Despite unemployment-driven commercial membership losses during the weak economy, U.S. health insurers appear to be on the mend as some companies' 2010 financial performance beat analysts' expectations thanks to a mild flu season, commercial rate increases, investment gains and lower medical utilization.

While roughly half of the nation's largest health insurers posted lower 2010 revenue compared with 2009, a majority reported higher net income (see chart).

Chicago-based Health Care Service Corp., whose 2010 net income more than doubled to $1.09 billion from 2009, reported the largest percentage gain of the group. The insurer's 2010 revenue also climbed nearly 13% to $19.53 billion, making it No. 7 on Business Insurance's ranking of U.S. health insurers.

Coventry Health Care posted the second-largest percentage gain in net income, up nearly 82% to $438.6 million in 2010 from the previous year. The insurer's revenues declined, however, dropping 16.7% to $11.59 billion in 2010.

Revenue at Minnetonka, Minn.-based UnitedHealth Group Inc., the nation's largest health insurer, grew 8.1% to $94.16 billion in 2010 from 2009. At the same time, its net income grew 21.3% to $4.63 billion in 2010. UnitedHealth's enrollment also grew just more than 3% to 33 million members in 2010 from the previous year.

But insurers' financial gains could evaporate quickly if a double-dip recession occurs, resulting in a further loss of commercial enrollment, or if insurance regulators clamp down on future premium increases as part of new minimum medical loss ratio and “rate reasonableness” requirements under the Patient Protection and Affordable Care Act, analysts warn.

Effective with the start of 2011, insurers must spend at least 80% of premiums in the individual and small-group markets and 85% of premiums in large-group market on medical care or pay rebates to policyholders of any sums below those thresholds. In addition, health insurers in the individual and small-group markets will need to justify rate increases of 10% or more for all rate filings after July 1 this year.

Insurers' financial strength also could erode if health care reform accelerates employers' use of self-funded health plans, or if the individual mandate in PPACA is repealed, analysts say.

The U.S. health insurance industry's financial future will depend largely on its ability to effectively manage its business through continued political and economic turmoil, analysts say.

“Despite the loss of commercial membership, 2010 ended up being pretty good for health insurers,” said Bradley Ellis, a director at Fitch Ratings Inc. in Chicago. “Everyone was expecting a more severe flu season, but overall, utilization was down. This industry is in good shape.”

“We didn't expect it to be a good year, but, lo and behold, it was a great year” for U.S. health insurers, said Stephen Zaharuk, senior vp at Moody's Investors Service Inc. in New York.

“In 2009, we were coming off a bit of a shaky year. Investors were shaken up with the economy, government intervention into COBRA, the possibility of an H1N1 flu epidemic. Companies were recasting guidance downward throughout the year,” Mr. Zaharuk said.

“In 2010, we expected companies to react with premium increases, but we didn't know if the regulators would allow it. On top of all this, the recession resulted in huge layoffs,” reducing commercial enrollment, he said.

But because the flu season ended up being mild, “a lot of built-up reserves from 2009 were released into 2010, and that boosted earnings,” Mr. Zaharuk said.

In addition, utilization declined among health insurers' commercial membership.

“People were hesitant to spend money they didn't have. The hospitals reported lower admissions for elective procedures, lower maternity rates. All this contributed to better experience for health insurers,” Mr. Zaharuk said.

Because the weak economy reduced income for many households, individuals may have thought twice about going to the doctor or filling a prescription, said Sally Rosen, managing senior financial analyst at A.M. Best Co. Inc. in Oldwick, N.J.

But even though overall health care utilization was declining, insurers still raised premiums to cover anticipated costs of health care reform provisions that took effect at the end of 2010, including extending coverage to adult children up to age 26, covering 100% of the cost of preventive care, and eliminating pre-existing condition exclusions as well as annual and lifetime benefit limits, analysts said.

As a result, “with the lower utilization, we saw prosperous underwriting for four months,” said David Mitchell, senior financial analyst at Best. In addition, as the financial markets gained strength toward year-end, “investment income came back” for most insurers, he said.

If PPACA's minimum medical loss ratio requirements were in place during 2010, Mr. Zaharuk said insurers might have been forced to rebate some of last year's financial gains to customers.

Instead, insurers can hold onto that capital to bolster their position heading into the next round of health reforms taking effect this year, analysts said. Some insurers may use any extra cash to diversify their operations, much like Aetna Inc. did in its December acquisition of Salt Lake City-based health information technology vendor Medicity Inc. for $500 million, analysts said.

Aetna is the nation's fourth-largest insurer with $34.2 billion in 2010 revenue. Though revenues fell 1.5% for the Hartford, Conn.-based insurer, its net income soared 38.4% to $1.77 billion in 2010 from 2009. Aetna has 18.5 million members.

“The combination of economic pressures and uncertainties over health reform had an impact in 2009 through the first part of 2010,” said Joseph Marinucci, primary credit analyst at New York-based Standard & Poor's Corp. “But the way things are playing out, we view this as something that has been managed reasonably well. In one year's time, they've gone from being very strongly defensive to having a much more balanced outlook.”

However, most industry analysts expect insurer earnings to decline from 2010's strong levels in response to health care reform and an increasing volume of government-sponsored plan members.

Although insurers gained enrollment in Medicare Advantage and Medicaid managed care plans during 2010, those lines typically are less profitable than commercial business, according to analysts.

Moreover, because states have been strapped for cash due to the economy, industry analysts say they expect states to limit insurance price increases. Likewise, caps on federal Medicare spending likely will keep the lid on increased federal contributions to Medicare Advantage plans.

Some analysts also expect health care reform to accelerate self-funding of health benefits, further eroding insurer profits.

“Even though the margins on that business are consistent, the amount of dollars they collect are lower because administrative fees are much lower than premiums,” Fitch's Mr. Ellis said.

Indianapolis-based WellPoint Inc. cited this as an issue when it reported that the proportion of self-funded membership grew to 59% in 2010 from 54% in 2009.

WellPoint, the nation's second-largest health insurer, saw its overall membership drop about 1% to 33.3 million members in 2010 compared with 2009. Its revenues also fell 9.6% to $58.8 billion, while its net income plummeted 39.2% to $2.89 billion.

Continuing high unemployment also could hamper insurers in 2011. The unemployment rate continues to be “stubbornly high,” and job growth has been disappointing, A.M. Best analysts said.

Analysts also are cautioning that health insurer margins could be squeezed should there be a return to normal levels of medical utilization.