After Streak of Strong Profits,
Health Insurers May See Decline
Aetna, Others Face Dilemma:
Hold Back Price Increases
Or Watch Customers Walk?
Mr. Johnson Drops Coverage
By VANESSA FUHRMANS
July 31, 2006; Wall Street Journal, Page A1
Last year, the top seven U.S. health insurers earned a combined $10 billion -- nearly triple their profits of five years earlier. The windfall came as insurers raised their prices faster than underlying health costs.
Now the good times may be rolling to a halt. Health insurance has become so expensive that many smaller employers are dumping insurance altogether. If insurers don't do something, they may find their business shriveling. Yet if they restrain price increases, or appear to, they get hammered by Wall Street.
Aetna Inc. has found that out twice this year, after each of its quarterly earnings announcements showed medical costs were taking a bigger bite of premium revenue. The first time, in April, Aetna's shares fell 20%. Last week came another 17% plunge as investors expressed fear that the company is restraining premium increases too aggressively.
Aetna Chief Executive Ronald Williams denies that. "We have continued to exhibit strong pricing discipline," he says. "Sometimes that's more than what an employer can afford" but it's necessary to maintain Aetna's financial health, he adds.
Other insurance executives have also suggested they would rather miss their targets for membership than succumb to a price war. David Colby, WellPoint's chief financial officer, says that if the company's profit margin fell by just 0.2 percentage point, "We'd have to gain two million lives to make it up. It doesn't take much analysis to ask, 'From where?' "
Earlier this month UnitedHealth Group Inc. reported a 26% increase in second-quarter net income but said it expects to add only 850,000 new members this year instead of the one million to 1.2 million it originally forecast. WellPoint Inc., which had projected around one million new members, now expects about 700,000, with many coming from Medicaid and other public contracts.
With insurers trying to protect their profit margins, some consumers -- especially those who work for small or midsize businesses -- could be losers as employers trim health benefits or cancel them altogether. Insurers' resolve to price every account at a profitable level means a smaller company with several chronically ill employees or a few premature births can quickly be priced out of the market.
Robert Laszewski, a Washington-based health-care consultant and former insurance executive, says the insurers' strategy can work for only so long before their employer customer base dwindles dangerously. "Where is this industry in four, five years if it can't control health-care costs?" he asks. "It's on a long walk off of a short pier."
Stagnation "is a very real scenario," agrees Jon Rubin, chief financial officer of Cigna Corp.'s health-care business. Cigna, which reports second-quarter earnings Wednesday, saw its share price fall 15% after its first-quarter results.
Yet Mr. Rubin is optimistic about growth, simply because the U.S. has so many uninsured and underinsured people. "It has the appearance of a mature market because we have employers who can no longer afford coverage," he says. "But underneath you still have a growing employee population that needs coverage."
Others say the troubles of employer-based health insurance point to the need for a "single-payer" system in which the government would guarantee or mandate health care for everyone. However, the potential cost of such a system and opposition from those who favor a free-market approach make it an unlikely prospect anytime soon.
Big employers typically pay employees' health costs out of their own coffers and hire an insurer to administer the benefit -- negotiating with doctors over prices and handling the paperwork. At smaller employers, health insurance is truly insurance: The employer pays a premium at the beginning of the year, and the insurer takes on the risk of covering employees' medical bills.
The latter business offers a potential for big profits if covered employees rack up fewer medical costs than expected. That is precisely what was happening until recently. The "risk business" accounts for more than half of most of the big insurers' profits. A typical member in a risk plan currently yields six times the profit that a beneficiary in an employer-paid plan does, according to Goldman Sachs analyst Matthew Borsch. The only problem is that these small-business customers are the least able to absorb fast-rising medical costs and the most likely to be priced out of the insurance market.
Insurers have enjoyed their rising profits without the public vilification they suffered a decade ago. In the 1980s and early 1990s, many believed that insurers could play a leading role in containing costs by rounding up people in tightly controlled health-maintenance organizations. The HMOs cracked down on supposedly unnecessary care by limiting choices of doctors and procedures.
The so-called managed-care revolution collapsed amid a public outcry. HMOs were accused of denying lifesaving treatments. State legislatures rushed to pass bills forcing insurers to pay for various kinds of care. After costs briefly stalled in the mid-1990s, they surged again and forced many HMOs into the red amid a bruising price war.
Insurers found that, instead of playing the bad guy, it was easier to treat surging health costs as an inescapable force of nature -- and to make sure price increases stayed ahead of costs as much as possible. Today, operating margins, once 4% to 5% in a good year, average 8% at the country's biggest insurers.
Aetna's turnaround effort after heavy losses symbolized the strategy shift. Once the country's biggest insurer with 21 million members, it abandoned its growth strategy in 2000 and replaced its management. It sharply raised premiums, especially on unprofitable accounts, and lost eight million members in a few years. In 2002, premiums went up nearly 19%.
