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Many HMO industry analysts are optimistic about 1996, despite last year's rising expenses, high utilization rates and disappointing earnings.

"Membership gains, which will be announced by the big commercial giants, will be pretty strong," said Thomas Snow, an HMO analyst with Buckingham Research Group in New York.

"I think the high utilization that was experienced in the first half of '95 might well be under control, and hopefully we won't have disappointments there. And commercial premium rates have stabilized" and may be up slightly, said Mr. Snow.

After a poor first half in 1995, HMO stocks rallied later in the year and were "among the very best industry groups by performance at year end," he said.

The eight HMO stocks tracked by the BI Industry Stock Report were off 6.6% as of Sept. 1, 1995, but by year end were up 19.9%, virtually the same as the BI Index for the overall insurance industry. HMO stocks did fare poorly early last week, but many had recovered by midweek.

"We've been through two or three days where the HMO stocks got hammered," said Robert Mains, an analyst with First Albany Corp. in Albany, N.Y. He attributed this to the downturn in the overall market as well as to concerns over premiums.

"I think the reaction earlier in the week is more tied to the (overall stock) market than anything else," said Randall Huyser, an analyst with Furman Selz in San Francisco. Pulled down primarily by technology stocks, the Dow Jones Industrial Average recorded one of its biggest two-day drops in recent years on Tuesday and Wednesday.

Despite that setback, analysts still like the prospects for HMOs.

"It'll be an interesting year after a distinctly 'yuck' year last year," said Michael LeConey, of Coleman & Co. in New York. In 1995, cost increases and higher utilization rates "caused margins to contract and earnings were generally disappointing throughout the industry," he said.

Now, however, premium rates have increased and "margins should rise or stabilize and we ought to see a much happier year for the HMO investors and the HMO group."

Acquisitions are expected to be a major factor for HMOs this year.

"It's takeover time again in HMO land, and the conditions that create that are basically good underlying earnings, industry trends, very high valuation of the big companies, and a big spread between the valuations on the big companies and the valuations on the smaller companies," said Mr. LeConey. That spread makes it possible for the bigger companies "to just make big, huge offers routinely for the smaller ones." As a result, several of the smaller HMOs are likely to disappear, he said.

Perhaps the biggest question in the industry right now is where Aetna Life & Casualty Co. will put the $4 billion it took in from the sale of its property/casualty operations to Travelers Corp. (BI, Dec. 4, 1995). Aetna, which said it would invest the proceeds in its core business, already runs the country's fourth-largest general service HMO.

In light of Aetna's announcement, the stock performance of a number of HMOs shows investors are "anticipating that they might be the one," said Mr. Huyser.

PacifiCare Health Systems of Cypress, Calif., and U.S. HealthCare Inc. of Blue Bell, Pa., are among those mentioned as possible Aetna purchases.

Better-run HMOs are expected to distinguish themselves in 1996.

"I think that 1996 in a lot of ways is going to bear some resemblance to 1995 in that the premium pricing environment remains tough, but I think that, as happened in 1995, the better-run HMOs are able to control their medical costs and grow their enrollment at such a rate that profitability and the growth will not be hindered," said Mr. Mains of First Albany.

"There's a perception if you can't raise premiums, you can't make money, and that's not true," added Mr. Mains. "There's certainly some companies that are facing a lot of pressure because they can't raise their rates, the medical costs are going up and they're not growing their enrollment."

But that generally is not true of the large publicly-traded companies, he added.

Though the whole industry is under pressure now over margins and probably will be for a while, Peter Costa, senior vp with the Chicago Corp. in Boston, stressed that the companies must be assessed individually.

"I think you have to really examine the different HMOs and recognize that some HMOs have better market positions than other HMOs, and the HMOs that have some degree of market strength or dominance will do better than those who don't," said Mr. Costa.

Long term, he suggested, investors should look at HMOs that are in under-penetrated markets, such as the southeastern United States.

Analysts also say HMOs that are in the Medicare market should do well this year thanks to expected generous rate increases.

"The rate increases are still subject to the final outcome of the budget process, but it appears rates for Medicare members will go up handsomely in 1996, and should to some degree mitigate the pricing pressures on the commercial side of the business," said Mr. Mains.

Mr. Huyser took a more cautious stance than some other analysts in evaluating the HMO stock's prospects, however. "We have no current recommendations in the HMO group, though we expect the industry to continue growing," he said.

"We're a little bit uncomfortable with valuations for most of the stocks, and also we think there's still some risk of earnings disappointment. But generally, we're optimistic on the industry, and we think investors over the long term will continue to make money on the stocks."

Other analysts were less reluctant to make recommendations.

United HealthCare Corp. of Minnetonka, Minn.; Norwalk, Conn.-based Oxford Health Plans; PacifiCare; and Nashville, Tenn.-based Healthwise of America are the recommendations of Ellie Kearns, of Alex. Brown & Sons in Boston.

Each has solid market position, strong management and strategic planning that allows for future growth, "not just taking advantage of their particular market," she said. They also have the opportunity to benefit from the Medicare situation. All this makes it likely they will hit their earnings targets, "which makes it likely that the stocks will appreciate," said Ms. Kearns.

United HealthCare was not a recommended buy for Mr. Mains. It is too high-priced right now, though it "is probably the top-quality name in the group," he said. However, he added, "It's close to the point where I would switch."

Firms that are on his recommended list include Oxford Health, which remains the fastest-growing publicly traded HMO and is expected to continue to experience good growth in 1996, he said.

He also recommends Trumbull, Conn.-based Physicians Health Services Inc., which he said has had "a very successful" entry into the New York City marketplace and is expanding into New Jersey this year, and Hooksett, N.H.-based Healthsource Inc., "which combines rapid enrollment growth with cost control for medical costs despite more or less flat premiums."

Also on his list is Mid-Atlantic Medical Services, based in Rockville, Md., which is the leading HMO in the Washington, D.C., Maryland and Virginia area and is expanding into West Virginia, North Carolina, Delaware and Pennsylvania.