Health-care insurers are among the very few American companies willing to worry about their problems in public. Like hypochondriacs counting their ailments, they trot out a long list: higher costs for medical equipment; bigger payments for doctors; the rising price of drugs. Fail to treat these symptoms, goes the logic, and the result will be terrible, just as it was for four years beginning in 1996, when the industry continuously lost money. The chief executives of two large companies, Aetna and Oxford Health Plans, were both kicked out and that of a third, Cigna, retired early. The only smart operator in the industry seemed to be Citigroup, which had dumped its health-insurance operations just before the slump.
Lost in the crunch was the simple fact that people need health insurance and are willing to pay almost any amount to have it. The industry’s customers, including the government, thus have no intention of letting private health insurance fail. The business has been evolving continuously, intermittent disasters notwithstanding, since the late 19th century, when it was first introduced in America at mining and logging camps.
A turn in the industry’s fortunes began in 2000. Health insurers’ customers (mostly companies, but unlucky individuals too) saw premiums rise at a double-digit rate that has lasted ever since. They put up with these increases partly because the industry was clearly in trouble and partly because they had little choice: every insurer raised rates. Last year even the federal government got on board, approving substantially larger rebates to health insurers for elderly clients receiving Medicare.
Meanwhile, the industry’s distress also led to downward pressure on costs. Against a backdrop of scathing press and prodding regulators, hospitals and (particularly) drugmakers sharply reduced their rates of price increase. Doctors were worst off: as individual suppliers, they had least leverage and not only faced lower repayment rates but also had often to surmount daunting and costly bureaucratic challenges to secure reimbursement. Quite a few doctors — typically, surgeons with good reputations — ceased accepting insurance altogether. This did the insurers no harm, as long as the defecting doctors turned their backs on every insurance plan. In fact, it probably did them a bit of good, by eliminating some of their costliest suppliers.
By the end of 2000, revenues were rising faster than expenses and operating margins swung into the black, according to Sanford Bernstein, a Wall Street research firm. By 2003 they had reached 5.1%, possibly an all-time high. That may sound low, but health insurers have huge operating leverage. They do not have to finance inventory. Quite the opposite, in fact: they receive premiums up front and pay out later. Although capital demands in health care are enormous, they are mostly the responsibility of hospitals and labs, not health insurers, whose investments are limited to the technology needed to accept or reject claims. Unlike life and property-and-casualty insurers, health-care insurers have no long-lasting liabilities. Their obligations usually last no more than one year. As a result, margins in the mid-single digits can produce returns on equity in the mid-teens or higher.
Shares of health insurers bottomed in early 2000 — as it happened, just when tech stocks reached their peak. Since then, the prices of many have quadrupled. And if shareholders have done well, executives have been more than amply rewarded, according to Graef Crystal, a compensation expert. Presumably, boards judged that the industry-wide resurgence was the product of their companies’ individual strokes of genius. William McGuire, head of UnitedHealth Group of Minnesota, earned $30m in pay in 2003 and exercised $84m in stock options from earlier years. This left him with options worth $840m at the company’s current share price. Mr McGuire’s number two, Stephen Hemsely, earned $13.7m in compensation and holds options worth $350m. John Rowe, the head of Aetna, earned $16m, Larry Glasscock of Anthem $51m and Leonard Schaeffer of WellPoint $27m. Compensation consultants will no doubt have spotted a flaw in these remuneration schemes: Mr Rowe’s relatively low pay.
In April, UnitedHealth agreed to acquire Oxford, which was one of the most troubled health insurers in the 1990s but has since recovered. Conveniently, a month before the deal was announced, according to a recent securities filing by Oxford, “eligible members of management” were granted stock worth $17m that would vest if the company underwent a change of control. About $3m of this will go to the chief executive since 2002, Charles Berg, whose options are currently worth $32m, in large part because of the deal.
Whether shareholders and executives can continue to enjoy such returns is questionable. Ellen Wilson, an analyst at Sanford Bernstein, says that the large recent returns will inevitably trigger price wars and rate cuts. Prices and returns in the insurance business tend to run in cycles. Unusually large returns attract capital, which drives them down.
There are other worries as well. A spate of mergers has raised concerns among doctors about too much concentration. There are rumblings of antitrust reviews. And lavish compensation in an industry like health care, which receives a fair amount of taxpayers’ dollars, will inevitably draw regulatory scrutiny. Indeed, the industry has been able to extract higher revenues and reduce its costs because it showed distress, not success. Its prospects were better when it could honestly say that times were bad.