The industry's price rises outpaced the increase in health-care costs, especially after 2001 as the rise of cheap generic drugs and higher co-payments for employees curbed spending. Mr. Laszewski, the consultant, says employers tended to accept the increases because they didn't realize health-care inflation was decelerating. "Every year the insurer charges what the benefits manager thought was last year's trend," he says.
Randy Perkinson, chief executive of Advertising Props Inc. in Atlanta, felt the blow from the industry's tougher pricing. His 30-employee company makes packaging prototypes for advertising. For several years insurers told Mr. Perkinson he would have to pay double-digit increases in health-insurance premiums unless he introduced additional plans that spread more costs to employees. His medical costs were roughly half of the premiums he paid between 2002 and 2004, according to his insurance data. But last year, after an employee was severely injured in a highway accident, WellPoint's Blue Cross Blue Shield of Georgia boosted premiums by 30%. It had asked for a 41% increase but came down after Mr. Perkinson agreed to make employees pay even more of their bills out of pocket.
"I'm paying a lot more than I did three years ago and getting a lot less insurance for it," says Mr. Perkinson, who shopped around for a better deal but couldn't find one. "How can they come back to you year after year with 10%, 20%, 30%? The system is broken." The WellPoint unit says it had to increase AdProp's premiums so much to cover the big claims it incurred after the employee's accident.
Health-insurance executives say their business still has lower margins than drug makers and some hospitals. They say they have improved efficiency and used their profits to invest in innovations that keep the cost of health care from rising even faster than it has. Aetna points to its MedQuery system, which uses software to uncover gaps in care, unfilled prescriptions and medical errors. Customers in its risk business get the system for no extra charge.
Nonetheless, high health costs have forced many smaller employers to drop coverage. Today only 59% of employers with fewer than 200 workers provide health benefits, compared with 68% in 2000, according to the Kaiser Family Foundation, a policy-research group in Menlo Park, Calif. Last year, premiums at small firms rose more than 11% while the increase at larger firms averaged 8.9%, according to the foundation.
Two years ago David Johnson opened ImageFreeway Document Solutions LLC, a suburban Atlanta document imaging business. Soon he had to stave off a 22% increase in health premiums by raising employee deductibles -- the out-of-pocket cost before insurance kicks in -- to $1,000 per year from $250. Last fall, after Mr. Johnson and his partner reincorporated their business, Aetna re-evaluated his health plan from scratch because it was technically a new company. With a couple of his staff suffering from chronic ailments, the insurer told him it needed to roughly double his premium. No one else would offer a better price.
Mr. Johnson dropped coverage. "I can't open my doors with that financial burden," he says. Already three of his most experienced employees have left for a bigger company that could offer benefits, he says.
His receptionist, Nirvani Zurzolo, stayed and remains uninsured. She and her husband quickly bought their 10-year-old daughter an individual policy. But as a 47-year-old with previous episodes of high blood pressure, Ms. Zurzolo couldn't afford one for herself. She plans to skip her annual physical. "Bottom line, no health care for me now," she says.
Georgia law offers employers some protection from sharp rate increases. The state requires insurers to price premiums for small employers within 25% of a reference rate, which insurers file with regulators each month. But the reference rates have been surging by 12% to 18% a year since 2002, according to brokers.
George DuMouchel, a benefits consultant and insurance broker who advised Mr. Johnson, says in the late 1990s the market was more fragmented and insurers were eager to grab market share. "I'd take something into the marketplace and come back with 10, 11 bids," says Mr. DuMouchel.
WellPoint, which operates the for-profit Blue Cross Blue Shield of Georgia, has about 40% of the state's market, while UnitedHealth and Aetna hold another 25% between them. The 10 largest health insurers control about half of the U.S. market today, up from a quarter a decade ago. The industry has seen a handful of megamergers, such as UnitedHealth Group's purchase of PacifiCare Health Systems last year, and dozens of smaller ones.
Mr. Williams, the Aetna chief executive, says some regional competitors in a few markets are offering cut-rate deals for small employers. Aetna lost some customers with generally healthy workers, leaving it with a slightly more expensive pool of members.
"Some plans become very competitive and enter at price points that we don't believe are appropriate for us to sell at," he says. Because the competitors tend to pick off employers with healthy work forces, he says Aetna has lost some "very attractive business."
Mr. Williams cautions that this wasn't the only reason for Aetna's disappointing medical-cost results in the second quarter. He cites other factors including one-time spikes in medical costs on one big government account.
The challenge for Aetna and other insurers is keeping prices up without losing members. Aetna says it will fall 17% to 30% short of its original target of one million new members this year.
Jay Gellert, chief executive of insurer Health Net Inc., says the industry can still enjoy plenty of growth if it finds low-cost alternatives to attract uninsured customers. Over the longer term, Mr. Gellert and other executives believe the recent trend toward giving consumers more data on price and quality, with the goal of steering them to cost-effective care, will help bring health-care expenditures under control.
Says Mr. Rubin of Cigna: "We need to drive new solutions because, ultimately, the trends that are reflected in the premium simply are not sustainable. The only viable alternative is the advance of consumerism."