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Managed care companies' first-quarter profits lower

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NEW YORK--Commercial health care costs and premium increases likely will remain in a stable range this year, despite unusually low profits for many of the major managed care companies in the first quarter of 2007.

Indianapolis-based WellPoint Inc., the largest managed care company in terms of membership, said it expects its medical cost trend to remain relatively flat in 2007 at just less than 8%.

Medical costs and rate hikes lingered in the 6% to 8% range in the first quarter.

Standard & Poor's Corp. expects medical costs and premiums to increase at the same pace among managed care companies this year, Shellie Stoddard, a director with S&P in New York, said during the company's conference "Health Insurance 2007: Realizing Reform" held in New York on June 6. "Margins have compressed to that level," she said.

In 2008, though, premium increases will fall below cost trends, as managed care companies face increasing price competition, she said.

The key question for health insurers is whether they have reached the end of a cycle of profitability, said Arun Kumar, managing director of J.P. Morgan Securities in New York. "In many ways, we're almost at the tail end of the best of times for the managed care industry," Mr. Kumar said at the S&P conference. "I don't think it's going to be as bad as it was 10 years ago... but there probably will be an end to the current run of profitability at some point, maybe in '08."

The two largest managed care companies reported smaller than normal gains during the first quarter of 2007.

Profits for UnitedHealth Group Inc., the largest managed care company in terms of net income, rose by only 4%, well below the strong double-digit gains the company usually enjoyed over the past several years (see chart). The Minnetonka, Minn.-based insurer took a pretax charge of $176 million to address liabilities related to its stock options practices, which are being examined by state and federal regulators.

"While we are certainly not pleased with this charge, we believe it is a positive step in putting the option-related matters behind the company and resolving any lingering uncertainty," President and Chief Executive Officer Stephen Hemsley said during the company's fourth-quarter earnings call.

UnitedHealth did well given that senior managers spent so much time last year focusing on the stock options issues, said Bradley Ellis, director at Fitch Ratings in Chicago. "I think most people, including us, expected a little turbulence in their earnings," he said. "It wasn't a bad quarter for United--maybe not what we're used to seeing."

WellPoint also experienced abnormally low profits in the first quarter, reporting a 9% increase in profits compared with increases of more than 20% in recent years for both quarterly and full year results. "It's getting more competitive out there and to manage these types of margins is a testament to their strength," Mr. Ellis said.

At WellPoint, though, the main focus is on changes in top management. Chief Financial Officer David Colby was forced to resign May 31 due to an unspecified violation of the company's code of conduct. The company declined to provide details, but said an investigation did not uncover illegal conduct and the violation was unrelated to the company's business.

"No doubt about it, David Colby was a well-respected, highly-regarded CFO in the industry," Mr. Ellis said. "I think it's a loss for the company," although the move speaks well of the company's willingness to apply its code of conduct to all employees regardless of their position.

Mr. Colby was replaced by Wayne DeVeydt, who has served as WellPoint's senior vp and chief accounting officer since March 2005. "There's no reason to believe he's anything but qualified," Mr. Ellis said.

The CFO change was announced the day before the planned retirement of President and Chief Executive Officer Larry Glasscock. Angela Braly became president and CEO on June 1 and Mr. Glasscock continues as chairman.

Among the managed care companies, Kaiser Permanente showed the strongest gains in the first quarter with profits up 56% amid rate increases and reduced costs in several key areas, including medical expenses and administrative costs. Kaiser's first half profits in 2006 were adversely affected by investments in infrastructure improvements the company made last year.

In terms of enrollment, Philadelphia-based CIGNA Corp. showed the largest gains, with medical membership growing 4.7% in the quarter after years of declining or flat enrollment. The company projects organic membership growth of between 5% to 6.5% this year with particularly strong gains in its consumer-driven health plans.

"CIGNA has solved a lot of the problems they have experienced over the years," Mr. Ellis said, adding, though, that companies that experience enrollment growth outside of industry norms should be monitored for potential pricing weakness.

The insurer expects medical cost trend for its total book of business to be in the range of 6.5% to 7.5% with pricing yields exceeding that, Mike Bell, CIGNA's CFO, said during the company's first-quarter earnings conference call.

Government efforts to reduce the number of the uninsured will be a major factor in future enrollment growth and profitability for health insurers, observers say.

"The political landscape is probably the biggest dynamic," said Gail Boudreaux, executive vp of Health Care Service Corp., a mutual insurance company that operates through its Blue Cross and Blue Shield divisions and other subsidiaries. "I think reform is inevitable."

Membership in the commercial sector is relatively flat so insurers are reaching out to the uninsured population, particularly the 8 million uninsured people in households with income over $75,000, Ms. Stoddard said. "Companies are really going after products with better price points to get these healthy people into the risk pools," she said.