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Bumpy Ride Ahead for Nation's Health Insurers

Underwriting gains are shrinking as the industry faces government-mandated health care reform.

Underwriting gains for the health insurance industry declined in the first quarter, setting insurers up for a potentially bumpy road as the industry confronts the political winds of health care reform.

A new study, released today by TheStreet.com Ratings, reports that gains from the insurers' core business of underwriting health coverage declined 2.6% in the first quarter. Investment gains, up nearly 42% compared with the same period last year, buoyed net profits, which rose 13.9%. While a

survey released last week by the Kaiser Family Foundation indicated that health insurance premiums increased an average of 6.1% this year, increases so far haven't been enough to cover medical costs.

The industry's constant state of change makes it difficult to follow patterns. But the troubling trends we are seeing now are reminiscent of the late 1990s, when the industry was taking a beating. Gatekeeper backlash, government pullback on Medicare funding and the unbridled drive to gain membership cost the industry dearly. Losses piled up, as well as lawsuits. In the end, massive consolidation ensued, and the industry's reputation was marred even further.

A few in the industry, particularly the Blue Cross Blue Shield companies, actually weathered that storm fairly well. Firms that were not heavily into network-modeled products or the Medicare market sidestepped those potholes. Just as important, though, was their ability to still net a profit -- or minimize losses -- due to gains made on large investment portfolios.

With those lessons in mind, three big problems loom for insurers over the course of the next two years. First, with open access to providers, medical costs have been rising annually. The trends indicate that insurers are beginning to struggle to keep premiums high enough to adequately cover the costs. While raising premiums makes smart business sense, it doesn't make customers happy, and insurers are feeling the pressure.

Second, the private Medicare program is all the rave again. While insurers are making out great, it is unclear how long the gravy train will last. The State Children Health Insurance Program reauthorization debate already has Congress discussing cutting payments on the program, and health care reform talk is rampant, particularly among the Democratic candidates for president.

Lastly, the health insurance industry's potential reliance on investment gains to cushion bottom-line numbers is troublesome. A look at filings from some of the large, publicly traded health insurers for the six-month period ending June 30 indicates a significant portion of income derived from investments -- and that portion has risen year over year.

UnitedHealth Group's

(UNH) - Get Report

second-quarter filings show investment/other income of $563 million, or 26% of net earnings, up from 21% in the same six-month period the prior year.

Wellpoint's

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(WLP)

investment income rose to $500 million in the second quarter, or 31% of net earnings, from $430.6 million, or 28% of net earnings, in the same period last year.

While the industry tends to hold high-quality, liquid assets, some insurers may be tempted to move into riskier holdings to maintain those returns in the face of shrinking underwriting gains. And the public markets haven't been very pretty lately.

It's not all bad news, though. The industry is far better-capitalized then it was back in the 1990s, which should mean that more companies can survive this bumpy ride. This is reflected in TheStreet.com Ratings' assignment of the "B" (good) or "A" (excellent) rating categories for financial strength to more than 60% of health insurers. (To find a rating on a health insurer click

here).

Over the long haul, however, the industry can adapt to whatever direction the market and government forces push it. If health care reform results in expansion of the government's role in financing, insurers could re-engineer themselves. There already has been a shift toward an administration-only role for self-funded clients, both private and public. Combine this with their experience in the Medicare and Medicaid markets, disease and chronic care management and technical capabilities, and there is little doubt that managed care organizations can adapt.

On the flip side, if the nation moves to expand the private insurance market, the participants have -- and will continue to create -- a range of products to meet the needs of the diverse population, while unloading as much of the cost and risk as possible to stay in business.

Every quarter, TheStreet.com Ratings looks at the financial strength of health insurers based on five-year financial performance, including an analysis of profitability, liquidity, stability and capitalization. Topping the list of highest-rated insurers with the largest membership are five Blue Cross Blue Shield companies, which could again be well-positioned to navigate the bumpy road ahead.

Donna O'Rourke joined Weiss Ratings, now TheStreet.com Ratings, Inc., in 1999, and is the senior analyst responsible for assigning financial safety ratings to health insurers and supporting other health care-related consumer products including Medicare supplement insurance, long-term care insurance and elder care information. She conducts industry analysis in these areas. She has more than 10 years experience in credit risk management and analyses. Previously she served as an assistant vice president at the Union Bank of Switzerland, where she analyzed hedge funds, insurance companies and structured products in support of the derivatives and foreign exchange businesses. She holds a bachelor of science in management from Binghamton University and a master's of science in health systems administration from the Rochester Institute of Technology.

While O'Rourke cannot provide investment advice or recommendations, she appreciates your feedback;

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