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Cost Worries Whack Aetna

Shares drop on concerns tied to UnitedHealth's expense problem.



investors better hope that


(UNH) - Get Free Report

problems don't spread.

Both Aetna and UnitedHealth rank as leaders in the consumer-directed health care movement. Aetna, a pioneer in the CDHC arena, has so far seen its investment in those high-deductible plans pay off.

But UnitedHealth, a later entrant in CDHC that became the market leader through major acquisitions, suffered an embarrassing surprise in the latest quarter. The giant health insurer -- long known for its actuarial precision -- failed to realize just how many CDHC plan members, having met their high out-of-pocket obligations, would rush out for treatment at the end of the year.

UnitedHealth failed to establish adequate reserves for those expenses and weathered a negative prior-period development in the first quarter as a result.

"The problem here is that UNH estimated the utilization pattern of the product wrong," explains Sheryl Skolnick, senior vice president of CRT Capital Group. And "at the core, UNH is an


company -- and an insurance company that makes mistakes estimating claims exposure usually has a lot of explaining to do to Wall Street."

To be fair, Skolnick says, UnitedHealth found itself facing one risk that lay beyond the company's control. Specifically, she notes, Christmas fell on a Monday last year and left many health care providers working -- and available to treat eager CDHC plan members -- the remainder of the week. Had the holiday fallen earlier or later in the week, she says, those workers may have been off more days instead.

But "that's the only risk I see with Aetna," says Skolnick, who has a fair value rating on UnitedHealth but does not formally cover Aetna. Otherwise, "I think this is company-specific. ... This is poor execution on UnitedHealth's part."

UnitedHealth clearly took the bigger hit on Thursday. The company's stock dropped $1.77 to $52.44 a share. Meanwhile, Aetna slipped 61 cents to $45.23. Most other managed-care stocks lost some ground as well.

But CIBC World Markets analyst Carl McDonald saw no good reason for that slide.

"Our initial take is that UnitedHealth's cost trend challenges are largely a company-specific phenomenon, but United's results will likely pressure the industry broadly," McDonald wrote on Thursday. "We'd look for opportunities across the group, since earnings over the next two weeks should be fine for most companies."

McDonald has an overweight rating on the managed-care industry. His firm seeks to do business with the companies it covers.

McDonald likes UnitedHealth in particular.

"The company wasn't able to come through on the metric the market was most focused on" -- commercial medical loss ratio, he conceded. But "despite a tough quarter in the commercial business, the company was still able to beat numbers and raise guidance. ... In a way, this quarter perfectly illustrates why United's diversified business model is valuable."