This week, another giant health insurer caused some hearts to skip over fears about industry trends.Like WellPoint ( WLP) before it, Aetna ( AET) on Thursday shocked Wall Street by cutting its full-year enrollment targets in light of fierce competition. Aetna met financial targets for the second quarter and raised financial guidance for the full year. But the company had to overcome both falling membership and rising medical costs in order to get the job done. Aetna blamed sicker patients in its mix, insisting that fundamentals remain strong for the industry as a whole. But the company's 17% plunge on Thursday dragged the entire sector down anyway. WellPoint, which delivered a generally
Clearly, Aetna has been taking its lumps. But a pressing question remains: Did other managed-care giants, particularly UnitedHealth, deserve the hits they received as well? Sheryl Skolnick, senior vice president of CRT Capital Group, doesn't necessarily think so. Skolnick doesn't formally follow Aetna, but she listened closely to the company's conference call for any signs that she should be concerned about UnitedHealth, which she recommended buying before a stock-options scandal hammered the stock. She currently has a "fair value" rating on UnitedHealth shares. In the end, Skolnick heard no sectorwide alarm bells. "I don't think this is reflective of problems with the industry," she concluded. "I think this is reflective of problems with Aetna." To begin, Skolnick sensed that Aetna has been raising its premiums less than some in order to grow enrollment. Even if those increases failed to fully offset rising medical costs, she explained, the company could still make cuts elsewhere -- particularly in overhead -- and improve its operating margins. That, in fact, happened in the latest quarter. The company's operating expenses, as a percentage of revenue, actually fell from 19.7% to 18.4% in spite of rising medical costs. But investors didn't care. Rather, they wanted to know why Aetna's medical costs had soared past expectations and what exactly the company planned to do about it. Aetna blamed three negative developments. First, Aetna said that intense competition for small-group accounts in several crucial markets caused the company to lose some customers with "favorable" utilization trends that have not been replaced. Second, the company said that a huge government account has generated an unexpected spike in claims for the treatment of seriously ill patients. Finally, the company said that it has weathered an unplanned surge in "stop-loss" claims -- which cover excess costs for self-insured employers -- as well.
"They had some very expensive cases," Skolnick says simply. "That's the bad luck of being a health insurance company." Nevertheless, Aetna has pledged to bring all of those problems under control. "I think the fact that we were able to detect and analyze and understand the nature of the emerging patterns in the second quarter and really have an action plan in place is something that we feel is reflective of the rigor with which we do this," Aetna CEO Ronald Williams insisted to a doubting audience during Thursday's conference call. "I think, obviously, we're not pleased with what has happened. (But) we take it very seriously, and we're very focused on making certain that we take actions to get the performance back where we would like it."
Nevertheless, Lake maintained his buy recommendation and his $50 price target on Aetna's stock. His firm has investment banking ties to the company. Meanwhile, Skolnick admits that Aetna has some work to do. In light of recent results, she questions whether the company's underwriting practices have been sound. At the end of the day, she believes the company will have to raise its premiums -- and lose some business as a result -- in order to correct the problem. But she feels that Aetna may have caused investors to lose some faith in the entire sector in the meantime. "There may very well be a credibility issue here that is causing some pressure on the other stocks," she said. "I think that, today, the market is much more inclined to believe bad news than good."