Very long article from today S&P, no mention of oxhp :
Friday May 22, 1998 (09:43 am EST)
"How to Analyze a Managed Care Company"
Robert Gold, S&P Health Care Analyst
NEW YORK, May 22 (Standard & Poor's) - When
looking at the managed care industry, it's important to
consider each individual company's fundamental
strengths and weaknesses.
Quantitative measures
To analyze a managed care organization's financial
health and future prospects, one should focus on the
following variables.
Membership.What is the breakdown of plan enrollees,
in terms of commercial members and Medicare and
Medicaid recipients? Although Medicare HMO
premium rates can be three times as high as
commercial rates, service utilization and benefits
packages are also high. Therefore, profit margins can
vary widely from year to year. The profitability of
serving commercial members has been held down by
industry competition and that of Medicaid members by
restricted state budgets that fund their coverage.
Provider relationships.Does management have the
proper set of provider contracts in place that will let it
control costs? What percentage of contracts are
capitated, whereby providers share part of the risk in
case medical costs exceed projections?
Geographic concentration of provider base.In which
areas does the plan operate, and into what areas will it
expand? An HMO needs to operate in an area with a
full range of doctors and hospitals in order to fully serve
its members. If the provider base is too small, service
will be poor for members, and enrollment will suffer.
Operating in a dense metropolitan area will be more
attractive than in a region of lower physician
population.
Costs. What is the company's medical loss ratio (the
ratio of medical costs to premium revenues)? Are
administrative costs under control as a percentage of
total revenues?
Growth. Has the company's growth been driven by
acquisitions or internal gains? Internal growth shows
how effectively managed the existing member base is,
and management's ability to profitably service the
existing members over a long period.
If growth is acquisition-driven, what are the operating
trends on a "same-store" basis, such as membership
growth, medical loss ratios, and other relevant
statistics? Growth generated through acquisitions can
often mask operational troubles, particularly with
respect to revenues, at health plans under the same
management for a year or more.
Other income. How much income does the HMO
generate from sources other than premiums, such as
administrative fees, interest income, and other
sources?
Earnings per share (EPS). Two questions must be
considered here. First, does the company have a
strong track record of meeting its earnings-per-share
estimates? Its history in this regard affects its stock
price. Second, is the rate of premium revenue growth
equivalent to that of earnings growth? This question
ascertains whether an HMO is sacrificing profits in
order to expand membership.
Looking beyond the numbers
In recent years, the benefits stemming from strong
enrollment growth have largely been offset by operating
margin compression. On the one hand, continued
membership gains validate the growing importance of
HMOs in the United States. On the other hand, fierce
competition among industry participants has kept a
tight lid on premium rates despite higher medical and
administrative costs. Thus, to assess the future
challenges a company is likely to face, and its ability to
do so, the analyst must delve into the trends beyond
premium revenue growth.
First, more about the margin crunch. This ongoing
trend is forcing HMOs to attempt to raise rates when
possible. During 1995 and 1996, for example, an
operating margin squeeze spurred many of the leading
HMOs to raise 1997 commercial premiums by about
5%. S&P anticipates that commercial rates will rise
another 5% during 1998, although these efforts may
lead to the loss of certain accounts. On the Medicare
front, average rate hikes will be slightly below 3% for
fiscal year 1998 -- well under historical increases, but
in line with most industry projections.
Yet other factors are preventing HMOs from raising
rates in line with their costs. One of them is the
consumer's perception of the industry. Consumers
apparently believe that there are no significant
differences between most health plans within a given
market, and that premium rates are the most important
factor in choosing an HMO.
Already, these perceptions have exacerbated the level
of competition. And as we move farther along the HMO
life cycle, more industry participants will seek to
differentiate themselves from their peers by offering
expanded benefits, broader provider choices, and
more flexible health plan options.
To compensate for this restriction on margins and the
greater demands placed on them, many HMOs will
seek to increase their membership levels. General
U.S. census data, with a focus on the breakdown of
population by state, are useful in assessing the
potential of a given region. As industry penetration
widens, the analyst can use these data to determine
the most attractive regions in which HMOs and other
managed care plans might seek new members.
Because more Medicare and Medicaid recipients are
being enrolled in HMOs, analysts often focus on areas
with older populations, those with less prosperous
economies, or those with a large proportion of
residents in the lower income levels.
