By Phillip Seligman
On Nov. 22, we at Standard & Poor's downgraded managed health-care companies UnitedHealth (UNH ), Anthem (ATH ), and WellPoint Health Networks (WLP ) to accumulate from buy. Despite our view of bright long-term prospects for these three superbly run managed-care giants, investors may believe all the good news for 2003 is already out there. And there's nothing to assuage their concern that post-2003 performance will not be as good.
Overall, the group should continue to deliver strong earnings growth. In 2003, as in 2002, this should be fueled by mid- to upper-teens premium price hikes that outpace low- to mid-teens medical-cost inflation. However, employers have been taking stronger positions against rising premiums, including cutting back on expensive options, reducing rate hikes in favor of higher co-payments (a practice referred to as buydowns), and passing on a higher percentage of the rate increases to their employees. Employers are likely to be even more insistent when contracts are negotiated for health insurance in 2004.
Despite putting through premium rate hikes that are exceeding medical-cost trends, most managed-care organizations are likely to experience increases in their medical-cost ratios. In light of buydowns, the premium-rate yields being realized can be one to three percentage points lower than the rate hikes, which narrows the gap with medical-cost trends. Looking beyond 2003, indications are that medical-cost trends are decelerating. However, to attract and retain accounts, managed-care organizations are likely to reduce their premium growth rate to more closely match the medical-cost trends.
Meanwhile, for some managed-care organizations, large-group accounts, which command lower rate increases than small-group and individual accounts, account for a larger percentage of membership.
To offset rising medical-cost ratios, managed-care organizations have been focusing on reducing their operating costs as a percentage of revenues. One way to do this is to improve computer systems to further automate paper handling. Some managed-care organizations are also consolidating service operations, including workforce reductions.
Other potential issues include the patients' rights legislation. President Bush has said he would veto patients' rights bills that were being considered by the Senate, because he claims damage awards would be costly and lead to increased premiums and higher numbers of uninsured. In any event, patients' rights and managed-care reform have been put on hold by Congress, which is focusing on the war on terrorism and rebuilding the economy.
TIME TO LOOK ELSEWHERE?
We at S&P expect earnings for managed health-care companies to increase 15% to 20% on average in 2002 and 2003. Well-managed companies, with strong underwriting skills, good cost control, and a stable of attractive products, should be able to sustain this earnings growth for the longer term.
However, there's no guarantee post-2003 performance will be as good as the industry enjoyed in the past several months. Year to date through Nov. 22, the S&P Managed Health Care Index gained 4.5%, vs. an 18.9% decline in the S&P 500 index.
Given the idea that the economy can only go up from here, many investors may now wish to reinvest the profits they've made from the run-up these defensive stocks enjoyed in the past few months into cyclical or higher- beta issues.
Analyst Seligman follows managed health-care companies for Standard & Poor's