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How Not to Analyze Health Insurers

WellPoint and Humana: Dead ducks?As a quick addendum to a recent post on whether health insurers are more properly viewed as health plans or transaction processors, I couldn't help noticing a recent research note by analyst Chris Kallos that underscores the blinkered way most financial analysts seem to view the healthcare industry.

Specifically, while Kallos appears to understand several of the major challenges facing health insurers -- primarily the fact that they have limited room to raise prices to cover still-rising medical costs -- he maintains a "neutral" outlook on the industry and proceeds to argue that size and scale will save the largest insurers:

[E]ven within the managed care arena, companies vary in terms of geographical spread, scale of operation, business mix (Medicare, Medicaid, Individual, etc.) and source of revenue. As a result, the dynamics of each managed care differ given the focus of its product and payor mix. That said, we believe several of the larger players are attractive at current levels....

WellPoint and Humana stand out at this time. WellPoint is the largest publicly traded commercial health benefits company in the United States and an independent licensee of the Blue Cross and Blue Shield Association. Humana reported a revenue increase of 14% driven by a 19% increase in the membership of its Medicare Advantage program, as well as the addition of CompBenefits and KMG America. Both companies are attractive on a valuation basis at current levels.

Which is all true so far as it goes, although that's not really very far. WellPoint, for instance, continues to expand its membership slightly -- its member ranks in the second quarter expanded 1.5 percent over a year earlier -- but a closer look shows that its more lucrative "fully insured" business continues to shrink steadily (by 3.3 percent in the quarter), while "self-funded" programs expanded rapidly (6.2 percent).

In short, that means that more of WellPoint's business customers are choosing to self-insure, meaning they'll shoulder the financial risks of providing employee health insurance while effectively hiring WellPoint as a contractor to manage the details. This is a natural consequence of escalating employer insurance costs, which here are leading many companies to simply cut out the middleman -- here, WellPoint --if they can do so. You don't get many clearer signs than your customers think you're an inefficient cost center than that.

Humana, meanwhile, is indeed seeing growth in Medicare Advantage plans, but its overall Medicare membership shrank during the quarter by roughly 123,000, or 2.9 percent. Meanwhile, if recent political developments in Congress have taught us anything, it's that the future of the Medicare Advantage program -- in which insurers like Humana receive a federal subsidy for managing care for Medicare patients -- is very likely a dim one.

None of which is to suggest that any of these companies are going to collapse tomorrow. But health-insurer executives can only reshuffle the deck chairs for so long while the fundamentals of their industry continue to disintegrate.

Image via Flickr user swanksalot, CC 2.0