Managed care companies had a profitable 2006 as health care costs hovered in a predictable range, allowing them to engage in disciplined pricing practices.

Commercial health care cost and premium increases settled mainly in the range of 6% to 8% last year. Although the range was lower than increases of 7% to 9% reported in 2005, health care costs continued rising faster than general inflation last year and analysts predict a slight uptick in cost trends this year.

Most of the major managed care companies reported higher full-year profits, recovering from profit slumps in the first half of 2006 that were related to the implementation of the Medicare prescription drug benefit. The exception was Philadelphia-based CIGNA Corp., which reported lower profits in 2006 than in 2005, which included income from discontinued operations and the sale of certain businesses.

"All the others are doing well, earnings wise," said Sally Rosen, a senior financial analyst with Oldwick, N.J.-based A.M. Best Co. Inc.

Louisville, Ky.-based Humana Inc. posted the largest percentage rise in profits due to substantial growth in its governmental sector (see chart).

Medical cost increases remained in a stable range, which allowed insurers to price their products appropriately. WellPoint Inc., for example, said its 2006 medical trend rose less than 8% and the Indianapolis-based insurer expects it will remain relatively flat in 2007 at just less than 8%.

"The marketplace remains competitive, but we see generally rational pricing, which allows us to achieve targeted margins," said David Colby, chief financial officer for WellPoint, during the company's fourth-quarter earnings conference call. "We remain very disciplined in our underwriting approach and will not sacrifice margin for market share."

Insurers are pricing their products at or slightly above their medical costs. "Pricing seems to be disciplined," said Stephen Zaharuk, vp and senior analyst for Moody's Investors Service Inc. in New York. "It's competitive, but restrained."

Although managed care companies have done a good job of developing products, such as consumer-driven health plans to keep premiums stable, it's difficult to say that any company is truly managing health care costs, given that they continue to rise at an unsustainable rate, analysts say.

Health care costs "simply cannot continue to grow," said Bradley Ellis, director at Fitch Ratings in Chicago.

Although there will be further efforts to contain costs via initiatives such as benefit buydowns, analysts say they anticipate cost trends will increase slightly in 2007, likely by fractions of a percentage point. "I think to some extent things are going to be fairly stable," Ms. Rosen said. "I think it might uptick slightly, but it's not going to be huge."

Federal and state efforts to manage rising health care costs and provide coverage for uninsured citizens will be the key factor to monitor this year for the managed care companies, particularly those that are dependent on government-funded business, such as Humana. Enrollment in the insurer's Medicare Advantage programs grew about 80% last year to just over 1 million lives and premium revenues increased 89% to $2.3 billion.

"A.M. Best is always cautious on any company that is reliant on government funding, whether it's Medicare or Medicaid," Ms. Rosen said.

Congress is analyzing the level of Medicare reimbursements, which could be problematic for insurers as federal officials have reduced reimbursements in the past, analysts say. "You really don't know when they're going to pull out the rug from under you," Mr. Zaharuk said.

Humana officials acknowledge the problems in traditional Medicare, with President and CEO Mike McCallister referring to the Medicare benefit as an "out of control entitlement program driven by rising cost and the power of demographics."

Mr. McCallister, though, said he does not accept the concept that Humana is being overpaid for its Medicare services. "It's a politically charged term," he said during the company's fourth-quarter earnings conference call.

State mandates for health insurance coverage, meanwhile, likely will result in a shift in growth in the commercial market from large and midsize employer-sponsored plans to the individual/small group market, Mr. Zaharuk said.

After a relatively slow year for mergers and acquisitions in the health care sector in 2006, the first notable deal in 2007 was announced earlier this month by UnitedHealth Group Inc. The Minnetonka, Minn.-based insurer's proposed acquisition of Las Vegas-based Sierra Health Services Inc. has been met with vocal opposition by consumer and provider groups (BI, March 19).

The acquisition, though, does not signal a trend of major M&A activity as fundamental factors likely will limit large deals in the in the health insurance market, analysts say. For example, the largest insurers--UnitedHealth and WellPoint--now have limited properties they can acquire due to their dominant market positions.

In addition, the profitability of the managed care companies works against M&A activity, Ms. Rosen said. "As plans have become financially sound, they've all become higher priced," she said.