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AIS's Health Business Daily
Featured Story June 25, 2009 Aggressive Pricing in 2008 Helped Aetna Boost Enrollment, but May Have Hurt Profitability Reprinted from HEALTH PLAN WEEK, the industry's leading source of business, financial and regulatory news of health plans, PPOs and POS plans. By Steve Davis, Managing Editor, (sdavis@aispub.com) With less than a month left in the second quarter, Aetna Inc. surprised investors by lowering its 2009 earnings projections after the market closed June 2. Analysts queried by HPW contend that aggressive pricing in 2008 helped the company boost enrollment as most of its competitors shed members. But that strategy also seems to have had a negative impact on Aetna's medical loss ratio (MLR). Aetna's MLR began to rise in the second half of 2008, but the company opted to maintain its earnings guidance, and didn't reprice its commercial book of business, which left it vulnerable in 2009, analysts say. Over the past 30 days, Aetna's commercial MLR guidance has dropped by 160 basis points (1.6%), according to Oppenheimer equities analyst Carl McDonald. "Clearly, Aetna's pricing isn't anywhere close to cost trends this year," he wrote in a June 3 letter to investors. Citing higher projected commercial medical costs — combined with lower projected 2009 Medicare revenue — the company reduced and widened its 2009 earnings per share (EPS) guidance from a range of $3.85 to $3.95 to a range of $3.55 to $3.70. While analysts say they were surprised by the timing of the announcement, some suggest it was inevitable after the company opted to maintain its full-year guidance despite a significant MLR increase in the first quarter. Matthew Coffina, an equities analyst at Morningstar, Inc., says the company's previous full-year earnings guidance of 12% to 14% growth on an adjusted basis was "ambitious," adding that his firm's modeling placed Aetna's 2009 earnings at $3.37 per share. "While Aetna might be gaining new clients, they are also losing clients and losing members due to rising unemployment," Coffina tells HPW. "Any time you have that kind of turnover, there is more potential for volatility in medical costs. Concern among employees that they might lose their job also can create a fair amount of variability." In a late-afternoon conference call with investors June 2, Aetna executives blamed the revision on a trend toward higher levels of services (e.g., more tests and treatments per member) billed from hospitals and clinics. The company cited a similar problem when it reported first-quarter 2009 earnings results. "But that doesn't square up with what United[Health Group] and WellPoint [Inc.] have been saying, which makes me think that this is the result of an aggressive pricing stance" as opposed to significantly higher utilization, says Steve Shubitz, an equities analyst with St. Louis-based Edward Jones. "While those [health plans] have acknowledged [higher utilization rates], neither has indicated that it is a threat to their 2009 earnings." In his note to investors, Wachovia Capital Markets analyst Matt Perry said health plans in 2008 revised their EPS guidance by an average of 34%. And most plans reduced their EPS guidance more than once during that year. It's difficult to tell if the revision is due to higher disease acuity or a mispricing of products, Perry tells HPW. "What I do know is that last year many management teams gave multiple reasons as to why they lowered their outlooks. For most, it came down to pricing pressure — not unexpected changes in utilization or higher prices with providers." Did Lower Provider Pay Rates Boost Services? Stifel Nicolaus equities analyst Tom Carroll says Aetna entered 2009 "thinly reserved" while pricing competitively. "And as a medical-cost offset, Aetna may have renegotiated provider contracts to drive lower provider costs," he suggests. That might have prompted providers to then increase services to maintain revenue. And that caused Aetna's costs to be higher than expected. "And since reserves were thin, the balance of price, costs and reserves tipped toward a downward revision," according to Carroll. Although other large health plans might also see increased utilization, Carroll suggests they might not be as negatively impacted. "WellPoint and United spent the last four quarters increasing their reserves and are better able to manage unexpected changes throughout the calendar year." While Carroll has covered the sector for nearly a decade, he does not officially cover Aetna. Aetna's stock price was $24.94 when the market opened June 3 — down 8.5% from the previous day's close. Other health plan stocks were pulled down as well. Analysts tell HPW that they don't expect other health plans will downgrade their 2009 earnings estimates next month when second-quarter earnings begin to be reported, but it's unlikely they will raise their guidance. "In the first quarter, we were looking for [some health plans] to raise guidance. But now they look smart for not having done that," Coffina says. "Plans that might have [intended] to raise their guidance next quarter are likely to stick where they are." Several large health plans (e.g., WellPoint and United) ended the first quarter of 2009 with improved MLRs. On April 29, however, Aetna executives said they had mispriced its 2009 commercial book of business, which resulted in a higher MLR. Equities analysts criticized Aetna's higher-than-expected MLR, which increased to 81.7% in the first quarter from 79.8% a year ago. Despite the miscalculation, the company opted to maintain its 2009 EPS guidance range. The higher-than-expected medical costs cited by Aetna executives, if an industry trend, could have a negative impact on other health plans. But while other large health plans have acknowledged similar trends, they have not suggested earnings this year would be hurt as a result. United and WellPoint "were relatively early in recognizing accelerating cost trends last year," says Coffina. "And they probably did a better job at raising premiums earlier than some of the smaller plans." In its conference call with investors, Aetna executives suggested that the cost trend would likely moderate later in the year. But Shubitz says that's in opposition to statements of other health plan executives, who have suggested that rising deductibles will likely translate to larger MLRs later in the year as members meet their deductibles and health insurance begins to pay for services. According
to Aetna, risk-adjustment payments from Medicare are coming in at lower-than-anticipated
levels. As a result, the company's Medicare-related revenue likely will
fall "well short of its prior expectations," according to
McDonald. The company concluded that its enrollment is healthier than
previously thought, which has led to lower risk-adjustment payments
this year. "But the issue seems to have been recognized early enough
to factor into the 2010 bids," McDonald said.
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