PacifiCare Health CEO Resigns After Only Three Months - TheStreet

Just two weeks after the managed care company issued a third-quarter profit warning and watched its stock value drop by half,

PacifiCare Health Systems

(PHSY)

announced Wednesday that its chief executive was leaving the post after just three months.

Robert O'Leary, who had served as company's chief executive of the Santa Ana, Calif.-based company, has been replaced on an interim basis by former chief financial officer Howard Phanstiel, who was also named to the board.

O'Leary only became chief executive in mid-July, replacing Alan Hoops, who was retiring after seven years as head of PacifiCare.

O'Leary said the company's short-term and long-term priorities had changed "substantially" from what he'd perceived when he took the job. "Unfortunately that change in perception has brought with it my realization that my skills and background are not a good fit to address the company's immediate priorities," he said in a statement.

Though O'Leary did not elaborate on the perceived changes, he acknowledged that PacifiCare needed a leader "well-grounded in the fundamentals of managed care to lead the company through the time immediately ahead, in order to position the company to unlock its real value and future potential."

Investors reacted negatively to O'Leary's departure. The company's stock closed Wednesday down $1.56, or 13%, at $10.44, after setting a new 52-week low of $10 earlier in the session. PacfiCare's shares have fallen 85%since hitting a 52-week high of $72.31 in mid-June.

O'Leary, a 35-year veteran in the health care industry, had been chairman of

Premier

, a nationwide alliance of hospitals and health care systems, before he joined PacifiCare. In announcing the management changes Thursday, PacifiCare Chairman David Reed said Phanstiel's background in financial management, information technology, and managed care makes him "well-suited" to replace O'Leary.

But analysts were skeptical about the reason for O'Leary's departure.

"Either he (O'Leary) genuinely believes the company needs a CEO with more managed care experience or he has serious concerns about the viability of the company given the revelations that have come out in the past few weeks -- or he doesn't want to take on the challenges. Any way I look at it, the implications are negative," said Lori Price, an analyst at

Chase H&Q

. "For him to resign this early in his tenure is not a good sign."

Price said PacifiCare will need to do more than find a new chief executive if it is to turn around the company.

Plenty of Work to Be Done

"There's a lot that needs to be rethought, reconsidered, and rejiggered. It's a tough challenge," said Price, who maintains a "market perform" rating on the stock. Her firm does not do underwriting for PacifiCare.

Two weeks after ago PacifiCare

warned it expected to break even or lose as much as 10 cents in the third-quarter, significantly lower than analysts' consensus earnings forecast at that time of $1.90 a share for the quarter, according to the research firm

First Call/Thomson Financial.

PacifiCare attributed the earnings shortfall to a jump in medical costs that forced it to curtail Medicare enrollment in some areas. The costs were driven higher in part by the ongoing conversion of fixed payment (or capitated) hospital contracts to shared-risk contracts.

Under the capitation system, managed care companies pay a predetermined fee to hospitals and doctors regardless of the cost of care. Under a shared-risk contract, the insurance companies pay fees after medical costs are incurred. But analysts say PacifiCare was unable to estimate the shared-risk costs as it was used to paying a fixed fee, and it underestimated the medical cost reimbursements.

"The question is, how do you price the product?" said Joseph France, an analyst at Credit Suisse First Boston. "They repriced 70% of their commercial business using flawed estimates of costs."

France said that even early this year, PacifiCare executives were still explaining how their capitation formula was a good thing, when it was clear to him that it was "exactly wrong." He has maintained a "sell" recommendation on PacifiCare's stock, and has not done underwriting for the company.

John Szabo, an analyst at

CIBC World Markets

, said there is no question that PacifiCare mispriced its shared-risk costs. "Now they're locked in. They're trying to price the other 30% aggressively to try and hang on until they can fix the way they pay providers," said Szabo, who predicts that process could take as much as two years.

"My guess is Rob O'Leary looked at this and said `I'm not up for this'," Szabo added. "From an outsider's perspective, you could draw the conclusion that the company is imploding."

Szabo's firm does not do underwriting for PacifiCare. He maintains a "hold" rating on the stock.

Making matters worse is PacifiCare's dependence on

Medicare

for a large portion of its revenues. The nation's largest provider of Medicare managed-care plans announced recently that it will temporarily suspend new enrollment in its Medicare program in selected markets due to higher costs.

Investors Beware

On Wednesday,

PaineWebber

sent out a note recommending investors stay away from Medicare HMOs like PacifiCare as it seems the "addback" bill being considered in

Congress

would only boost Medicare premiums to 3% from 2% -- "well short of reversing the unattractiveness of the Medicare market for the industry."

"Pacificare has business model and business mix issues: too much capitation and too much Medicare," Szabo said. "Until they change their business model, I think it's going to be tough for the company."