Online Extra: A Sharp Eye on Humana's Health

Some analysts think the resurgent managed-care provider could soon hit a rough patch. CEO Michael McCallister thinks otherwise
The BusinessWeek 50

When Michael McCallister took Humana's helm as chief executive in 2000, the prognosis for the Louisville-based managed-care provider wasn't good. Fearful that the one-two punch of declining government reimbursements to private Medicare providers and stiff competition from nonprofit carriers would leave earnings of for-profits like Humana (HUM ) in a bind, investors bid its stock down below $5 a share.

In his three years as chief, however, McCallister has gotten Humana back on track: Profits soared 60% last year, to $228.9 million, on a 9% rise in sales -- a strong recovery that sent its shares up 124%, to around $20, in the year ended Feb. 27. That performance was good enough to get Humana onto the 2004 BusinessWeek 50 ranking of America's top-performing companies, at No. 49.

One key: Giving consumers more flexibility in choosing a health plan that's right for them and at the same time allowing employers -- the payers -- to rein in the spiraling expense of providing health care to their employees. McCallister spoke recently with BusinessWeek Atlanta Bureau Chief Dean Foust about the forward outlook for Humana. Edited excerpts of their conversation follow:

Q: What has been the key to your turnaround? How can you generate more profits when employers are no longer willing to absorb any more increases in their health-care costs?


Well, let's just face the facts: The employer community cannot continue to tolerate the cost trends they've been seeing. It's no longer a benefits issue in most companies, it's an actual business problem. And so, my attitude has been that the [health-benefits] company that can find the solution for that ongoing problem would be positioned beautifully to solve the employer's problem and therefore grow.

So we've attacked this around the idea that the way to get costs under control is to get the consumer engaged, informed, and empowered through their benefits structure, through the information that's available to them, through the choices that they make, to basically take out what is incredible disorganization and waste in the system.

And so far, the experience has been very, very good. The early results around all of our smart products we're taking to the market have been very, very good. It has really been an engine of innovation and excitement in the company, and it's beginning to have some results for us.

Q: Can you talk a little bit about what you offer consumers as a carrot to motivate them to help you, and their employers, save money?


Well, first of all, let's just talk about the SmartSuite [plan] that we have out there. It starts with the idea that an individual has many plans to pick from, and the individual gets to buy the level of insurance that they like for themselves.

I tell employers all the time that you cannot possibly make a good decision here because you can't satisfy all of your employees by picking [one] benefit plan. So we break that mold and say [employees] are not all the same, and they would buy different coverage if they were given the chance to do so.

Now, what we know in that process is a lot of people today are overinsured because the employer buys too much coverage. So when they get a chance to trade benefits -- payroll vs. benefits -- they make lots of different choices.

One of the advantages I have as a company is I'm a very large employer in multiple states. But I also happen to be in the health-benefits business. I'm no different than any other employer, and I've had serious medical-cost problems inside of my benefits program. So, if I can solve my own problem, I can solve it for my customers.

We're in our third year now with all the things I talked about with our own employee base, and it has been remarkable. We've learned an awful lot. Our employees and associates are smart. They know how to pick the plans that are right for them. They will change their behavior.

We've taken our own medical costs as a company -- our [expense] trend was in the mid- to high-teens -- we're down to running right around 5%. So I'm a big believer that there's a real opportunity here.

Q: Your stock has made quite a comeback -- from a low of $5 in 2000 to around $20 [as of Mar. 25]. But there are really divergent perspectives right now in the analyst community about your prospects going forward. The bullish analysts talk about the growing importance of scale -- the ability to have lower unit costs, to be able to offer better provider contracts. Does scale really matter?


Scale is important. And we've invested very heavily in all the capabilities I've just described, and ultimately, we want as much business to cross over to that platform as we possibly can, so it becomes important.

People tend to think of [scale] in terms of getting better deals with hospitals and doctors. But I would also argue that the top handful of players in these markets are all going to have very similar deals because the providers have no real incentive to set one above the others relative to what they're paid. So I think over time, the networks come to a pretty narrow range in terms of price, if you want to think of it like that. And so you're not going to win as a company by out-negotiating your competition.

So, I basically have stipulated that I need a competitive network in all my markets. But I'm not going to win based on my network. I'm going to win based on other solutions.

You know, speaking of the divergence of opinions, there's always going to be some of that, but this company was under some pressure because a number of analysts and others were worried about the Medicare program.

Q: That was my next question. The bearish analysts contend that the government may feel political pressure to take back some of increases in reimbursements it granted last fall.


We've been into the Medicare program since the '80s, and there's no question that the 1997 Balanced Budget Act put pressure on the reimbursement model for that business. But all through the period that we've been operating the business, Medicare has been a great contributor to this company. And the [congressional legislation] that was passed last fall really fundamentally and structurally fixes the reimbursement model for that.

So the good news is we hung in there during the darker times and are now positioned beautifully, and we can, basically, do very well in this new Medicare world. We were doing well before, but now there's great opportunity.

So there has been some nice upward movement in the stock because that cloud was taken off of our head. We went from being, in some people's view, troubled because of Medicare to -- all of a sudden -- we have a great opportunity.

Q: But the bearish analysts are convinced that, for political reasons, the Medicare program can't allow for-profit providers like you to reap higher profits and that if your profits come under pressure, the stock isn't a good buy.


Well, I don't know what to say to that. They're welcome to their opinion. I'm a rather large stockholder around here, and I like my spot. Some of those very [analysts] you're talking about also sat on the sidelines while our stock went from $4.75 to $24.

Q: One of the bearish analysts, at Goldman Sachs, has said companies such as yours that earned so much in 2003 are going to have to give it back. You can't sustain it. And that the payers -- government or private employers -- in general are going to want it back.


What they're basically concerned about is the pricing cycle, and if you go back in the history of this business, there clearly has been one. And we've gone through good times and bad times, largely because we either didn't predict medical costs properly or didn't price them appropriately.

I think the environment has changed rather dramatically. But there will be pressure from employers. I go back to my original point: Clearly they cannot tolerate double-digit increases year after year after year.

Now are they going to solve that by beating their chests and saying, "We won't pay"? I would argue no. I will say that that's exactly why I think what we're doing relative to our approach to business is the smart way to go, because I'm going to solve the problem in an intelligent, smart way through products and technology and information, which, to me, gives me the advantage.

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