Vital Signs At Humana
When Michael B. McCallister took over at Humana Inc. (HUM ) four years ago, the Louisville-based health insurer was on the critical list. Its commercial business was bleeding red ink, and it faced the potential loss of government contracts that constituted a third of its revenues. In the ultimate irony, the health insurer was suffering from a problem all too familiar to its customers: soaring employee health-care costs. After years of double-digit increases, McCallister was facing an expected 19.2% surge in his company's health costs in 2001.
That's when the 52-year-old former hospital administrator began his radical surgery. He quickly exited the 15 states where Humana's commercial group was weakest and moved to secure its grip on lucrative government contracts. And to rein in his own spiraling health-care costs, McCallister restructured Humana's health plan to coax 4,800 headquarters workers to manage their own health-care spending before the company's coverage kicked in. In doing so, McCallister hoped to sensitize his own employees to the true costs of medical care -- and force them to be more discriminating in their use of high-cost specialists, emergency rooms, and procedures like CAT scans. He recalls: "I told my employees, 'I'm not going to be your father anymore. I'm going to set the table for you to make your own health decisions."'
McCallister's triage paid off. Bolstered by a subsequent increase in Medicare reimbursements, he reversed the $382.4 million loss Humana suffered the year before he became CEO with a healthy $228 million profit in 2003. That sharp improvement sent Humana's shares soaring from around $7 in February, 2000, to as high as $24 last January -- earning the company a spot on the BusinessWeek 50 ranking of America's top-performing large companies. As for Humana's own health costs, the company claims that the cost of insuring its headquarters workers rose just 4.9% the first year, and 2.7% the next year -- well below the 12% national annual average for the past three years. "You have to give him credit for turning the ship around," says Abbott Keller, chief investment officer for Kestrel Investment Management Corp., which owns 1.6 million Humana shares.
But despite a strong first quarter this year -- in which profits rose 117% -- some investors clearly are betting that McCallister can't sustain his turnaround much longer. Indeed, analysts believe Humana and other health insurers will see renewed pressure from corporate clients to give back some of their recent profits through price reductions. Humana could also face political pressure to make similar concessions in its Medicare contracts, which still account for 22% of revenues. Humana's own warning that second-quarter profits would be slightly below expectations on pricing pressures sent its shares tumbling, to about $16 today.
That's why McCallister is embarking on his boldest gambit to date: persuading his corporate clients to adopt the same "consumer-driven" health policies Humana successfully deployed three years ago. The move may represent McCallister's best shot at ensuring Humana's independence at a time when larger rivals like Anthem and UnitedHealth Group (UNH ) are gobbling up regional players like Humana. Even if he's successful, those giants may still target Humana -- which has one-eighth the member base of UnitedHealth -- for takeover, analysts say.
The theory behind the new medical plans is that the only way to break the spiral of ever-rising health-care costs is to give employees a direct incentive to reduce their expenses. Says McCallister: "We've tried everything else -- legislative restrictions, turning doctors into risk-takers -- but the one thing we haven't done is turn to the actual users of health care and power them up." Under the plans, workers get a basic level of annual medical coverage -- say, $500 per family member. When those funds are exhausted, workers are subjected to a deductible, perhaps $3,000 per family. That sounds steep, but it's offset by the fact that employees are no longer paying monthly premiums for their coverage. Once the deductible is met, the employer generally provides full coverage of additional expenses for the year.
McCallister is so confident he can deliver results like those at his own company that he's promising to cap any cost increases at 9.9% in the second year after adoption of Humana's SmartSuite plan. "They're the only insurer offering a plan like this that's willing to put their money where their mouth is," notes James R. Mueller, president of Frank F. Haack & Associates Inc., a Wauwatosa (Wis.) insurance consultant and brokerage. But some analysts fear that Humana may be pricing too aggressively. "The more that they make cost guarantees, the greater the risk that they may make underwriting mistakes," warns Charles Boorady, an analyst at Smith Barney Citigroup. Critics also worry that to save money, consumers may stint on care -- creating bigger health problems, and bigger bills, down the road.
McCallister dismisses such concerns, arguing that the biggest savings come from some simple shifts in consumer behavior -- from costly specialists to primary-care physicians, and from branded drugs to cheaper generics. Humana does its part, offering Internet-based tools to help members compare health plans and monitor their expenses.
For all of McCallister's proselytizing, companies have been slow to embrace the new policies. Of the 3 million members in Humana's commercial accounts, just 225,000 have enrolled in SmartSuite. "There's a lot of inertia," McCallister admits. "But we're going through exactly what HMOs went through when they were introduced in the 1980s."
Humana probably doesn't have the decade or so that it took for HMOs to catch on. McCallister has to hope that his customers see the light. Otherwise, Humana will remain vulnerable to getting swept aside in the rapidly evolving health-care industry.
By Dean Foust in Louisville