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Medicare Mess Hits UnitedHealth

Shares fall as a slowdown looms in a key growth business.

UnitedHealth

(UNH) - Get Report

is nursing another messy wound.

In a stunning setback, the giant health insurer revealed late Thursday that it could soon lose roughly 15% of its booming Medicare Part D business. Because of the high price of UnitedHealth's new Part D plans, which exceed the benchmark in more than half the regions where the company operates, Medicare will now direct some of its poorest customers elsewhere.

Customers must now choose other carriers -- such as

Humana

(HUM) - Get Report

or

WellPoint

(WLP)

-- if they wish to keep their government-subsidized, no-premium Part D benefits.

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Financial experts were rattled by the news.

"With 27% of the total membership in the program and with presumably a more favorable cost structure given its size and purchasing power, we would have thought that UnitedHealth was in a position to submit a fairly aggressive bid and freeze out smaller competitors," Credit Suisse analyst Gregory Nersessian wrote on Friday. Indeed, "we would have been very surprised had UnitedHealth missed the benchmark in one region, much less 18 out of 34. ... Frankly, we are shocked."

Still, the financial hit could prove modest. Even if UnitedHealth loses all 650,000 Part D customers being directed to cheaper plans, the company should see its 2008 profits -- currently projected at $3.96 a share -- drop by just a couple of pennies a share.

Nersessian is maintaining his outperform rating on UnitedHealth in the meantime. He values the stock, down 2.2% to $48.17 on Friday's news, at $62 a share. His firm has investment banking ties to the company.

But CRT Capital analyst Sheryl Skolnick has started questioning whether UnitedHealth -- once a Wall Street darling -- still qualifies as a genuine growth stock at all. Through so-called "pricing discipline," UnitedHealth has protected its generous margins but has now sacrificed growth in its commercial and Medicare businesses alike.

"And Medicare is supposed to be the growth engine," Skolnick stresses. "The margins may be lovely. But there reaches a point in time when you have to recognize that you're not in a growth business anymore. ... With respect to the insurance piece of their business, I think that is the case now."

Going forward, in fact, Skolnick sees UnitedHealth's Medicare business shrinking even more. Like many, she assumes that UnitedHealth will lose most of the poor 650,000 Part D customers who currently rely on the company for free coverage. But she fears that other seniors, originally wooed by AARP's powerful endorsement of UnitedHealth, could seek out cheaper plans as well.

"As Part D is now going into its third year, competing non-AARP-branded plans have more established track records, and some have very good reputations," Skolnick notes. "Thus, seniors' innate (and sometimes extreme) price sensitivity may force them to abandon the brand they know in favor of a lower-priced plan with the same -- or even better -- benefits."

For now, Skolnick is maintaining her fair-value on UnitedHealth but expressing an "increasingly negative" view on the shares. Quite simply, she says that she doesn't like all of the troubling trends at the company.

Moreover, Skolnick wishes that UnitedHealth would do a better job of leveling with investors. But she feels that the company keeps on masking bad news instead.

For example, Skolnick says, UnitedHealth recently portrayed a government settlement as "a breakthrough in regulatory relations" rather than "the black eye" that it really was. Now, she says, the company has touted "the stable costs and broad list of covered drugs" in an announcement that actually revealed a big threat to its crucial Medicare business.

"How about a straightforward title that doesn't beat around the bush, as in 'UNH Could Lose up to 650,000 Auto-Enrollees as It Bids above the Benchmark to Maintain Margins?'" Skolnick demands. "This is not the new, more transparent UNH that we observed last year at this time, and we view this as a turn for the worse -- not the better -- at the company."