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UnitedHealth Tackles Its A-Rod Problem

Analysts now say it must prove it can deliver.


(UNH) - Get UnitedHealth Group Incorporated Report

popularity has faded so much that one analyst on Friday labeled the company "the Alex Rodriguez of managed care."

Like Rodriguez, a Yankee great known for faltering in post-season play, UnitedHealth has struggled lately to deliver the wins its fans have long come to expect. CIBC World Markets analyst Carl McDonald, reminded of the athlete, sees a talented company that must prove itself all over again.

McDonald painted rare reserving problems, triggered by high utilization patterns that caught UnitedHealth off guard, as "just the latest in a series of miscues

that give the company's critics ample evidence to justify their views." Specifically, UnitedHealth failed to predict that so many users of its popular consumer-directed healthcare plans would rush out for treatment -- at the company's expense -- as last year drew to a close. The company suffered a rare unfavorable prior-period development as a result.

"This is the first time since the Clinton administration that UnitedHealth has acknowledged negative prior-period reserve development in its commercial risk book of business," declared Credit Suisse analyst Gregory Nersessian. Moreover, "it's not likely that there will be any favorable development in the commercial book for the remainder of the year.

"If we are right, the seven-year string of increasingly large favorable development will come to an end in 2007."

Nersessian, while still a fan of UnitedHealth's stock, seems troubled by this issue.

For the second straight quarter, Nersessian notes, UnitedHealth has reported higher medical costs than the Street has expected. And this time around, he adds, the company posted its highest commercial medical loss ratio in four years.

Looking ahead, Nersessian fears that further surprises loom. Specifically, he points out, UnitedHealth is banking on second-half MLR improvements that seem to contradict the fourth-quarter usage trend that just took the company by surprise.

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Nersessian feels uneasy about that forecast as a result. Still, he remains confident in the company -- due to its strong Medicare business -- overall.

Indeed, both he and McDonald still recommend UnitedHealth's stock. His firm has provided investment banking services to the company in the past, and McDonald's firm hopes to do the same going forward.

At the same time, however, Nersessian readily admits that serious risks for the company -- plagued last year by corporate governance scandals -- still remain.

"Just when you thought the worst of UnitedHealth's troubles were behind it, the company reported its sloppiest quarter in almost a decade," he laments. So "how confident should we be about the company's outlook?

"Going forward, we would argue that there is less visibility into UnitedHealth's current-year earnings than we have seen in a long time."

Such statements were virtually unheard of when UnitedHealth operated under the reign of accomplished CEO William McGuire. McGuire resigned from UnitedHealth in disgrace last year, the casualty of a huge stock options scandal, and left a distracted company with a battered reputation in his wake.

UnitedHealth has weathered some troubling setbacks -- prominently evident in its first-quarter results -- since that time. Thus, experts seem worried about the company's growth prospects and its forecasting abilities alike.

"Were clients troubled by the stock options scandal, making it difficult to grow membership meaningfully for 2007?" A.G. Edwards analyst J. Paul Newsome asks. "Perhaps management was so distracted that it just stumbled on managing reserves, product development and medical management?

"The scariest alternative explanation is that Dr. McGuire really was that important to the success and efficiency" of the company.

Newsome believes that is unlikely. But he remains on the sidelines with a hold recommendation on UnitedHealth for now. He says that the problem-riddled company, which has no ties to his firm, looks fairly valued already.

UnitedHealth's stock rose 85 cents Friday to $52.98, regaining some of the ground it lost on Thursday's first-quarter report. The stock was approaching $65 a share before stock-option questions started hammering it last year.