Health Insurers Battle Rising Costs

Health insurers continued to boost profits in the second quarter, even as they struggled to raise premiums in line with health care costs. TheStreet.com Ratings' review of the financial performance of the 648 health insurers it tracks found that total net income rose by 27.5% during the first six months of 2007 to $8.8 billion, up from $6.9 billion the prior year.

Investment gains helped bridge the gap. They comprised 43.4% of industry profits, up from 35.7% the prior year, growing 55% to $3.8 billion through June 30, 2007 -- up from $2.5 billion a year earlier. By comparison, profits from insurer's core underwriting business increased just 9.1% to $5.8 billion through June 30, 2007, up from $5.3 billion the prior year.

(The study is based on the latest available statutory filings with the National Association of Insurance Commisssioners.)

Donna O'Rourke, senior financial analyst with TheStreet.com Ratings, explains.

Q. Are rising health care costs the biggest risk for insurers?

A. On the one hand, insurers are dealing with rising health costs, and on the other hand -- as a result of competitive pressures and unwillingness by consumers to absorb more premium rate increases -- the ability to raise additional revenue to cover those costs.

But the industry also does business in an uncertain political environment. Revamping the financing of health care is a hot topic among the presidential hopefuls and many state governors.

The industry has also recently placed a lot of its efforts on the unstable Medicare line of business that is often the target of cost-cutting and heavy oversight by the federal government.

Q. But if profits are rising, should investors -- and consumers -- be worried?

A. The industry has been going strong for several years, really since 2003, when we came out of the last recession.

This continued profitability and strong market capitalization is reflected in the latest rating review; we upgraded 27 insurers and only downgraded four. This follows first-quarter ratings upgrades of 21 insurers and nine downgrades.

But health care costs continue to rise at a faster pace than revenue, because insurers struggle with raising premiums, and this is starting to affect their bottom line.

Q. Should we be concerned about a rise in investment gains? Are insurers making riskier investments?

A. Not necessarily. Normally, the industry makes some of its money by investing its liquid assets gained through prior years gains in various investments while making most of its profits from the actual business of health insurance.

An increase in investment income is not in itself a bad thing. But in an environment where margins on the core business are starting to narrow, it could become a concern in the future. What we see happening is an uptick in the percentage of profits coming from investments.

Health insurers, which are highly regulated, typically don't own high-risk investments. If they continue to hold low-risk investments, the income generated from them may not be sufficient to offset a decline in their business.

If insurers choose to raise the risk profile of their portfolios, they will need to make sure they have sufficient capital in place to pay out claims if their bets move in the wrong direction.

Q. Where are the largest areas of growth for health insurers?

A. The Medicare line of business, both the Medicare Advantage business and Medicare Part D, has had the biggest impact in terms of growth on the industry. Margins are very high and have been compensating for the highly competitive employer health insurance market. While this is still very small, we are also seeing growth in the individual private insurance market, and insurers continue to expand their offerings to self-funded employers.

Q. This competition should be good news for consumers, though, right?

A. That's right. Competition in these lines of business means more choice for consumers and downward pressure on premiums.

Ratings of Largest Health Insurers based on Asset Size
	Company	State	Total Assets as of 6/30/07	Rating
1	Kaiser Foundation Health Plan	CA	33,003,361,000	A-
2	Health Care Svc Corp A Mut Leg Res	IL	9,861,680,655	A+
3	Blue Cross Blue Shield of Michigan	MI	5,404,145,776	A
4	Highmark	PA	5,201,782,687	B
5	Blue Cross Blue Shield of Florida	FL	4,399,508,746	B+
6	Blue Cross of California	CA	4,351,015,000	A+
7	California Physicians Service	CA	4,114,799,000	A
8	Empire Heathchoice Assurance	NY	3,324,959,768	A
9	Horizon Healthcare	NJ	2,870,146,522	A+
10	Anthem Ins Companies	IN	2,511,867,719	B
11	Blue Cross Blue Shield of NC	NC	2,439,170,273	A-
12	Excellus Health Plan	NY	2,324,695,809	A+
13	Anthem Health Plans of Virginia	VA	2,076,404,924	A-
14	Pacificare of California	CA	2,056,684,000	B+
15	Heath Net of California	CA	2,043,743,640	B+
16	Blue Cross Blue Shield of SC	SC	1,953,227,315	A-
17	Blue Cross Blue Shield of MA	MA	1,902,913,776	A
18	Blue Cross Blue Shield of Alabama	AL	1,880,826,618	A
19	Indepdendence Blue Cross	PA	1,822,559,284	B-
20	Blue Cross Blue Shield of Minnesota	MN	1,820,556,301	B+
21	Oxford Health Plans (NY)	NY	1,799,949,565	A+
22	Health Insurance Plan of Greater NY	NY	1,796,784,286	A
23	Group Hosp & Medical Services	DC	1,739,733,900	A+
24	Wellmark	IA	1,717,485,161	B
25	Community Ins Co	OH	1,677,998,198	A-
Source: TheStreet.com Ratings