UnitedHealth's Head Winds [WSJ]
Insurer Must Navigate Competitive Pressures, Stock Option Issue
By VANESSA FUHRMANS
May 2, 2006 11:08 a.m.
Shareholders at UnitedHealth Group Inc.'s annual meeting today will be demanding to know whether Chief Executive William McGuire and other senior managers backdated past stock options. But just as central to the company's prospects -- and to investors -- is how UnitedHealth will navigate the growing competitive pressures that threaten the thick profit margins of major health insurers.
After a long streak of record earnings, the managed-care industry appears to be on the downward slope of its profit cycle. Soaring health-care costs and premiums have led growing numbers of employers to curtail or shun health benefits for their employees. So insurers are struggling to expand, and more appear to be willing to win business with more aggressively priced premiums. Those that are trying to hold the line face seeing some customers walk away.
After soaring 41% last year, UnitedHealth's stock has declined 20% in 2006 -- sliding 10% even before the flap over stock options at the company broke out in March.
In 4 p.m. New York Stock Exchange composite trading Monday, UnitedHealth's shares rose six cents to $49.80, giving the company a market value of $67.87 billion.
MORE
• Read more about stock-options grants made to UnitedHealth, Comverse and other companies' executives in The Perfect Payday (March 18) and see charts of the option grants.
• Comverse CEO Quits Amid Probe
05/02/06
So far, both UnitedHealth and WellPoint Inc. have reported disappointing growth in health-plan enrollment in the first quarter. And Aetna Inc.'s shares plunged 20% last week after investors were spooked by a slight uptick in its ratio of medical costs to premiums. That ratio is often considered an indicator of the size of its profit margins, and the change in the ratio was interpreted as a sign that more competitive prices will cut into earnings growth. On the whole, the S&P Managed Health Care index has fallen 16% this year.
UnitedHealth heads into the tougher environment with a few extra wrinkles. Its top management and board have come under fire over a series of stock-option grants in past years dated just before a substantial run-up in the share price or at a yearly low. The pattern has prompted a board review of UnitedHealth's option-granting practices and a call from the Securities and Exchange Commission.
The company also is digesting its $8.1 billion purchase late last year of PacifiCare Health Systems Inc., among other acquisitions. Despite the recent decline, UnitedHealth shares still trade at a higher price-to-earnings multiple than major health-insurance rivals. UnitedHealth's P/E ratio is 18.7 based on the past 12 months of earnings.
The stock's premium has much to do with UnitedHealth's wider range of businesses. Under Dr. McGuire, the company has girded against the cyclical ups and downs of health insurance by diversifying into other areas, such as the new Medicare drug benefit and the high-margin business of health-care data analytics. Its senior executives heavily promote the company on Wall Street as a "health and well-being company" and bristle when analysts or investors refer to UnitedHealth as an insurer.
By and large, most investors agree. "In that sense, they deserve some slight premium," says Jordan Schreiber, who manages roughly $700 million in health-care funds at Merrill Lynch. He adds, however, that he has reduced his position in UnitedHealth and other managed-care stocks in recent months because of their "mature" share prices.
But nearly half of UnitedHealth's operating profits come from old-fashioned commercial health insurance, where it takes on the full risk of insuring a health plan. That is partly because the business has enjoyed much bigger profits in recent years. Most of UnitedHealth's jumbo acquisitions in recent years -- including Oxford Health Plans Inc., Mid Atlantic Medical Services Inc. and Golden Rule Insurance Co. -- also have helped increase the company's exposure to traditional commercial health insurance, where UnitedHealth fully insures group plans. UnitedHealth and its rivals also administer self-insured employer health plans on a fee basis.
"The reality is, more of UnitedHealth's earnings come from the risk business than at the beginning of the decade," says Matthew Borsch, analyst at Goldman Sachs, who rates UnitedHealth as "underperform." Goldman Sachs has done business with UnitedHealth in the past 12 months, including advising it on its deal to acquire PacifiCare.
By comparison, Ingenix, the company's health-data unit, with 22% operating margins that are often highlighted at investor conferences, contributed $177 million of UnitedHealth $5.37 billion operating earnings last year.
UnitedHealth isn't as reliant on traditional health insurance as rivals such as WellPoint. So far, UnitedHealth says it is making sure it prices health plans conservatively enough. But it appears to be losing some customers as a result. UnitedHealth officials say growth will come increasingly from nontraditional insurance businesses, such as Medicare, high-deductible consumer-directed plans and consulting to foreign health-care systems.
Last quarter, UnitedHealth's commercial health-plan membership, discounting its most recent acquisitions, grew by 650,000, at the bottom of its projected range. The number of people in its fully insured health plans fell by a greater-than-expected 295,000 members. The company said part of the decline was because it is actively moving more into the fee-based business of administering self-insured plans. But analysts note that the risk business has been three to six times as profitable.
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