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Employers should brace for higher health plan costs next year, as health maintenance organizations plan for 1998 rates to restore flagging profitability.

Anticipated 1998 rate hikes, which range from 2% to 10% depending upon the region and particular contract, should bring some relief to HMOs after a rough period of lower earnings against flat or decreasing rates, market analysts say.

The surprising $78.2 million third-quarter net loss reported by Norwalk, Conn.-based Oxford Health Systems Inc., however, is more reflective of that HMO's specific problems in managing its computer systems, rather than an indication of serious problems within the industry as a whole, analysts say (BI, Nov. 10). Oxford reported a $6.6 million net loss for the nine months compared with net income of $67.6 million for the comparable period a year ago.

Similarly, lower-than-expected third-quarter earnings report of Aetna Inc. have been attributed to its particular circumstances, namely its acquisition of U.S. Healthcare Inc. and the problems inherent in digesting a major acquisition. Many market observers, however, expect the pace, if not necessarily the magnitude, of merger and acquisition activity among HMOs to continue.

Aetna's net income for the third quarter totaled $117.8 million, down 3.8% from $122.4 million. For the nine-month period, the company had $627.2 million in net income, down 17.3% from $758.1 million in 1996.

Among other HMO results reported:

Minneapolis-based United HealthCare Corp. reported nine-month net earnings of $340.7 million, up 14.7% from the same period a year ago.

CIGNA Corp.'s employee life and health benefits segment, which includes its HMO and indemnity operations as well as results for Healthsource Inc. as of June 25, reported quarterly operating income of $128 million, up less than 1% from a year earlier. For the nine months, CIGNA's HMO and indemnity operations had operating income of $371 million, up 3.1% from $360 million for the same period last year.

Louisville, Ky.-based Humana Inc.'s reported nine-month net income of $125 million, up 4.2% before special charges for the comparable period a year ago. For the third quarter alone, net income increased 37.5% to $44 million.

Santa Ana, Calif.-based PacifiCare Health Systems Inc., which completed its FHP International acquisition earlier this year, reported $92.3 million in net income for the nine-month period, including $44 million in pretax charges, which was a 109.8% increase from the same period of 1996.

Woodland Hills, Calif.-based WellPoint Health Networks Inc. reported net income, excluding non-recurring costs, of $164.2 million for the nine-month period, up 5.9% from 1996. For the third quarter alone, net income was up 23.3% to $55.6 million.

Los Angeles-based Foundation Health Systems Inc., formed by the April merger of Foundation Health Corp. and Health Systems International Inc., reported a nine-month loss of $72.7 million, down 139% from $186.3 million in net income for the comparable period, due to $406 million in one-time charges in the second quarter.

Foundation, however, reported $68.9 million in net income for the third quarter, up 19.8% from 1996.

Los Angeles-based Maxicare Health Plans Inc. reported a net loss of $23.7 million, down 310% from net income of $11.3 million a year earlier.

Maxicare posted a loss of $18 million for the quarter, down 460% from net income of $5 million for the comparable period in 1996. Results reflect a $20 million charge to increase health care claims reserves for anticipated health care costs.

Among the publicly traded HMOs, a number of factors are reflected in earnings, said Mark Jamilkowski, an HMO analyst at Conning & Co. in Hartford, Conn. "You have integration issues at PacifiCare not unlike the integration issues when United took over MetraHealth a year-and-a-half ago. You have operational issues at Aetna and Oxford, and I would say probably CIGNA as well.

"So are these companies truly producing results that are indicative of their long-run earnings power at this point in time? The answer is probably 'no,' " Mr. Jamilkowski said.

Quarterly earnings performances have been better overall than those of the previous year, which reflects that HMOs have begun to raise prices, said Arun N. Kumar, a director at rating agency Standard & Poor's Corp. in New York.

Meanwhile, the lower-than-expected results of Oxford, Aetna and CIGNA "were indicative of deeper problems in the industry only to the extent to which industry participants are doing the same things as those companies, i.e., completing large acquisitions like Aetna or CIGNA, or having problems with information systems like Oxford," said Rob Mains, an HMO analyst with Advest Inc. in Albany, N.Y.

"I don't think there's a common thread running through the companies that have had problems this quarter, and consequently I don't see why other HMOs should be adversely affected," he said.

"I think the problems are company-specific," agreed Greg Baird, senior vp of group sales for Blue Cross of California, a WellPoint subsidiary. "I don't feel our industry is in any kind of trouble and it's my understanding that my company, for example, has met its Wall Street expected numbers 13 quarters in a row and we're pleased with that."

The outlook for higher earnings next year is promising for HMOs, say some market observers.

Next year could be better than the second half of 1997, said Mr. Kumar, who added that average rate increases of 5% to 10% are being introduced. "We think the outlook for the industry for 1998 is cautiously optimistic," he added.

"We think that the problems of '97 will probably be resolved by early '98, and we think that since the growing pressure to gain market share seems to have abated a little bit, companies will return to a better profitability in '98," Mr. Kumar said.

Oxford "was the last shoe to drop in the industry in terms of having a problem discovering they were vulnerable to the difficult trends that have developed in the last year and a half, and so I think we've pretty much gone full circle here on the down trend in the industry," said Michael LeConey, an analyst with National Securities Inc. in New York.

"The outlook for next year is pretty good, given everybody's talking about 4% to 7% commercial rate increases," said Mr. Mains of Advest.

"Generally, the market seems to be receptive to rate increases in the mid-single digits, which is, on an historic basis, still lower than experience trends," said Mr. Jamilkowski.

Employers seem to understand "that the zero to negative price increases over the past couple of years were more an aberration than the norm," he said.

Nevertheless, Mr. Jamilkowski said, "It's going to take another quarter or two" to determine how successful companies are in overcoming their problems.

"There are still operational issues to overcome; the group is going to continue to consolidate. There are just fundamental forces at play here that are not going away," Mr. Jamilkowski said.

The outlook for next year is "somewhat guarded, depending upon how the integrations of the acquisitions that occurred through '96 and '97 finish," said Richard Shaw, a financial analyst with Oldwick, N.J.-based A.M. Best Co. "If everything goes according to plan, I think '98 will be better than '97," he said.

Meanwhile, the pace of merger and acquisition activity is expected to continue.

Earlier this month, for instance, Des Moines, Iowa-based Principal Mutual Life Insurance Co. signed a definitive agreement to combine its wholly owned managed care subsidiary, Bethesda, Md.-based Principal Health Care, Inc., with Nashville, Tenn.-based Coventry Corp. to form a new company, Coventry Health Care Inc., in a deal valued at about $375 million.

And on the horizon is the possible acquisition of Prudential Insurance Co. of America's health care business (see story, page 2).

"It's been a trend in the industry. I expect it to continue to be a trend in the industry," said Mary O'Connell, an HMO analyst with Louis Nicaud & Associates in San Francisco.

However, Gary Frazier, managing director at Bear Stearns & Co. in New York, believes the pace of major deals might slow down a bit, at least for a while. "I think that the PacifiCare-FHP deal, the United-MetraHealth deal, the Aetna-U.S. Healthcare deal and even the Foundation Health Systems deal have all stumbled in one way or another" during the integration process and some of their stock prices have suffered as a result, he said.

Because of this, he added, many chief executive and chief financial officers "realize it's going to be very difficult to sell major HMO consolidations to Wall Street."