WellPoint Warning Bloodies Health Insurers

Updated from 10:57 a.m. EDT

OKLAHOMA CITY -- WellPoint (WLP Quote) knows how to cause some pain.

The company sent the health insurance sector reeling Tuesday after it announced that escalating medical costs -- the biggest threat to industry profits -- would cause a shortfall in its full-year earnings.

WellPoint's stock lost a more than a quarter of its value, while its rivals' shares were pummeled by worries about deteriorating trends in the sector.

To be fair, WellPoint blamed its own miscalculations for part of the rise in its medical cost ratio. Earlier this year, however, rival UnitedHealth (UNH Quote) reported a spike in its all-important MCR as well.

Thus, some experts now fear that a full-blown industry-wide downturn could be on the way.

"In the case of a cyclical correction, health insurance companies have historically suffered through several years of downward margin pressure," Goldman Sachs analyst Matthew Borsch reminded on Tuesday. Therefore, "a quick fix may be elusive" this time around, he said.

Borsch downgraded his outlook for the entire group from attractive to neutral as a result.

He offered a key piece of evidence on Tuesday that WellPoint's problems could prove widespread. Although WellPoint suggested that it had priced its policies too low, he observed, the company has been losing commercially insured customers who could have secured even cheaper coverage elsewhere.

"Specifically, WellPoint lost more than 450,000 price-sensitive commercial risk lives during 2007," Borsch wrote. "This suggests that the industry pricing trends have been equally -- if not more -- aggressive in comparison to WellPoint."

Health insurers have paid dearly for price wars in the past. At times, they sold policies so cheap that the companies failed to profit despite their booming growth. Some, like Cigna(CI Quote), had to revamp the entire business as a result.

Today, Borsch actually views Cigna as the safest pick in the group. Notably, he points out, Cigna now makes most of its money from fee-based business rather than from the fully insured plans that promise higher profits but -- when medical costs rise -- carry higher risks as well.

Borsch's firm has investment banking ties to the company.

Still, Cigna fell with the rest of the group on Tuesday. So did Borsch's other top picks, Humana (HUM Quote) and Health Net(HNT Quote).

Indeed, WellPoint's warning hit those two companies especially hard. Fears about Medicare and Medicaid caused some of that pain.

Importantly, WellPoint has seen medical costs rise and enrollment weaken in its Medicare Advantage division. Some now fear that Humana, with its heavy focus on Medicare Advantage, could suffer that same fate.

Going forward, WellPoint expects looming cutbacks in California's Medicaid program to hurt its performance as well. Even Borsch concedes that Health Net faces "considerable exposure" to this same problem. He still likes the company, however.

"For Health Net," he explains, "our positive view is driven by the potential we see for an acquisition of the company, given the consolidation trend in managed care, as well as a diversified business mix and a low sector-relative evaluation."

Meanwhile, Aetna (AET Quote) is trying to stand out from the pack. Early Tuesday, before investors could start trading on WellPoint's warning, Aetna issued a press release confirming its own earnings guidance for the year.

For its part, WellPoint now expects to earn just $5.76 to $6.41 per share this year, compared with the $6.41 Wall Street has been forecasting. The company's first-quarter guidance, calling for profits of $1.16 to $1.26 per share, badly missed analysts' target of $1.43 as well.

"While we are disappointed with having to revise our 2008 outlook, we are still expecting growth this year," WellPoint CEO Angela Braly stressed. Meanwhile, "we are taking actions and making investments in our business to further improve our performance during the balance of this year and beyond."