Combined with managed care industry information,
these census data can help analysts determine the
areas most underpenetrated by managed care. This
information can provide a context for making
statements about an HMO's expansion policies.
The regulatory environment plays a key role in
assessing an HMO's prospects. Changes in federal
reimbursement rates or policies can have a dramatic
impact on managed care plans with high exposure to
Medicare or Medicaid. It's helpful to follow the
healthcare-related debates taking place in
Washington, D.C., as the tone of such debates can
often be as influential as the ultimate outcome.
Financial Statements of Managed Care
Organizations
Other quantitative measures include an examination of
the financial statements of a HMO. Although an in
depth analysis of salient income and balance sheet
measures is beyond the scope of this learning curve, it
is still important to be aware of the most important
items.
The Income Statement
The four most important items to consider on the
income statement are premium revenues earned, the
medical loss ratio, expense, and profit margins.
Premium revenues earned An HMO analyst will begin
his focus on premium revenues earned. This
component is derived both from the number of current
members and the premium rates.
For commercial contracts, rates are generally set at
the start of each calendar year. For Medicare
contracts, the Health Care Financing Administration
sets rates by geographic region during the month of
September, while Medicaid rates are set by state
regulators sometime in mid-year.
Premium revenues are recognized in the month in
which the related enrollees are first entitled to
healthcare services, whether they are actually collected
or not. Premiums collected in advance are recorded as
unearned premiums.
The medical loss ratioThe gross profit margin in the
managed care sector is referred to as the "medical
loss ratio." It's determined by dividing a company's
total amount of direct medical costs--such as
pharmaceuticals, doctors, and hospital-related
costs--by its premium revenues. Traditionally, this ratio
has been used to determine a company's
effectiveness in managing its enrollees; it can indicate
management's ability to control costs and predict its
future costs in an era of rapid membership growth.
Expenses
The remaining items on a managed care
organization's income statement revolve primarily
around spending on administrative functions, such as
marketing, billings and collections, database
maintenance, and customer service. The
"administrative cost ratio"--calculated by dividing the
selling, general, and administrative (SG&A) costs by
total revenues--should approximate 10% during a
normal business cycle, but it can rise or fall depending
on the company's current operating strategies.
The Balance Sheet
Looking at a typical HMO balance sheet, one will see a
large amount of cash along with very little debt. These
companies must maintain certain financial ratios in
order to bid on potentially lucrative Medicare and
Medicaid contracts. For example, a debt-to-equity ratio
of 1-to-1 is currently required for contracts for Medicaid
and the Civilian Health and Medical Program of the
Uniformed Services (CHAMPUS). (CHAMPUS is a
program for dependents of active-duty military
personnel, military retirees under age 65, and their
dependents.) In addition, potential commercial
members must feel confident that an HMO will maintain
adequate liquidity to ensure that the member's
employees won't lose their medical coverage if the
HMO stumbles during a difficult business cycle.
Among the more significant items on an HMO's
balance sheet are the reserves for claims, losses, and
loss adjustment expenses. Those reserve levels are
calculated based on the accumulation of cost
estimates for unpaid claims and losses reported
before the close of the accounting period. Added in is
a provision for the current estimate of the probable
cost of claims, losses, and loss adjustment expenses
that have happened but haven't yet been reported
(called "incurred but not reported expenses"). The
methods for making such estimates vary from
company to company, and any adjustments resulting
from these estimates will be reflected in the HMO's
current operations.
Other concerns
Analysts looking at this often-volatile market segment
must be aware of all trends affecting HMOs. They must
ask whether these trends will directly impact industry
fundamentals or alter the industry's psychology. Such
trends may include politically charged rhetoric from
Washington, D.C., as well as magazine and
newspaper articles that criticize certain aspects of
for-profit healthcare systems.
For investors and analysts, it is increasingly important
to monitor regulatory developments and keep a sharp
eye on emerging trends that can lead to deteriorating
fundamentals such as rising pharmaceutical, doctor, or
hospital costs. In addition, investors can benefit from
the frequent waves of takeover speculation within this
still-consolidating sector. While HMO valuations vary
widely according to the profile of the target company,
most of the recent HMO mergers have been completed
for approximately $1,000 to $1,300 per member,
although prices can range from $800 per member to
as high as $1,500.
22-May-1998 09:43:14 (01203015)
personalwealth.com
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