One sector that had been touted as a refuge while the broader stock market works through its funk, hit investors with a bombshell on Mar. 10. WellPoint (WLP) cut its earnings outlook, causing some analysts to worry that other health insurance providers may have underestimated health-care costs, which could lead to lower profits for the entire group.
After the market closed on Mar. 10, WellPoint cut its 2008 earnings-per-share outlook by 6% to 10%, to $5.76 to $6.01, from a prior estimate of $6.41, citing higher than expected medical costs, lower than expected enrollment in fully insured health plans, and uncertain economic conditions.
The largest provider of Blue Cross Blue Shield insurance in the U.S. also reduced its first-quarter EPS forecast to $1.16 to $1.26, from $1.44. Wall Street analysts had projected, on average, earnings of $1.44 in the first quarter and $6.41 for the full year.
Slower Growth Due to Slump
The Indianapolis (Ind.) company said it now expects medical costs to be 0.5% higher than anticipated for both 2007 and 2008, with neonatal, cancer treatment, and physician costs contributing to the increase. HMOs, which are known for consistently raising their prices over the last several years, can't pass these higher costs on to its customers given that pricing for their annual health-care plans have already been set. Now it looks as if higher costs for medical care will bite into their hefty profits.
What's more, WellPoint's enrollment in Medical Advantage and commercial fully-insured risk coverage has grown more slowly than expected, in part due to the economic slump. WellPoint also said the funding reduction of California's Medicaid program slated for July 1 will hurt earnings.
For investors who consider health care to be one of the few safe sectors in what could be an extended bear market, the news was a slap in the face. Investors dumped WellPoint shares, which skidded 28.3% to a new 52-week low of $47.26. Other stocks in the group got hammered too. Cigna (CI) shares fell 9.8%, to $38.76, and Aetna (AET) lost 8%, at $42.65. UnitedHealth Group (UNH) shares were down 15.2%, to $38.24.
Taking a Cautious Stance
Analysts were quick to downgrade some stocks on the surprising news. Stifel Nicolaus lowered WellPoint to hold from buy, with analyst Thomas Carroll saying in a research note that he was "shocked by this revision considering the level of confidence with which management spoke as recently as Feb. 13, 2008."
Carroll had believed WellPoint was the managed-care name to own in an increasingly competitive market and uncertain economic times, but said investors will probably now take the same cautious stance toward the stock as they do toward the sector in general. "Our view of WellPoint share as defensive is no longer valid," he said in the note.
About 40% of the companies that use WellPoint renew their health-care plan contracts in January — and these tend to be its biggest customers, Carroll said in an interview. Once those prices are locked in, WellPoint can't raise them for another year. While it could over-compensate by charging prices above the increase in medical costs to the remainder of its customers, most of which renew in July, Carroll thinks the company would risk losing customers. "It's a balance between getting it right the first time and keeping it right throughout the year," he said.
To a lesser extent, growth in enrollment has leaned toward self-insured rather than fully-insured products and is also expected to hurt profitability. With companies that buy self-insured coverage for employees, WellPoint processes the paperwork and sends the checks to doctors and hospitals instead of taking on any risk. For that it gets $15 to $20 per member per month in revenue, vs. $400 to $500 from taking on the full medical risk for fully insured plans.