New era crimps profits

Health insurance industry watchers predict that plan profits will be seriously squeezed by the Patient Protection and Affordable Care Act (PPACA). One stock analyst recently announced sell recommendations for all managed care stocks and dropped coverage of the sector because of what he sees as the law's negative effect on profitability.

But as health reform ramps up, insurers remain profitable. Ten of the largest commercial companies reported more than $9.3 billion in profits for the first three quarters of 2010, up $2.1 billion over the same period in 2009. The companies' average earnings growth was 41%. Such positive gains in the sluggish economy prompted House Ways and Means health subcommittee chairman Pete Stark (D-Calif.) to urge plan CEOs in November to share their profits with their customers by reducing premiums.

The requirement that plans pay out a set percentage of premium dollars for medical costs essentially caps profits. Rules for guaranteed issue regardless of pre-existing conditions, narrow premium adjustments for age, first-dollar coverage for preventive care, and coverage for dependents on their parents' policies up to age 26 will increase medical costs. Tougher rate review by the states and feds will likely crimp plans' ability to charge enough to pay for the added costs.

"Our net view is the law will have a negative impact on profitability," says John Stephens, principal of Bridge Strategy, a Chicago-based management consulting firm that works with health insurers. "How negative? We can't make that calculation. But for the average payer it will be a much more challenging operating environment."

But even health reform skeptics see potential upsides for profitability.

The industry can look forward to millions of new commercial and Medicaid customers after years of enrollment decline. There will be quality bonuses for Medicare Advantage plans to offset PPACA's cuts in payment rates. Updated medical loss ratio (MLR) guidance may give states and health plans some leeway to keep markets stable and plans in business. And standardization of benefit designs in the forthcoming state health insurance exchanges could reduce plans' administrative costs.

"All the major plans will continue to be around," says Carl McDonald, a managed care analyst with Citi Investment Research & Analysis in Boston. "Diversification will be the focus. One area I like is the Medicaid business, because the reform law will add about 16 million new enrollees [to Medicaid and the Children's Health Insurance Program] and states increasingly are turning to Medicaid managed care to lower their costs."

Currently, about 70% of Medicaid enrollees receive some or all of their services through managed care, according to the Kaiser Family Foundation.

Reform supporters argue, however, that the features giving insurers heartburn-such as minimum MLRs-are the same ones that serve the public good.

"I understand the insurers would like to make more profit," says Timothy Jost, a Washington & Lee University law professor who has written extensively on health reform and the MLR rules. "But from a consumer perspective, this guarantees that most of the premium dollar goes to healthcare costs rather than disappearing into the bureaucracy."

Similarly, insurers fret about the new health insurance exchanges for the same reason consumer advocates love them. With the exchanges offering consumers apples-to-apples comparisons of plans on premiums and benefits starting in 2014, McDonald says, "for the first time you'll have total transparency on pricing. That commoditizes small-group and individual products, and then there's no reason for consumers to buy the more expensive product."

As a result, he predicts, margins on small-group products will be cut in half from the typical 8% to 10% today.