Several managed care companies reported lower earnings in the first half compared with the same period last year because of the impact of costs related to implementing the Medicare prescription drug benefit.

For example, Humana Inc., based in Louisville, Kentucky, reported a 7.9 percent drop in first-half profits, with the earnings decline occurring in the first quarter of the year because of high administrative costs for its Medicare programs.

Analysts were unconcerned about Cigna Corp.'s 45.9 percent decrease in profits, noting that profits for the year-earlier period were amplified by several factors, including the sale of its retirement benefit business. First-quarter 2006 earnings were adversely affected by reduced returns in its health care business and higher-than-expected Medicare Part D losses, but the second quarter produced improvement in its health care unit earnings and strong results in other segments.

"They still have some work to do, but they're in better shape than they have been in the last couple of years," says Bradley Ellis, director at Fitch Ratings in Chicago.

Philadelphia-based Cigna reported flat enrollment of 9 million, stabilizing its membership base after years of significant declines and helping to moderate revenue losses.

"We're still seeing a lot of consistency and stability there," says Joseph Marinucci, credit analyst with New York-based Standard & Poor's Corp.

Aetna Inc., based in Hartford, Connecticut, reported flat first-half profits because of a ratio of medical costs to other costs that was higher than previous quarters—driven by high-dollar claims in areas such as oncology, neonatal intensive care and cardiology—and an underperforming small-group book of business caused by increased competition in key markets such as the Northeast and mid-Atlantic region.

Aetna says its medical cost trend is projected to average 8.5 percent for the year with premium yield greater than 7 percent.

"It will be interesting to watch them in the second half to see if they can increase pricing at all," Ellis says. "The problems they have are something they can fix."

Overall earnings for the managed care sector, though, were solid, driven by substantial double-digit earnings for Minnetonka, Minnesota-based UnitedHealth Group Inc. and Indianapolis-based WellPoint Inc.

"The sector is doing fairly well on a profitability basis," Ellis says.

UnitedHealth is still dealing with the ramifications of probes into its stock-option granting practices. The company recently announced it would delay filing quarterly earnings reports with the U.S. Securities and Exchange Commission because of its ongoing review of these practices. In response, S&P revised its outlook on the company to "negative" from "stable," citing a potential financial restatement arising from misaccounting for its stock-option plan.

Even with the revision, though, the company is still the highest-rated health care carrier, Marinucci notes. "They're going through some challenges, obviously, but the model still seems to be holding up," he says of UnitedHealth. "We still have some concerns about accounting and governance. We're concerned about further balance sheet impairment. But the bottom line is the money and earnings are still being generated at a significant clip."

The major managed care companies reported that medical cost trends have hovered in a predictable range. WellPoint, the largest managed care organization in terms of membership, says it continues to expect its 2006 medical costs to increase less than 8 percent.

Humana, meanwhile, reported that medical cost trends for its fully insured commercial book of business were in the 5.5 percent to 6.5 percent range, a decline from the 6 percent to 7 percent range reported in the first quarter of 2006.

"We're seeing some compression in medical inflation," Marinucci says.

Insurers say they are pricing their products at or slightly above their medical costs.

"We remain very disciplined in our underwriting approach and will not sacrifice margin for market share," WellPoint CFO David Colby says.

Moderating pharmacy trends are a key driver of the deceleration of overall medical cost trends, insurers say. Aetna, for example, was projecting pharmacy cost increases in the high single digits, but now expects these cost trends to fall in the mid-single-digit range. The insurer expects its pharmacy costs, which account for about 15 percent of total medical costs, to decline in the second half of the year because several drugs, including the blockbuster cholesterol-reducing drug Zocor, are shifting to generic status.

Pharmacy costs could moderate further than expected in the second half of this year due to discounted pricing offered by Zocor manufacturer Merck & Co. and the unexpected introduction of generic Plavix, which is used to prevent heart attacks and strokes, says Sally Rosen, a senior financial analyst with A.M. Best Company Inc.

The movement toward consumer-driven health plans could have an impact on cost trends going forward, observers say.

WellPoint president and CEO Larry Glasscock says there still is tremendous interest from employers in CDHPs, and that nearly every quote the insurer develops includes a detailed review of WellPoint's consumerism capabilities.

Achieving membership growth, meanwhile, is a key factor for health insurers, analysts say. Certain companies are seeking to increase enrollment by focusing on the government segment of the market rather than the commercial business because of opportunities presented by the revamped Medicare program and states turning to managed Medicaid programs to control rising health care costs. A.M. Best, though, remains ambivalent about government-funded programs because of potential changes in reimbursement rates, Rosen says.

Managed care companies have been increasing membership primarily through acquisitions or by taking accounts from other insurers, primarily Cigna, analysts note. But consolidation in the industry is expected to continue on a smaller scale than it has in recent years because of emerging antitrust concerns, they say.

UnitedHealth, for example, had to sell PacifiCare Health Systems Inc.'s commercial health insurance businesses in Tucson, Arizona, and Boulder, Colorado, to secure regulatory approval for its acquisition of the Cypress, California-based insurer.

"As some of these companies get bigger, that's going to become an issue," Rosen says.

–Gloria Gonzalez is a writer for Business Insurance, a sister publication of Workforce Management.