Time for a Rethink on Recession-Proof

Like children who believe in the tooth fairy or Santa Claus, investors love to dream about allegedly recession-proof industries, such as tobacco or food and beverages.

In their view, no matter how tough economic conditions get, people still need to spend money on "necessities." Investors generally include health care on this list.

Yet based on the New York Times report that follows, "Insurer Says Economy Has Dented Its Prospects," it seems that a growing number of Americans cannot afford to pay for a service they supposedly can't do without -- so they are, er, going without.

Perhaps equity investors need to rethink their assumptions?

It is never a good thing if many of your customers can no longer afford what you are selling.

The UnitedHealth Group, which announced disappointing first-quarter earnings on Tuesday, said the weakening economy was causing fewer businesses and employees to sign up for its health insurance. UnitedHealth, whose stock fell sharply on the report, also cut its overall profit outlook for 2008.

“We are clearly being impacted by the declining economic outlook,” Stephen J. Hemsley, the company’s chief executive, told investors Tuesday.

While he acknowledged the company’s own missteps, Mr. Hemsley said that fewer employers — particularly small businesses — were offering health coverage to their workers, and that when they did, fewer employees were choosing to enroll.

As one of the nation’s largest insurers and the first to report earnings this period, UnitedHealth’s results have raised anxiety about the industry’s challenges. While some analysts say UnitedHealth has simply hit a trough in the industry’s normal business cycle, others are worried about more fundamental challenges to the insurance business model.

In recent years, despite soaring medical costs, insurers have made big profits by keeping premiums well ahead of health care inflation. But analysts say that business strategy may be reaching its limits, with companies finding it harder to raise prices without losing substantial numbers of customers.

“The market is not growing — it’s shrinking,” said Sheryl Skolnick, a health care analyst for CRT Capital Holdings in Stamford, Conn.

The market for employer-purchased coverage remains a large one, accounting for 158 million people. But Ms. Skolnick says that UnitedHealth, like many insurers, has priced its product beyond the reach of too many people and is now fighting with its competitors over a shrinking pool of customers.

Investors in insurance stocks have been particularly anxious since WellPoint, another big player, warned last month that it expected disappointing first-quarter earnings.

UnitedHealth’s profit report on Tuesday, which felt short of expectations, started a sell-off of its shares, which carried over to smaller declines in the stock of competitors like Aetna and WellPoint. Shares of UnitedHealth fell $3.66, or nearly 10 percent, to $34.15, which was near the 52-week low of last month.

UnitedHealth earned $994 million, or 78 cents a share, on revenue of $20 billion for the first quarter. Although that was a 5 percent increase in earnings per share over last year, the company cut its 2008 profit outlook by 40 cents, to $3.55 to $3.60 a share.

It cited, in part, the decline of its core commercial insurance business, estimating it may lose about 700,000 customers this year. That would reduced its core commercial business to about 10 million insured people.

The main issue facing UnitedHealth is how much it can protect its profits as it loses customers for its traditional health insurance. “The issue for them is growth, and where is the growth going to come from?” asked Les Funtleyder, the health care strategist for Miller Tabak & Company, who rates the stock as neutral.

Analysts disagree on whether UnitedHealth has already weathered the worst of the business cycle, or is at the onset of what could be two to three years of a difficult environment. Matthew Borsch, an analyst at Goldman Sachs, thinks the competition for customers is likely to make it hard for insurers like UnitedHealth to raise prices.

The economy makes it even harder, said Charles Boorady, an analyst with Citigroup Investment Research.

But while Mr. Boorady said he expected more earnings disappointments from other insurers — WellPoint is scheduled to report results on Wednesday and Aetna on Thursday — he predicts the cycle will be on the upswing as soon as next year, as profits stabilize. And while he says UnitedHealth’s shares could continue to be a poor performer for a time, he judges them to be cheap at the current price.

UnitedHealth has also struggled since the departure of the company’s chief executive, William W. McGuire, who agreed to leave in October 2006 after being caught up in an options trading scandal.

The company has received sharp criticism from many of its customers as well as the hospitals and doctors with whom it contracts for care. Regulators are also looking into some of the company’s business practices, including an inquiry by the New York state attorney general into the UnitedHealth unit that helps insurers determine how much of a doctor’s bill to pay.

“It’s the litany,” said Ms. Skolnick, who argued that the company has expanded into too many businesses to be well managed. “There’s too much going on.”

On Tuesday’s conference call some of the company’s major shareholders raised doubts about some of management’s decisions, arguing that UnitedHealth should pay shareholders a sizable dividend on shares instead of buying it back, or should consider selling some of its businesses that might be worth more as separate companies.

“We have not executed well and have not executed well over the last two years,” said Mr. Hemsley, who emphasized that the company would consider a variety of moves.

Mr. Boorady said UnitedHealth had not been as receptive as it should be to outside ideas, saying executives were “tone deaf to their customers and their shareholders.”

And even if companies like UnitedHealth are not convinced that they need to do anything fundamentally different, Mr. Funtleyder said, there is a chance that the politicians will. For the insurers, that might not be a bad thing, he said.

A new administration in Washington could decide to address the increasing number of uninsured Americans by asking the private insurers to play a role. The companies would benefit from a new pool of potential customers. “The hail Mary may be that we turn to some sort of universal care,” he said.

Still, he recommends holding off on buying shares since he, too, thinks that there could be a tougher environment ahead. “There’s no sense in buying now if there’s more risk to come,” he said.

Comments

[Aaron Krowne]

Good pickup.

Incidentally, I pointed this trend out and predicted it would get worse a year and a half ago.

http://www.autodogmatic.com/index.php/sst/2006/10/20/p341

[Boom2Bust.com]

I'm seeing quite a few articles from the mainstream financial media about recession-proofing one's portfolio. Just one more reason to take their "advice" with a grain of salt...

[Jes]

Michael--this is off topic--I saw at Mish's Global (http://globaleconomicanalysis.blogspot.com/) this header: Ambac expects losses of 81.8% of underlying collateral

What does this mean for the rest of us (besides likely bankruptcy for Ambac)?

[Michael Panzner]

The story refers to the collateral on some of the mortgage-backed securities Ambac guaranteed. In essence, the insurer is alleging that whoever packaged up those deals stuffed them with bad or fraudulent loans. Gee, I wonder how that happened? Of course, the optimists will probably say that these were isolated problems. Yeah, right.

[Al]

Do you remember the saying "you can't put a price on your health."? Apparently it can be done, and we're reaching that price point. Health care providers are going to have to start thinking more like business people, and lower their prices to get the volume.

[Barbara Ann]

Once the health insurance parasites bankrupt themselves we may finally have the ability to reclaim our health care system.