-month price performance.


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*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Sam Stovall is chief investment strategist for Standard & Poor's

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