Next year could finally test the health of managed-care providers.
For years, double-digit premium increases have kept profits -- and stock prices -- soaring in the health insurance sector. Thus, companies like
have consistently ranked among the healthiest performers in the market. But recent trends indicate that industry doubters, who have long warned of an inevitable downturn, may soon be proven right.
Goldman Sachs analyst Matthew Borsch, known for his caution on the group, recently offered up fresh evidence of a looming down cycle. He pointed to this year's health benefits report from Mercer Consulting, which showed health insurance costs increasing at just half the clip of a year ago, when making his case against the sector.
Borsch offered a reasonable explanation for the slowdown. He said that not-for-profit health insurers, which dominate the industry, have been generating excess profits in recent years. As a result, he said, they have scaled back their premium increases and -- in the process -- have pressured their for-profit competitors to do the same. He predicted that 2005 will be a tough year for the sector as a result.
"We are convinced that, within the next six to nine months, we will see a meaningful deterioration in earnings within the group," wrote Borsch, who has a neutral rating on the sector. And "we caution that the recent very strong rally in managed care may lead to a correction in the stocks when evidence of the downturn becomes widespread."
Still, Borsch believes that strong players -- such as
and WellPoint -- can weather the coming storm. He likes UnitedHealth, long an outperformer, as well. All three stocks have handily outpaced the broader market over the past year.
A year ago, Borsch said, Mercer's survey showed that employers expected a 13% jump in health insurance rates for 2004. Looking ahead, he said, the same survey is now showing that employers expect a hike of just 6.6% for 2005.
Blaine Bos, principal author of the Mercer report, pointed to heightened industry competition as a reason.
"Last year, what we saw was the beginning of a trend toward increasing price competition that started in the Northeast and South toward the end of the year," Bos said in a recent presentation hosted by Goldman Sachs. "This year, price competition is prevalent across all regions."
Bos, too, singled out not-for-profit health insurers -- flush with excess earnings -- as the drivers behind that change.
"If you have a not-for-profit that's willing to renew rates at a flat trend or maybe even give a 5% reduction in order to burn off excess surplus, it creates a competitive market situation that we haven't seen for a long time," Box explained. "So the for-profit companies face the challenge of competing against not-for-profit companies that essentially under-price business for a year."
Borsch portrays that competitive pressure as a "fundamental risk" for the group.
Picks and Pans
The analyst warns investors away from several mid-cap insurance carriers in particular.
, with its high exposure to not-for-profit competition, as especially risky. He feels cautious about
and, to a lesser extent,
He also considers
-- despite its size -- a poor choice for investors. Bos sees problems with the giant insurer as well. He believes the company is lagging its peers as a result of constant management changes and "some real issues" with its technology platforms.
"They're improving," he conceded. But "that is as far as we would go. My customers are not telling me that they are yet on a par with UnitedHealth or Aetna."
Meanwhile, Bos noted that the two latter companies have also established themselves as leaders in consumer-driven health plans. He expects the increasingly popular plans, often linked to new health savings accounts, to enjoy "exponential growth" in coming years.
"It does not create a situation where CDHPs take over the world before the end of this decade," he admitted. But "I wouldn't be surprised to see around 25% of very large employers offering CDHPs as a choice" over the next few years.
If so, UnitedHealth looks especially well-positioned. In late November, the company inked a deal to buy Definity Health -- which ranks as the largest CDHP provider in the country.
Prudential analyst David Shove, who quickly applauded the deal, noted that Definity boasts twice as much CDHP business as its largest competitor, Aetna. He said that Definity, co-founded in 1998 by a UnitedHealth executive, started with just 5,000 plan members in 2000. But looking ahead, he said, the company expects to be serving some 500,000 customers -- and generating $100 million in revenue -- in the coming year.
"We believe UnitedHealth ... will emerge as the dominant
company in this fast-growing product segment," wrote Shove, who, unlike Borsch, has a favorable view of the entire group.
Shove also likes the industry's biggest giant. Following its merger with Anthem, he said, WellPoint has emerged as a "new managed-care Goliath" with powerful opportunities for growth. Going forward, he predicted, WellPoint could shake up the industry as a whole.
"As a national managed-care company with a sizable enrollment base ... we believe WellPoint Inc. will redefine the industry's competitive landscape, which may spark a new round of consolidation activity," Shove wrote.
Borsch also likes WellPoint due, in part, to the company's limited exposure to not-for-profit health insurers. But he continues to steer investors away from many others in the group.
Still, even Borsch concedes that the current rally may have a little steam left.
"We continue to believe bullish sentiment will prevail into early 2005 -- up to, and possibly beyond, fourth-quarter earnings season," Borsch wrote. But he added that "we believe the downward competitive pressure on rates is becoming a more important factor ... consistent with our expectation for a cyclical industry downturn."