Wellpoint Says Price Hikes Will Fix Its Bottom Line; Analysts are Skeptical

Wellpoint Inc. (WLP) is fixing its profitability problems by increasing its health insurance premium prices and refusing to buy or retain enrollees with price cuts, Angela F. Braly, president and CEO, told analysts during a conference call held after the company announced a 24.9% drop in first quarter earnings. As a result of a continuing stock buy back program that reduced the number of shares outstanding, earnings per share fell 15.1%, which will help some of the company's valuation ratios.

The company had warned early last month that things weren't going as well as expected, and during the conference call Braly attributed the lower first quarter earnings to pricing mistakes that she promised are being fixed.

That was good enough for the market, which yesterday boosted WLP $3.39, or 7.28% to $49.94. In the first quarter, Wellpoint reported that net income fell to $588.1 million, or $1.07 per share, from $783.1 million, or $1.26 a share a year ago. Total revenues rose 3.5% to $14.2 billion from $13.8 billion. Total medical enrollments rose 1.6% in the first quarter and 1.4% compared with a year ago to 35.4 million people. WLP's margins shrank, with commerical business operating margins going to 9.3% from 9.7% a year ago and consumer business operating margins going to a minus 3% from 3.9% a year earlier.

During the conference call, Braly and other executives reinforced the company's determination to not get caught up in a cyclical health insurance industry price war, much as the executives at UnitedHealth Group (UNH) did in their call yesterday. In his call with analysts yesterday, UnitedHealth CEO Stephen Hemsley, delcared, "We are committed to sustaining a quality business without taking shortsighted pricing positions." Was that price signaling or just reassurance for investors? Braly told analysts:

We are utilizing our better visibility into 2007 claims experience and trends to price our business more appropriately on a going-forward basis. One of the advantages of having many of our renewals spread through out the year is that we do not have to wait until January 1, to adjust our pricing for the experience we are now seeing.

Analysts are skeptical that health insurers can afford to lose enrollees for long without cutting their premiums and margins. Wellpoint's executives put much less blame for its lower first quarter earnings and guidance for the year on a slowing economy and higher flu claims, although they did say flu claims rose at the end of March. Some of their otherwise positive enrollment numbers reflect price resistance by consumers.

One big problem for WLP was the continuing rise in claims, the company said in its announcement:

The benefit expense ratio was 85.1 percent in the first quarter of 2008, an increase of 200 basis points from 83.1 percent in the prior year quarter. While the company experienced significant favorable prior period reserve development in the first quarter of 2008, the level of development was approximately $120 million less favorable than in the first quarter of 2007.

The company also incurred higher claims experience in the Senior business during the first quarter of 2008, as a result of benefit design changes in certain product categories. The increase in the benefit expense ratio was almost entirely attributable to the Consumer Business segment. Approximately 160 basis points of the increase resulted from the Senior business. Benefit designs of certain Medicare Advantage products have resulted in adverse selection and negatively impacted 2008 financial results

. The Company has implemented medical management initiatives to address the high claims experience in its Medicare Advantage products and is in the process of adjusting benefits and pricing for 2009. The Company also experienced an increase in the benefit expense ratio for its Medicare Prescription Drug Plan (“PDP”) offerings due to a change in benefit design that resulted in the recognition of medical costs earlier in 2008 as compared to 2007. The seasonality of this benefit design change is expected to result in an improving benefit expense ratio for PDP products during the balance of 2008. Approximately 30 basis points of the increase in the consolidated benefit expense ratio were due to the Company’s Individual business.

The Company is adjusting pricing and plan designs in certain markets, rolling out new product offerings and enhancing customer retention efforts to improve Individual results. The remaining 10 basis points of increase in the consolidated benefit expense ratio represented the net impact of changes in all other lines of business.

For all of 2008, WLP is projecting the benefit ratio will be in the range of 83.3% to 83.6%. As for medical cost trends, WLP said:

For the rolling twelve month period ended March 31, 2008, unit cost increases continue to be the primary drivers of medical cost trends. Medical cost trends are expected to be in the range of 8.0 percent, plus or minus 50 basis points for the full year of 2008, and the Company continues to price its business so that expected premium yield exceeds total cost trend, where total cost trend includes medical costs and selling, general and administrative (“SG&A”) expense.

Morningstar.com, an independent online subscription-based research service, rates WLP a 5-star stock with an estimated fair value of $88. These charts show that WLP, Aetna (AET), CIGNA (CI), Coventry (CVH), Health Net (HNT), Humana (HUM) and UnitedHealth (UNH) are all down sharply from early March when Wellpoint lowered its guidance and tanked the stocks. Click on the WLP chart to see daily, weekly and point and figure charts; the latter shows a bullish $59 price objective.

Full disclosure: I don't own any of these stocks.

Comments

[User 178215]

With Wellpoint's competitors having better margins and better management it's better to invest in them rather than Wellpoint. The whole healthcare sector is changing and trying to penalize or disincentivize the seniors in their Medicare Advantage plan will bode badly for wellpoint. Already they've cut their commissions to their brokers who are pushing for the other insurances who are better run. Doctors in California are disenrolling since Blue Cross now pays below Medicare rates. S&P 500 just downgraded Wellpoint. Also Wellpoint's investment losses are troubling if you look at the fine print. I wouldn't catch a falling knife as of yet. The other companies are just better run.