Aetna (AET)

• Article
• Discussion
• Edit
• History
• Bookmark

See all 5 Bulls Reasons Bulls: Reasons To Buy Aetna's innovative tendencies are appealing 100% agree Aetna's innovative tendencies are appealing Aetna's innovative tendencies are appealing. Although its commitment to transparency, for example, has not demonstrated obvious profitability, innovation is often rewarded. View or Edit Reason 1 votes 100% agree "Q3 2007 organic growth exceeded internal projection of 200k, reaching 230k" 0% agree "Q3 2007 organic growth exceeded internal projection of 200k, reaching 230k" Aetna's Q3 2007 organic growth in membership exceeded internal projection of 200,000, reaching 230,000. Aetna has raised it's projection for FY2007 from 575,000-600,000 to 600,000-650,000 new memberships. View or Edit Reason 0 votes 0% agree Q3 2007 organic growth exceeded internal projection of 200k, reaching 230k 0% agree Q3 2007 organic growth exceeded internal projection of 200k, reaching 230k Aetna's Q3 2007 organic growth in membership exceeded internal projection of 200,000, reaching 230,000. Aetna has raised it's projection for FY2007 from 575,000-600,000 to 600,000-650,000 new memberships. View or Edit Reason 0 votes 0% agree See all Bears Reasons Bears: Reasons To Sell "As a health insurer, Aetna is exposed to a lot of risk" 0% agree "As a health insurer, Aetna is exposed to a lot of risk" As a health insurer, Aetna is exposed to a lot of risk. It has managed its health risk well, but faces legislative risk because it could lose revenue if the government decides to cut Medicare programs. View or Edit Reason 0 votes 0% agree As a health insurer, Aetna is exposed to a lot of risk 0% agree As a health insurer, Aetna is exposed to a lot of risk As a health insurer, Aetna is exposed to a lot of risk. It has managed its health risk well, but faces legislative risk because it could lose revenue if the government decides to cut Medicare programs. View or Edit Reason 0 votes 0% agree Low penetration rates 0% agree Low penetration rates Aetna needs to grow. Its low penetration rates are worrisome, and its medical loss ratio is needlessly low. The company could improve profitability by raising its ratio but increasing enrollment even more. View or Edit Reason 0 votes 0% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

Top Contributors Dan Sacks Sean Hinton Kai Ross Related Articles UnitedHealth Group (UNH) Pharmaceuticals - Political pressure Humana (HUM) Insurance Sector Pharmaceutical patents

Aetna Inc. (NYSE: AET) is the third largest healthcare provider in the United States. Based in Hartford, Connecticut, Aetna sells a wide range of health and life insurance products categorized as health, dental, pharmacy, group life, disability, and long-term care.

Healthcare providers such as Aetna earn income by charging their insured costumers premiums and fees for health care coverage. The premium is the cost for enrollment in a health care coverage program, such as a Health Maintenance Organization (HMO), Preferred Provider Organization (PPO), or point of service plan (POS), and the fees are additional case-dependent expenses. Healthcare providers serve to limit medical expenditures while ensuring quality care by regulating which medical treatments are covered.

Right now, Aetna is an industry leader by profitability. It has achieved this feat by ruthlessly cutting expensive clients and by charging risky enrollees hefty premiums. This strategy is effective for raising profits, but it has resulted in slowing enrollment growth and low market penetration rates. Right now, Aetna is faced with the challenge of expanding business without sacrificing profitability.

[edit] Business Operations

Aetna's business operations consist of three parts: health care, group insurance, and large case pensions. The majority of Aetna's income - about 85% - comes from the premiums it charges customers. The remainder comes from pension management fees and from investment income. Aetna essentially sells protection from risk: as a health insurer, it agrees to pay for a percentage of its customers' medical expenses in exchange for a fee, called the premium. The basic business plan is to offer clients a premium based on the the expected cost of caring for them, plus a markup for administrative costs and profit. An insurance company can actually turn a profit even if the cost of administration and insurance claims equals the premiums it generates. It does so by investing income on the float. The idea is that in the time between when a client pays a premium and the time when the client needs payment for his or her medical expenses, Aetna can invest the premium. In Aetna's case, however, this is not strictly necessary. In 2006, administrative and sales expenses amounted to 21% of income from premiums - this is known as the cost ratio - and medical expenses account for another 72% - this, the medical loss ratio. Adding the two up, we see that without any investment, Aetna would earn 7% profit on its premiums alone. Nonetheless, Aetna does take advantage of the float, and earns about 7% net interest income on the premiums, for a profit margin of around 14%. The following table presents the vital statistics for Aetna for the past three years and summarizes the sources of Aetna's revenue.

