Health Insurers Take Sickly Turn

Recent warnings by WellPoint and Humana could be just the first signs of long-term ills.
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OKLAHOMA CITY -- Following an especially stormy March -- which hit

WellPoint

(WLP)

and

Humana

(HUM) - Get Report

shares like an F-5 tornado -- the managed care sector no longer resembles a "safe haven" at all.

Over the past few weeks, several health insurers have issued warnings about looming profit shortfalls. WellPoint blamed rising medical costs. Humana cited forecasting mistakes.

Coventry

(CVH)

mentioned the flu.

Other players tried to look strong, with

Cigna

(CI) - Get Report

and

Aetna

(AET)

coming across as somewhat immune.

Nevertheless, many investors have already fled the space. Others have weathered serious damage that could take months -- if not years -- to repair. All have been left to wonder just how long this storm will last.

News You Need: Wellpoint, Humana

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To be sure, some analysts still forecast sunny days ahead. But others, such as Goldman Sachs analyst Matthew Borsch, see more dark clouds on the horizon.

"We disagree with managements and the apparent Street consensus that the reductions to guidance amount to a freak occurrence of simultaneous unrelated events," Borsch wrote earlier this month. "Instead, the common thread is the industry underwriting cycle -- which is, far and away, the most important driver of industry fundamentals ... What we have characterized as a 'cyclical slowdown' over the past two years, since the end of the 2000-2005 up-cycle, looks to be headed towards an outright downturn."

By now, Borsch has gathered plenty of evidence to support his cautious stance. He has gone a step further than most by regularly studying the performance of health insurance companies that never report to Wall Street at all.

Despite rampant consolidation, which has created publicly traded giants like WellPoint and

UnitedHealth

(UNH) - Get Report

, nonprofit Blue Cross providers still control much of the health insurance market. In recent years, Borsch notes, these companies have made so much money that they have been able to cut their premiums without depleting their rich surplus accounts.

Importantly, he says, those companies have managed to steal market share from their for-profit competitors -- and put pressure on their prices -- as a result.

Now, however, they seem to be paying a price. For the first time in nearly a decade, Borsch recently wrote, the nonprofit Blues have started to lose money. Eventually, Borsch fears, that pain could spread.

"We had hoped further declines in operating profit at the Blues might translate to less pricing pressure on the public companies this year," Borsch wrote last week. "While that is still possible, the recent raft of earnings warnings from public companies suggests to us instead that the underwriting cycle has entered a worsening stage, setting the stage for a period of impaired earnings growth for most of the public companies until the downturn washes out excess competitive pressures -- historically, a two- to three-year process" for the group.

For the most part, Borsch is urging industry investors to remain on the sidelines in the meantime. His firm seeks to do business with the companies it covers.

"What keeps us from being wholly bearish is that the market has already taken a sledgehammer to valuations," Borsch explained, when maintaining his neutral outlook on the group. Still, "things should get worse -- not better -- for some time."

Conflicting Messages

Publicly traded health insurers, such as WellPoint and Humana, are banking on temporary setbacks instead.

WellPoint rattled the industry first, when it issued a

profit warning

earlier this month. The company blamed high medical costs and weak enrollment -- particularly in its Medicare Advantage division -- for the looming shortfall. Its stock, downgraded by Lehman Brothers on Friday, has lost one-third of its value since that time.

Two days after WellPoint's warning, Humana

dropped a bombshell

of its own. For its part, Humana portrayed its core Medicare Advantage business as quite healthy. It pointed to problems with its Medicare prescription drug business instead.

The warnings slammed the stocks of other insurers, even those that never warned at all.

"The catalyst for the clear change in group sentiment was first WellPoint's acknowledgement that mostly everything had gone wrong except for its stand-alone Medicare prescription drug plan business (PDPs) on Monday and Humana's statement yesterday that everything had gone right except for PDPs," CRT Capital Group analyst Sheryl Skolnick wrote earlier this month. "As UnitedHealth is exposed to almost all of the same factors that caused WLP and HUM to lower guidance dramatically, the market punished UNH shares" as well.

Humana's problems, at least, may not spread. Based on its recent testimony, the company seemed to create its own woes.

For starters, Humana assumed that seniors would use more expensive drugs than they did and -- in an effort to meet government coverage ratios -- wound up covering too much of their bills as a result. Seniors, spotting a bargain, snatched up the generous policies in high numbers. Meanwhile, cheaper customers dropped the company's standard plan.

As a result, Humana expects to spend $360 million more on Part D coverage this year than it had originally planned. The company apologized for the "professional embarrassment" and promised to regain its momentum by next year.

However, Humana's lucrative Medicare Advantage business -- already under attack by some prominent Democrats -- could face new political threats following this year's elections.

The company's stock continues to suffer in the meantime. It has lost almost half of its value in the last two months alone.

Domino Effect

UnitedHeath has fallen hard as well.

So far, the company has stuck with its original guidance. At the same time, however, it has warned about possible "pressure" on its future results.

Meanwhile, Coventry has gone ahead and trimmed its own forecast. However, the company offered new excuses -- including rising flu-related costs and falling interest-related earnings -- for its likely shortfall.

Other giant health insurers, including Cigna and Aetna, continue to hope for the best. Shortly after WellPoint's warning, Cigna rushed forward to reaffirm its guidance. Days later, Aetna went on to offer a bullish update at its annual conference for investors.

Notably, two years ago, it was Aetna that was sparking industry-wide fears.

"We had a blip in medical costs that we saw right away that we felt that we needed to share," Aetna President Mark Bertolini reminded investors earlier this month. But "we said that we had fundamentals that were solid and that they were going to show up over the rest of the year -- and they did ... You just didn't believe us is what happened."

Of course, several companies have warned about looming shortfalls this time around. Borsch, for one, fears lasting damage as a result.

"While the timing of these announcements caught Street analysts (including us) by surprise and certainly include significant 'company-specific' elements, we do not agree with what appears to be the emerging post-mortem consensus ideas that these are fundamentally unrelated events from which the group will quickly recover," Borsch stressed this month. Rather, "we think the build-up of competitive pressures has made earnings growth more difficult across the managed care product universe."