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The announcement last week that United HealthCare and Humana would not merge in the aftermath of United's $900 million second quarter charge, followed the next day by news of Oxford Health Plans' $507.6 million pretax quarterly loss, dramatically illustrates the managed care industry's sometimes difficult struggle for pro-fitability.

But some analysts nevertheless see promising signs in second-quarter results that rate hikes introduced earlier this year are starting to help, though employers still may face additional rate increases.

For example, United HealthCare Corp. Vp-Investor Relations Bernie McDonagh said the company expects to seek rate increases of about 8% to offset the higher medical costs the company anticipates.

Louisville, Ky.-based Humana Inc. and Minnetonka, Minn.-based United HealthCare Corp. announced last Monday that their boards of directors had mutually agreed to terminate their planned merger, originally valued at $5.5 billion (BI, Aug. 10).

A Humana spokesman said in light of United's second-quarter earnings report, "We made the decision that it would be in the interest of our shareholders to continue as an independent company."

But both still are walking away from the deal strong companies. United HealthCare is expected to recover from the financial setback and remain a market leader, while Humana is not expected to feel under any particular pressure to find another merger partner.

"I don't think it's cataclysmic. It's just a disappointing event," said Rob Mains, an analyst with Advest Inc. in Albany, N.Y.

"Both companies have been relatively successful over the years," said Doug Sherlock, a health care analyst with Sherlock & Co. in Gwynedd, Pa. "I think things will continue along pretty much as it had been before."

The spokesman said Humana feels no pressure to find another merger partner. "This was always a merger of two strong companies," and Humana remains a strong, diversified firm, he said. "We are not compelled to merge with any other company," said the spokesman, noting the company has just reported a 24% increase in second-quarter net income, to $52 million.

"I think Humana is a very strong company," said Richard Shaw, an analyst with A.M. Best Co. in Oldwick, N.J. "I think they will proceed and do what's best for them at this point," said Mr. Shaw. Whether it means acquiring or being acquired "is strictly up to management," he said.

A United HealthCare spokeswoman said the company "will continue to explore strategic opportunities" within its business segments. In fact, last week it announced it has completed the acquisition of Corpus Christi, Texas-based Principal Health Care of Texas Inc., a 38,000-member health plan that has more than 1,200 physicians, 27 hospitals and 80 pharmacies in its south Texas network. Terms of the transaction were not disclosed.

The Humana deal's failure means not only that United lost a sound merger candidate, but the organization's credibility has been eroded in terms of its ability to manage its medical costs as well, said Patrick Finnegan, senior vp at rating agency Moody's Investors Service Inc. in New York.

"It also perhaps may cast a little bit of shadow on the progress of their integration of past acquisitions" the company has completed over the past five years.

"I think that probably it will take them a while to rebuild or regain, but as an industry leader, I would expect them to do just that," added Mr. Finnegan.

Mr. Shaw also said that United "is a very strong company, well capitalized with no debt, and still a very good balance sheet. Ultimately, they'll be challenged going forward, but I don't see any problem with their staying ability," he said.

"I think we're seeing the sorts of things that occur in the final stages of a shakeout in an industry," said Michael LeConey, an analyst with National Securities Corp. in New York.

"Probably the worst should be behind us here, shortly," Mr. LeConey said.

Norwalk, Conn.-based Oxford Health Plans' pretax $507.6 million loss in part reflects $174 million in restructuring charges and another $112 million in "unusual" charges. Results also reflect a $152 million addition to surplus ordered by the New York Insurance Department.

The restructuring charge includes $45 million in provisions related to consolidation of operations; a $62 million provision for disposition of non-core assets, investments and subsidiaries, a $51 million reserve for non-core Medicare and Medicaid businesses that the company will restructure or exit by year end, and $16 million in reserves for certain other assets.

The $112 million in unusual charges includes $38 million for the write-off of the company's investment in San Diego-based FPA Medical Management, a physician practice management company that filed for Chapter 11 bankruptcy protection last month. Another $74 million relates to strengthening of various reserves and allowances.

Dr. Norman C. Payson, Oxford's chief executive officer, said at a news conference that despite the results, the company remains fundamentally strong. Many of the charges relate to its turnaround plan, under which the company will focus on core commercial customers in New York, New Jersey and Connecticut, he said.

He said he anticipates Oxford will be profitable by the second half of 1999 and generate margins of 3% to 5% by the year 2000. "We believe Oxford has a strong and high value franchise, one that is nearly impossible to replicate," said Dr. Payson.

