December 22, 2014

Pilgrim's Problem

David Poppe | 7/1/1995
The financial equivalent of a Nor'easter is buffeting Miami health insurer John Alden Financial Corp.

Since March, John Alden has taken $25 million in pretax charges to earnings to create a reserve for higher-than-expected claims levels. The company, which took in $1.5 billion in revenues last year, provides health insurance for 1.3 million Americans. It says its medical claims ran about 15% over budget in February and stayed over budget in March and April.

John Alden is named after one of the Pilgrims who sailed from England to America and landed at Plymouth Rock in 1620. The company itself, however, isn't much of a pioneer. Most of John Alden's customers belong to traditional indemnity, or fee-for-service health plans; they choose their own physicians and usually are reimbursed 80% of medical charges after an annual deductible is met.

Like other traditional health insurers, John Alden is reporting unsettling results. For the first three months of the year, John Alden's earnings dropped 58.8% compared to the year before, and earnings in its health-care segment were down 82%, to $6 million from $33.7 million a year earlier. John Alden paid out 72.6 cents in claims for every dollar in premiums earned, compared to 66.3 cents a year earlier.

On Wall Street, John Alden's shares dipped to a 52-week low of $15.25, half their February level, less than the company's $17 per share book value.

Analysts, who predicted at the beginning of the year that John Alden would earn $4.20 per share, have halved that prediction. Several who rated the company a buy at $30 per share have turned "neutral" on the stock. David O. Lewis of The Robinson-Humphrey Co. in Atlanta estimates John Alden will earn $2.25 per share this year, and he allows that he's not confident even of that.

John Alden may be miserable, but it's not alone. A publicly traded rival, Emphesys Financial Group, reported an 8% improvement in earnings per share during the first quarter, but only because it added 15% more customers. Its earnings of $1 per share missed analysts' estimates by about 5%. And Emphesys said its medical loss ratio, the ratio of benefits provided to premium revenues, rose to 75.3% from 73.6% for the first quarter of 1994. Wisconsin-based Emphesys provides health insurance to 1.2 million people and, like John Alden, Emphesys insures mostly small businesses.

Another health insurer, United Wisconsin Services of Milwaukee, blamed an earnings-per-share drop of 53% in the first quarter on weak results from policies covering small-business customers.

Most indemnity insurers plan to raise rates by at least 10% this year. John Alden already raised premiums, on the average, by 11% on policies that came up for renewal in the first half of 1995 and plans to raise premiums on policies that come up for renewal after July by 13%.

But is it that simple? A rising chorus of observers notes that indemnity insurers seem unable to control costs as well as managed care plans and that the cost of indemnity insurance is soaring compared to the cost of HMOs. Industry giant Aetna, for example, will hold rates flat this year for its 2.5 million HMO-member customers, while raising insurance rates by 12% to 14% on its 8 million indemnity health insurance customers, says Mark Schoder, a research analyst with Alex. Brown & Sons in Baltimore.

HMOs have shown a willingness to sacrifice profitability for market share. In April, the HMO U.S. Healthcare said it would absorb an increase in its medical-loss ratio, and possibly even cut premiums, to hit its growth targets.

Big HMO stocks like PacifiCare Health Systems, FHP International and Humana Inc. trade near their 52-week lows, and many of them failed to meet analysts' first quarter earnings projections.

But this HMS bloodletting isn't good news for indemnity providers. An HMO needs high market share to give it clout with doctors. The more HMOs compete for market share, the more they lower rates and the more uncompetitive indemnity plans begin to look.

Michael B. Fernandez, chairman and CEO of Physicians Healthcare Plans, a Coral Gables-based company that runs Medicaid HMOs in Tampa, Orlando and Fort Myers and plans to expand into Miami this summer, says 28% of Americans currently belong to managed care plans, but he expects that number to grow to 50% in just five years.

Fernandez, who clearly has a bias in this debate, flatly describes the current financial crisis at John Alden as the beginning of the end. "Traditional indemnity providers like John Alden will disappear," Fernandez predicts boldly.