[edit] History

To understand Aetna's current situation, we have to look to the late 1990s, when Aetna was performing poorly. The problem was an excessively high medical loss ratio (MLR); it had too many risky clients who were not paying high enough premiums. From 2001-2003, the company shed many of these expensive clients, pruning itself to improve profitability. In total, enrollment shrunk by about one third. Prior to this action, the medical loss ratio had stood at 90%, but the draconian cuts pushed this figure down to 77.6%. A low MLR implies high profit margins, but not necessarily high nominal profits; in order to lower this ratio, Aetna had to reduce its gross revenue. Now Aetna's challenge will be to expand enrollment without taking on high-risk clients.

[edit] Innovation

There are many ways for an insurance company to compete or turn a profit. It can design pricing schemes to make sure clients pay their fair share. It can dominate certain markets to minimize advertising costs and other costs. Or, like Aetna, it can continually develop new products and interfaces to keep customers and employees happy. Aetna's strength among insurers is its innovative designs.

In 2002, Aetna introduced its Health Fund program, and since then the insurance plan has seen tremendous growth: from 38,000 in March, 2003, to 644,000 in September, 2006. The plan allows individual customers to choose the coverage they want, providing them with the flexibility to select the scheme that works for them. The success of Health Fund has been driven by the emergence of consumerism in health care: more and more individual consumers are paying for their own health care. This trend is partly due to the national rise in health care costs, which has discouraged employers from providing health benefits. Even beyond Health Fund, Aetna has been an industry pioneer in providing health services to individuals rather than companies. In 2004, Aetna acquired Strategic Resource Group to help it provide benefits to hourly and part-time workers. A year later, Cigna Corporation (CI) followed suit by purchasing Star HRG, a competitor of SRG. Aetna has been an industry leader in other areas as well. Through the Internet, it allows patients and doctors to see its pricing scheme, which is part of the move towards greater transparency, and it has led the way in bundling dental, vision, and behavioral insurance products.

[edit] Trends and Forces

[edit] Insurance contraction advantage

Insurance is a diverse industry, and that diversity is present even for health providers. Aetna primarily provides health insurance, but it also offers dental, vision, and behavioral insurance coverage. Individuals and (even more so) companies that buy these products need not buy them from the same provider; they may find the best rates by shopping around. Recently, the personal insurance industry has been contracting, and firms have been looking to simplify their operations by buying insurance from a single provider, providing a boost to companies like Aetna that offer several different types of insurance coverage. In 2002, the four largest health insurance providers held a combined 13% share of the U.S. market; in 2005, however, the same companies controlled 22% of the market. The increased concentration of revenues at the top of ladder has resulted from the bundling of various products, which increases a company's revenue without driving up sales costs. Aetna has been a pioneer in this area: three-quarters of its medical subscribers also have behavioral health insurance, and another 86.5% have dental insurance.

[edit] Exposure to national health insurance issue

An aging population will require more medical care

National health insurance has become a hot topic on the legislative agenda. The national insurance plan is currently quite limited, restricting participation to lower-income (Medicaid) and senior citizens (Medicare). A national insurance program for some children is under consideration in congress. If passed, it would greatly expand the coverage offered by S-chip, the insurance program sponsored by both the state and federal governments. Increasingly, states have begun offering their own universal health care plans, with Massachusetts and California leading the way. These plans, if they become more widely implemented, could increase competition for Aetna and other insurance companies. But the federal subsidies also present another possible risk; because of the looming budget deficit, funding may not always exist for Medicare. If the government were to cut the program, Aetna would lose both enrollment and revenue. Since Democrats, who have historically been more keen to promote programs like Medicare, currently control both houses of Congress, a substantial cut in Medicare funding is fairly unlikely, at least for the near future.

Nonetheless, Medicare spending is expensive--at $230 billion, it was one of the Federal government's greatest expenses in 2006. This is because the elderly require substantially more medical care than younger people, often at a higher cost, and the U.S. population is aging at a considerable rate. This has two potential effects for Aetna. A population with greater health care needs requires additional insurance: age drives demand. But to the extent that people already insured face rising health care costs, medical losses rise in response to population aging.

