Managed care companies are under doctor's orders to bulk up their disclosures.

New York Attorney General Eliot Spitzer on Tuesday formally diagnosed the group as noncompliant and threatened legal action if they fail to remedy their ways. Specifically, Spitzer said the vast majority of big health insurers fail to provide state-mandated information designed to protect sick customers who are shopping for insurance that covers their specific ailments.

Spitzer made his determination at the end of an extensive study in which staff members, posing as potential customers, sought information from 22 health plans about medically necessary treatments related to five common health problems.

Half of the plans -- including Aetna ( AET), Cigna ( CI) and Health Net ( HNT) -- flunked the test entirely. Most of the rest -- including Oxford ( OHP) and UnitedHealth ( UNH) -- scored Ds. Not one emerged as totally compliant.

"This report shows that consumers are being deprived of information that is both required under state law and necessary to ensure appropriate health care," Spitzer announced on Tuesday. "My office is now working with health plans to ensure that appropriate information is made available to consumers. We are continuing to monitor the health plans' performance, and we are proposing new legislation to strengthen penalties for noncompliance."

Currently, Spitzer said, the companies are violating New York's Managed Care Consumer Bill of Rights. However, he said, the bill fails to authorize any specific penalties for noncompliance. He is, therefore, pursuing legislation that would specify fines of up to $5,000 -- depending on the harm done to consumers -- for each violation. In the meantime, he could begin taking companies to court.

"The attorney general's office has sent letters to each of the plans surveyed, detailing particular violations and requesting that each plan take immediate measures to comply with the law and set a meeting date to discuss permanent compliance measures," Spitzer stated. "Plans that repeatedly fail to comply with the law could face legal action."

Investors simply yawned, pushing managed care players -- among the healthiest performers in the market -- even higher on Wednesday.

Immune System

Analysts tended to downplay the news as well.

Citigroup's Charles Boorady actually pounced on the opportunity to recommend managed care stocks anew. He acknowledged that industry disclosures could use enhancements that, in turn, could raise administrative costs. But he doubts the insurers face material penalties or any excess costs that couldn't be covered by price increases.

Credit Suisse First Boston analyst Patrick Hojlo expressed even less concern.

"Spitzer has made it clear that he will not pursue legal action against the health plans but instead will work with them to ensure that appropriate corrective actions are taken," wrote Hojlo, who has an overweight rating on the sector. "This development is immaterial to the financial standing of any of the companies we follow."

Merrill Lynch analyst Doug Simpson also sees no immediate impact on industry fundamentals. He does, however, believe that disclosure issues could linger over the sector for some time.

Already, Spitzer has indicated that he will crack down on noncompliant insurers that may be profiting at the expense of those companies that actually follow the law.

"The health plans that violate the law are benefiting by deterring the sickest New Yorkers with high-cost health needs from enrolling in their plans," Spitzer stated, "while those that diligently follow the law are being penalized by helping higher-cost enrollees to acquire their plans -- a penalty for following the law that is forced upon their competitors."

Still, Hojlo sees no real threat to the big managed care players.

"Granted, it is possible that the unresponsiveness of some plans is a veiled attempt to discourage the enrollment of individuals with pre-existing conditions," Hojlo wrote. "However, such activity is unlikely to be commonplace and, furthermore, unlikely to prove effective at impacting a health plan's enrollment trends or financial performance."

To bolster his argument, Hojlo went on to point out that WellChoice ( WC) -- the "most compliant" health plan Spitzer surveyed -- faces medical costs that are similar to, and sometimes even lower than, those of its peers.

WellPoint tacked on 53 cents to hit $113.56 on Wednesday.

Double Vision

Critics have been screaming for better disclosure across the health care sector.

Earlier this month, for example, the California Public Employees' Retirement System stepped up its scrutiny of the hidden list prices that can drive up hospital costs. In the meantime, the giant agency dropped dozens of particularly expensive hospitals from its coverage network. It continues to call for added visibility on hospital pricing that -- if exposed -- could actually lower costs and help the managed care players.

But health insurers could see other costs rise as they step up to meet their own disclosure requirements. And it least one industry analyst is looking for administrative expenses to fall, rather than climb, down the road.

In a bullish note published early this month, John Rex of Bear Stearns pointed to reduced expenses as a key driver for margin improvement in the future.

"We note our view that sustained underwriting margin improvement will be increasingly difficult to come by," wrote Rex, who has an overweight rating on the sector. "Looking ahead, we believe that selling, general and administrative leverage will need to become a more meaningful aspect of the margin story for the managed care group."

Rex acknowledged that sector G&A expenses actually rose in 2003 and may do so again this year. But he expects the expenses to level out by 2005 and show meaningful improvement afterwards.

Meanwhile, he points to strong fundamentals across the sector. He is particularly bullish on large-cap companies -- such as Anthem ( ATH), UnitedHealth and WellPoint -- after the big run in smaller-cap players last year.

Morgan Stanley analyst Christine Arnold has spotted pockets of trouble, however. She points out that four companies -- including Health Net and Humana ( HUM) -- have already lowered their first-quarter earnings guidance. Another analyst has expressed concern about Health Net in particular.

Banc of America analyst Joseph France, this week, cut his target price on Health Net to $21, well below Wednesday's trading price of $25.12, after losing faith in the company's management. He raised questions because management suddenly cut its earnings guidance to account for specific drags -- including rising costs in New Jersey and the effect of Leap Year Day -- that, he believes, should have been obvious earlier. Instead, he claims, the company has spent a lot of time dodging its investors.

"Health Net has cancelled multiple meetings with investors -- including two hosted by our company -- which begs the question as to what else may be lurking," he wrote.

France also dismissed speculation that Health Net, at its current stock price, might be scooped up by a competitor. He ruled out several big-pocketed suitors as unlikely. And he said another player, PacifiCare ( PHS), may lack funding for such a deal.

"PacifiCare Health Systems could potentially be interested in Health Net, given their complementary markets in the West, though PacifiCare's debt covenants could make a deal of this size difficult. And PacifiCare," he concluded, "has been keeping its scheduled meetings with investors."

PacifiCare -- one of the strongest performers last year -- slid 24 cents to $39.50 on Wednesday.

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