Health Insurance Market Trends Fuel Climbing Medical Expenses, Which Are a Sore Point on Wall Street
Health insurance
— despite being famous for confusing jargon and complicated forms —
operates under a pretty simple business model.
Collect premiums. Pay claims. Whatever is left, minus administrative costs, is profit.
That basic formula, though, is at the heart of the many hurdles WellPoint
faces as it seeks to regain investor confidence shattered last month
when it unexpectedly reduced its profit forecast for 2008, largely
because of higher-than-expected medical costs.
When WellPoint reports its first-quarter financial results to Wall Street on
April 23, one of the most closely watched measures will be how much of
each premium dollar the company is paying out for health care.
Because of factors including new medical technology, an aging population and
industry changes, WellPoint has been spending more of each premium
dollar for actual health claims in recent years.
For investors, that trend is a concern because profits are being affected.
For WellPoint customers, it could mean higher premiums are on the way.
WellPoint declined an interview request, citing a quiet period before its earnings report.
But in a March interview, Chief Financial Officer Wayne DeVeydt was clear
about his company’s task: "The biggest priority right now is to get our
hands around the rising medical trends that we’re seeing in the
industry."
WellPoint, which provides health benefits to 35 million people, became the
nation’s largest insurer in terms of membership through a series of
mega-mergers in recent years, most notably the $20.8 billion merger of
Anthem of Indianapolis and WellPoint Health Networks of California in
late 2004.
Since that deal, WellPoint’s medical expenses have been creeping upward. In
2005, the first full year of the newly combined company, WellPoint paid
80.1 percent of its premium revenue toward health claims.
In 2007, WellPoint paid out 82.4 percent of its $55.9 billion in premium
revenue for health claims — an increase of 2.3 percentage points over
the past three years.
This year, the company expects its medical expenses versus premium revenue
— called the medical-loss ratio in industry jargon — to be 82.8
percent to 83.1 percent of its premium revenue.
If a jump of 2 or 3 percentage points doesn’t seem like much, consider
this: WellPoint would have paid almost $1.3 billion less in health
claims in 2007 if the company had been able to duplicate its 80.1
percent medical-loss ratio from 2005, instead of its actual 82.4
percent.
That expense increase comes straight out of WellPoint’s bottom line.
Despite those challenges, WellPoint earned profit of $3.3 billion on $61.1
billion in revenue last year and expects record profit again this year.
The company also has cut its administrative expenses from 16.5 percent
of operating revenue in 2005 to 14.5 percent last year.
But Wall Street, seemingly fixated on medical costs, has not been
impressed. WellPoint shares, which closed Friday at $46, have lost 47
percent in value since the start of 2008.
Some see a tough road ahead for WellPoint and its rivals.
"A lot of the upward pressure on the medical-loss ratio at WellPoint comes from a change in business mix," said Dave Shove, senior analyst with BMO Capital Markets in New York.
Large insurers such as WellPoint used to be able to count on big national
employers for much of their profit and growth, he said.
But with the large employer market stagnant, insurers are relying on less
profitable customers such as individual and small-employer policies and
government business, including Medicare and state-run Medicaid programs.
WellPoint, for instance, ended its participation in Ohio’s Medicaid program at the end of March because medical expenses were higher than expected. The
company also has seen higher expenses from its Connecticut Medicaid
program and its Medicare Advantage business.
Other expenses are rising, too. Speaking during a conference call last month,
WellPoint Chief Executive Officer Angela Braly reported that the
company has faced higher expenses from physician services and more
high-dollar claims from oncology and neonatal intensive care.
Shove said, historically, market forces usually have kept medical expenses at
around 80 percent of premium revenue. But he doesn’t see those levels
coming back anytime soon for WellPoint.
With government business, for instance, insurers have less power to set
their own rates. Medicare business, Shove said, typically requires an
insurer to pay out 84 percent of premium revenue for health claims.
Shove is predicting an 83 percent medical-loss ratio for WellPoint in 2008, with 82.7 percent expected for 2009.
One way to deal with those rising costs, of course, is to charge more for
health coverage. "They’re going to have to correct their pricing…
higher prices in this case," Shove said of premiums paid by WellPoint
customers.
One industry critic, however, said large for-profit insurers such as
WellPoint are in a bind because they have tapped out consumers’ ability
to pay more.
"Premium increases now have been saturated to the point the majority of the market can’t afford more increase," said Jerry Flanagan, health-care
policy director for Consumer Watchdog, a California advocacy group.
"Low- and middle-income Americans can’t afford to pay more for their
health care.
"Many have already cut back on coverage to the point where if they cut back more they won’t have coverage."
The average annual premium for family health coverage provided through the
workplace was $12,106 last year, according to the Kaiser Family
Foundation, a California-based nonprofit research group. Premiums for
family coverage have risen 78 percent since 2001, far outpacing the 17
percent rise in overall inflation over that time.
DeVeydt, WellPoint’s CFO, sees an aging population as well as new medications
and medical technology all contributing to health-care cost increases.
WellPoint is developing ways to get more information about its members that can be used to determine how to best treat those with certain risk factors or conditions. Officials also want to start programs to better manage
and coordinate care in costly areas such as neonatal care and radiology.
DeVeydt said he knows the challenges ahead.
"We have an aging population," he said. "I don’t necessarily see the utilization of health care declining anytime in the near future. I see it only increasing."
