Health Insurers Taking Heat – Rightly So?

By Randy D. Lewis, CFA, MBA
Senior Analyst, EquityNet Research
February 22, 2010

I always tell myself I will not write on topics that are too “macroeconomic” or political, but that is what seems to be dominating the news lately – and I cannot help but mention the downward spiral of health insurance in the U.S.

All the buzz is predicated on the recent announcement of earnings by the nation’s five largest health insurers, Aetna Inc. (NYSE:AET), Cigna Corp. (NYSE:CI), Humana Inc. (NYSE:HUM), UnitedHealth Group (NYSE:UNH), and WellPoint Inc. (NYSE:WLP). The week before last, the five reported a combined profit of $12.2 billion for 2009, up 56% over 2008. All this while they covered 2.7 million less people than they did the year before.

This logic harkens back to the summer of 2008, when crude oil prices topped $125 a barrel and the oil companies’ profits skyrocketed. It is not so much the amount as the timing. The recession was in full swing, and today, while the U.S. still struggles with high unemployment and a stagnant economy, more people are being dropped from coverage while the insurance companies post record profits – AND propose rate increases of nearly 40% in some cases.

On the surface, it sure does not make the insurance companies look great in the eyes of the consumer, the media – or the government. If we take everything at face value, it appears they are dropping coverage for the customers that are costing them the most (and thus need coverage the most) and raising rates for everyone else. Of course, their main argument is the spiraling cost of healthcare, which is true, but there is also another reason for these figures.

For simplicity, insurance companies follow a basic equation: Premiums – Claims = Profit, where premiums make up a pool from which claims are paid out. The individuals that form this pool are of paramount importance to the insurance companies. There has to be a strong collection of healthy people with little or no claims to make up for those whose claims are large. Every business has the right to make a profit, and we certainly should not expect insurers to payout more in claims than they collect in premiums, at least for any lengthy period of time. Of course, this would be unsustainable.

So here is the downward spiral: As people get laid-off and employers drop coverage, more healthy people are forgoing any coverage at all. This raises the cost to everyone else, making it even less likely that healthy people will want to pay higher prices for coverage, and so on and so on…

We can blame the insurance companies all we want (and I don’t want to sound like I am defending them) but this is the system we have created. With these companies tied to the pressures of Wall Street, it is a system that is clearly broken. As an industry analyst with CRT Capital Group put it, “It is a terrible thing to run your business for Wall Street…. There is no way that as long as these businesses are publicly-traded, they can have the best interest of their customers at heart.” (source: Los Angeles Times)

Well said, true, sad and also unsustainable.

Randy Lewis, CFA, MBA is founder and senior analyst at EquityNet Research, (www.equitynet.net) a boutique investment, industry and economic research firm. He is also founder of The GSL Group, LLC, a company focusing on private business valuation and advisory services. www.thegslgroupllc.com.