Investopedia: Fear And Uncertainty Still Keeping A Lid On WellPoint

It seems as though investors have made their peace with health insurance reform to some extent, as WellPoint (NYSE:WLP) shares have more than doubled off of their bottom in late 2008/early 2009. That said, major health insurance names like WellPoint, Unitedhealth (NYSE:UNH), Aetna (NYSE:AET) and Coventry (NYSE:CVH) still seem to be trading below their inherent earning power as investors try to digest the impact of upcoming regulation on their medical costs and membership expansion potential. 

A Surprisingly Strong First Quarter 

WellPoint's first quarter once again highlights the difference between absolute and relative performance. On an absolute basis, it would seem that revenue contraction of over 1% would be something of a disappointment. In this case, though, analysts were expecting a bigger decline and WLP's top line and profit performance were surprisingly strong.

While WellPoint did see a small increase in administrative fees, premium revenue dropped more than 1% (and that's more than 85% of the revenue base). Membership did grow over 1%, though, with strong performance in national and senior categories. (For more, see 5 Health Insurance Considerations.)

Looking at the profit picture, WellPoint saw operating profits rise almost 5% despite a small uptick in the medical loss ratio (up to 82.1). Especially noteworthy was the better than 5% year-on-year decline in general and administrative expenses, and it is impressive to consider that the company is still finding that amount of cost savings in the system. 

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A No-Brainer For CVS

On the last day of the year, CVS Caremark (NYSE: CVS) announced that they are effectively buying the Medicare Part D business of Universal American Financial (NYSE: UAM) for $1.25 billion in cash. With this deal, CVS will more than double the size of its Medicare Part D business - from 1.2 million covered lives to 3.1 million covered lives.

In actual fact, the deal is a little more complicated that prior paragraph suggests. CVS is actually buying all of UAM, for roughly $12.80 to $13.00 per share in cash, but also simultaneously giving each UAM shareholder a share in the "NewCo" that will be created to continue UAM's current Medicare Advantage and other insurance businesses. So, at the end of it all, each UAM shareholder walks away with about $13 a share and shares in a UAM that will no longer have this Part D business.

For CVS this looks like a no-brainer type of deal. CVS is paying less than $660 per covered life. To put that in scale, the average senior citizen pays about $2,800 for prescription drugs each year and a year's prescription for a common drug like Pfizer's (NYSE: PFE) Lipitor or Merck's (NYSE: MRK) Fosamax is about $900.

Now, it is absolutely true that pharmacy benefits companies like CVS, Express Scripts (Nasdaq: ESRX), and MedcoHealth (NYSE: MHS) make only tiny margins on their drug businesses, but there are significant advantages to scale in the business. Moreover, Medicare Part D isn't exactly like "regular" PBM operations, so CVS is no doubt looking at this deal as a way of expanding a more protected and potentially more lucrative niche at a time when the standard PBM business is not doing as well.

This looks like a reasonable deal for UAM, though I think the surviving company is going to have a hard time getting much attention or much analyst/institutional investor love. In point of fact, I would not be surprised to see another company (say, maybe, Coventry (NYSE: CVH)?) come in and acquire what's left of this business after the CVS transaction. That leverage and scale I mentioned goes both ways, and I think UAM's Medicare Advantage business is not going to be all that appealing on its own - at least not in the form of a publicly-traded company.