Mark Puccia, managing director-insurance ratings group at New York-based Standard & Poor's Corp., which placed Oxford on CreditWatch with negative implications last week, said the company now has $1.4 billion in assets and current liabilities of $1.2 billion. "That's not a lot of margin, there."

"The fact is that Dr. Payson basically has to engineer a turnaround in profitability," which means having customers pay higher premiums and providers accepting less compensation, "and he's got to do this high-wire act all the while he's keeping customers," said Mr. Puccia.

"The historical strength of Oxford has been they provide a very comprehensive and flexible physicians network while being very competitive on their rates, and now they're going to have to rework some of the underpinning of that concept," said Mr. Puccia. "We think they can pull it off, but there's a lot of vulnerability in their ability" to do so, he said.

Other reported HMO results:

* Santa Ana, Calif.-based PacifiCare Health Systems Inc. reported $90.2 million in net income for the six months, up 46.7% for the comparable period in 1997.

* CIGNA Corp. reported its HMO and indemnity operations had operating income of $273 million for the six months, a 12.3% increase over the comparable period in 1997. Results for Healthsource, which CIGNA bought last year, are reflected as of June 25, 1997.

* Los Angeles-based Foundation Health Systems Inc. reported $956,000 in second-quarter net income from continuing operations after a $50 million charge in connection with FPA.

This compares with a $205.8 million net loss from continuing operations for the comparable period in 1997, when FHS had posted $403.6 million in charges associated with the merger between Foundation Health Corp. and Health Systems International Inc.

* St. Louis-based RightCHOICE Managed Care Inc. reported $1.2 million in second-quarter net income, vs. a $2.3 million loss for the comparable period a year ago. For the six-month period, the company reported $2.2 million in net income, a 43.6% decline over the same period in 1997.

* Hartford, Conn.-based Aetna U.S. Healthcare, which includes the managed care, indemnity and group insurance products and services of Aetna Inc., reported $180.7 million in operating earnings, down 38.3% from 1997's first half, after unusual items in both years.

* Oakland, Calif.-based Kaiser Permanente reported $2 million in net income for the quarter, which reflects $61 million in operating losses and $63 million in net investment gains and interest. This follows the $33 million net loss reported for the first quarter and a $270 million 1997 loss (BI, May 18). Kaiser did not report comparable results a year ago.

* Los Angeles-based Maxicare Inc. reported a $19.8 million net loss for the quarter vs. $4.2 million in net income for the comparable period a year ago.

* After special charges related to the disposal of its workers compensation business and FPA, Woodland Hills, Calif.-based WellPoint Health Networks reported a $46.8 million net loss for the quarter compared with $49.3 million in net income for the same period last year. For the first half, it reported an $11.7 million profit vs. a $100 million profit for the same period in 1997.

"It continues to be tough," said Mr. LeConey. "I keep thinking that we're hitting bottom, and a lot of things seem to suggest that," including management changes, write-offs and poor earnings.

"You continue to see an erosion in several fundamental areas for many companies," which has been primarily related to the "lag risk" taken as managed care companies base their price hikes on claims costs to date, said Moody's Mr. Finnegan. Medicare also has been a problem for managed care firms, he said.

However, "I think just in general the industry results seem to have stabilized in 1998" with improvement by several companies, said Douglas L. Meyer, an analyst with Duff & Phelps Credit Rating Co. in Chicago, pointing specifically to PacifiCare.

"I guess from my standpoint we're generally positive in terms of the outlook for the industry near-term. We see some significant firming up in terms of pricing, and it's beginning to reflect itself in the earnings improvement," Mr. Meyer said.

"I think managed care is still a strong industry," said Best's Mr. Shaw. "You're starting to see some of the implications of the rate increases that were applied for '98, and you're seeing a return to more favorable results on a lot of their plans. I think that will continue over the short term, definitely, but I think you'll also see some challenges hitting the HMOs," including maintaining profitability and provider relationships.

He said the industry is unlikely to return to 15% to 20% rate hikes, but "normal" rate increases of 3% to 5% will continue. "That's most likely what the plans will be able to get at this point," he said.

More rate hikes may still be needed, said Greg Baird, senior vp of group sales for Woodland Hills, Calif.-based Blue Cross of California, a subsidiary of WellPoint Health Networks Inc.

"I think we're seeing HMO rate increases in the 5% to 8% range, and that could be enough, and it could be that we need to increase it more over time," said Mr. Baird.

"We clearly are in a cycle of higher medical costs," Jay M. Gellert, FHS' president and CEO, said at the press conference announcing his company's results. He said the two antidotes are higher rates and more efficient medical management.