Fernandez is by no means alone in voicing doubt about the future of indemnity insurance plans. "There's no doubt that the cost of indemnity coverage continues to become increasingly expensive to the employer, and to employees," says Larry G. Mayewski, senior vice president for the Life/Health Division of the A.M. Best Co., an insurance-rating company based in Oldwick, New Jersey. "With claims costs continuing to grow, the business is under pressure in terms of rates, and insurers' profitability becomes more difficult to maintain."

Mayewski adds that John Alden already is looking at ways to move from an indemnity-based business to a managed care business. "Pure fee-for-service medicine is becoming something that doesn't work favorably for all interested parties," he says.

Fernandez agrees, but adds that John Alden faces difficulties in trying to transform its business. "There hasn't been an insurer yet that has made a good migration from indemnity provider to managed care," he says.

John Alden puts on a brave face, but management isn't saying much right now. Only a few months ago, the company eagerly courted press attention, but lately, top executives have been unavailable for interviews. President and COO Roger Rosenberger, in fact, resigned abruptly in mid-May. Glendon Johnson, chairman and CEO, assumed his duties. Syed Ali, the company's vice president of investor relations and regulatory affairs, says John Alden's core customers - small groups with three or four members - either can't or won't belong to an HMO.

"Our customers mostly are small employers, maybe with three or four employees in a small group, and the owner and his family are the ones being insured," he says. "These are people who are enterprising; they like freedom of choice, and they hate HMOs. They would rather pay a higher premium to see the doctor of their choice."

Ali also says employers covered by John Alden won't necessarily see rates rise by 13%; many will opt for plans with higher deductibles or higher patient co-payments to keep premiums lower. But the end result is the same: it costs more money for less coverage every year.

Analyst Schoder thinks there are plenty of people who will pay to choose their own physician, and he compares the diverging costs of HMOs and indemnity plans to cars. "Are people going to buy a Mercedes Benz based on its price increase compared to a Yugo?" he asks rhetorically. His belief: that millions of Americans will resist managed care as long as they can.

However, John Alden is having to struggle to keep its customers. The company expected 20% premium growth this year, through a combination of new customers and rate hikes. Instead, premiums were just 1.2% higher in the first quarter than in the fourth quarter of 1994, indicating rate hikes chased some customers away. Lewis, the Robinson-Humphrey analyst, says John Alden saw 3% of its policies lapse every month during the first quarter, compared to 2% per month during 1994.

Nevertheless, Lewis mildly voices optimism that rate increases will scare fewer customers off as the year progresses. "I think John Alden may have seen higher claims increases before the competition," Lewis says. "A month ago, we were seeing no rate increases among the competition, and now there is pretty wide agreement on raising rates."

Schoder agrees. In the first quarter, when John Alden raised premiums by 11%, sales to new customers dropped by 15%. But by April, when the rest of the industry started raising rates, too, John Alden's first-time sales actually rose, he says.

Analysts say managed care plans control their own costs better than indemnity providers like John Alden because HMOs pay doctors set fees for each patient, leaving it to the physician to control his own costs. An HMO frequently also controls a patient's access to specialists.

With indemnity plans, however, insurers don't control patient access to health care and don't monitor doctors' decisions as closely. The result: the sheer number of claims filed is rising at a surprisingly rapid rate. Indeed, John Alden acknowledges that claims for hospital outpatient and related physician services and diagnostic tests rose during the first four months of the year.

There's an obvious reason for that, say industry experts. Doctors who see their incomes under pressure from managed care companies are performing more tests and routine procedures on non-HMO patients. "They want to raise prices because they can't negotiate with HMOs," says Ali. Fee-for-service customers may end up paying the difference.

John Alden, Ali says, is taking steps to become more like a managed care company. It plans to cut its claims loss ratio by auditing bills more closely, encouraging some indemnity plan members to join HMOs and reviewing customary prices it pays to medical providers.

"We are going to be even more careful [about costs]," says Ali. "Or more aggressive, I guess you could say."

Tags: Florida Small Business, Politics & Law, Business Florida

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