The national plans under consideration usually call for the government to provide insurance. But Medicare part D, effective January 1, 2007, enables all Medicare-eligible senior citizens to purchase medication with the help of subsidies from the federal government. Whereas the competition inherent in national insurance is bad for Aetna's bottom lines, subsidies can only boost profitability. Of the 40 million eligible seniors, some 6.5 million have already signed up for the program. Aetna already has Medicare Part D plans in place in all 50 states, so it does not stand to gain many clients as a result of the plan, but, since the plan provides a direct subsidy to insurers, it should reduce Aetna's net outlays for customers' prescription drugs and other medical expenses.

[edit] Campaigning for generic drugs

Prescription drugs are one of the largest outlays that Aetna makes on behalf of its clients, and prescription drug costs have been rising rapidly. For the ten years prior to 2005, prescription drug costs increased by an average of 12%, while other medical costs increased by 5-6%. Aetna saves money when its clients purchase generic drugs instead of brand name drugs. The differences between generic and brand name drugs can be staggering: Costco Wholesale (COST) sells Prozac and Zocor for over $140; it sells their generic equivalent for $5 each. Consequently Aetna, like all health insurers, strongly advocates generic drugs over branded equivalents.

Aetna has also actively lobbied Congress to loosen the patent restriction on pharmaceuticals, which restricts the range of generics available. Sanofi-Aventis is suing Teva Pharmaceutical Industries (TEVA) and Sandoz, a subsidiary of Novartis AG (NVS) for violating the patent of Eloxatin, an anti-cancer drug. If the suit is successful, Aetna's patients will be forced to purchase Eloxatin, and Aetna's profitability will fall. This is but one example of how developments in the pharmaceutical industry can impact Aetna and other health insurance companies.

[edit] Globalization and Expatriate Workers

Globalization of products and services, as perpetuated by large multinational organizations, has had many direct impacts on the world market; in some cases, increased competition has lowered the price of products and services to the end-users. In other cases, monopolistic markets have emerged because of natural barriers to entry only allowing for the largest and most cost efficient multinationals to enter said markets. Transcending both cases of market integration is the need of multinational corporations to provide support for these products and services abroad, with the same level of competence.

This expatriation of intellectual capital itself opens the doors for further globalization. In particular, when a multinational corporation expands into the international market, an additional market has been opened, particularly for travel, medical, life, and other types insurance for their expatriate workers. Particularly in the case of emerging markets such as Africa, East Asia, India, and the Middle East, the demand for expertise in expatriate insurance is surging. As the international integration of these markets develop and mature, this expertise will first serve as a differentiating factor when consumers choose expatriate insurance plans and second as a paradigm for additional insurance companies entering the expatriate insurance market. Aetna’s acquisition of Goodhealth Worldwide will expand its international footprint, particularly in Asia and Africa, and significantly increase knowledge of international expat medical benefit infrastructure design.

[edit] Competition

The following table compares Aetna to three other leading health insurers across various measures of performance and profitability. In addition to MLR and ACR, it presents two other important statistics:

• Investment Ratio: The ratio of investment income to revenue is the investment ratio. It reflects the contribution of investment to an insurer's profit margin.

• Implied operating margin: The implied profit margin is equal to what the operating margin would be if investment income, premiums, and fees were the only source of revenue, and medical losses, benefits, and administration costs were the only expenses. (It is equal to the 100% plus the investment ratio, less the ACR and MLR.)

In reality other factors also influence profitability, especially legal fees. The investment ratio is equal to net investment income divided by revenue from premiums and fees.

Note that for Cigna and UnitedHealth Group, the data refer only to medical insurance, not other products.

On basically every measure, Aetna outperforms its peers. It is larger and more profitable, with a far lower medical loss ratio than any company but Cigna, which has an exceptionally high cost ratio. Yet, Aetna may well be underperforming relative to its potential.

This approach likely hinders growth; relative to its peers, Aetna has very low penetration rates, despite its large size. It is difficult to compare market shares for health insurers since not all of them are active in every state, a result of variations in legislation from state to state. One way to make comparisons, however, is to calculate market share for a company in the 15 states in which it does the most business. This approach leads to a 9.8% market share for Aetna and an average rank of 3.9, meaning that, on average, Aetna is the fourth-largest insurer in its 15 largest markets. By contrast, United Health's market share is 16.2%, and Well Point, another national insurer, scores in at a whopping 32.9%.

[edit] References