The Humana Message

Apr.26.10 | About: Humana Inc. (HUM)

The Humana (NYSE:HUM) conference call (4/26/2010) was one of the most informative in recent memory. The market’s early enthusiasm for the stock gave way well before the call concluded. Reversals of accruals and outsized premium increases accounted for much of the earnings. Commercial enrollment continued to fall while Medicare Advantage (MA) increased 19% to 1.74M members. The company’s unbalanced book continues to get worse, increasing its dependence on government programs further.

Humana profoundly stated that healthcare reform is now the law, so they must adapt and become much more efficient. Only the large and dominant insurers will survive; the other smaller players will either merge or go out of business. The dominant players will vary by market.

The company’s perspective on the upcoming medical loss ratio (NYSE:MLR) regulations differed from other insurers' public statements. While others primarily focused on moving costs from admin to MLR, Humana was more concerned in how finely pools would be cut in calculating MLR. They believed they are close to the required 85% in large groups and 80% in small groups, but have too much administrative overhead and broker commissions in the individual market to meet the 80% mark.

While Humana might be able to meet the benchmarks nationwide, MLR varies by plan pool, state and even metropolitan area. If every individual product is weighed by a fine geographical slice, Humana sees difficulty.

While Medicare Advantage is in the process of almost completely engulfing the company, they say that their plans must be at least 15% more cost effective than traditional Medicare to survive under healthcare reform. This comes from the previous environment where MA providers were given a 15% premium over traditional Medicare. The path Humana sees to achieving this is disease management of their most costly seniors.

Disease management could take both positive and negative paths. Chronic seniors with long life expectancies would receive extensive calls and home visits from Humana nurses to insure care regiments are adhered to. This is the positive side the company highlighted.

The negative side of disease management is moving their entire MA population to managed care and making referrals cumbersome for the more frail seniors with short life expectancies and high end of life medical costs. This might be the private insurers’ route to pulling the plug on grandma.

Humana is accelerating its move into the individual market in preparation for the opening of the insurance exchanges in 2014. In another profound statement, the company sees an acceleration in employers dropping health insurance when the exchanges open. It will become much more efficient for employees to purchase coverage on the exchanges because only the most efficient insurers will survive the highly competitive exchange system.

Allowing employees of larger companies to participate on the insurance exchanges is phased in during the years following 2014. I agree with Humana’s analysis of the shift from employer to individual health insurance. I think it is truly a healthy trend as long as insurance regulation remains strong.

The evaluation of Humana as a stock rests on whether you believe they can deliver on the efficiencies their new business plan requires. This quarter’s success was built on onetime events and beating Medicare at its own game by 15% is difficult for me to imagine.

Politico’s “Democrats move to blunt Citizens United ruling” reveals that the Schumer, Van Hollen, Castle’s campaign finance bill will prevent government contractors from spending money to influence elections. This legislation could be as profound to private health insurers as the healthcare bill recently signed by President Obama. All of the major insurers are large government contractors, so their influence on public policy could begin to wane.

On the positive side, Humana has shown the wisdom to accept healthcare reform and is trying to adapt. However, I do not believe they will be successful. While they talk a good game, they more than hinted during the call that they are still counting on state insurance commissioners to prioritize insurer financial stability over lower premiums. Translation – they have not really convinced themselves that change is inevitable.

Disclosure: Author is long HUM puts.