Health Net Inc. (NYSE: HNT) is one of today’s worse performers on the heels of losing its Pentagon health insurance contract.  The Pentagon picked Aetna Inc. (NYSE: AET) and UnitedHealth Group Inc. (NYSE: UNH) for its Tricare health program  for members of the armed forces, their families, and survivors.  They will replace Humana Inc. (NYSE: HUM) and Health Net Inc. in 2010.  There is an interesting take here, and it is one that all large health care insurers serving federal and local governments should pay close attention to now that the Administration is on the attack in the field of health care insurance.

Is it any secret that the Obama administration and Congress have a health care reform proposal coming?  No it is not.  The question to consider though is “Just how different will it be?”…  After that will come the cost consideration for the public, and then how the gap will be paid for.

It now seems certain that the new plan is going to include the insurers and the large health care systems, but the heat is on for companies to cut costs on many fronts.  That being said, there has to be a lesson here that the insurance companies may see more of the same.

Large government agencies are probably now better able to demand lower prices in the bidding for major contracts than they have been for at least the last eight years.  Large insurance buyers are already able to make bids then go into competition with each other, particularly by giving an incumbent provider a last look on the bids.  In the private sector, it is not uncommon for customers to tell their suppliers, “We want you widgets, but a competitor of yours is offering us widgets for 4% less.”

Aetna won the support contract for the north and will provide health care and services and UnitedHealth won the contract for the southern region.  There is also an aspect that Aetna and UnitedHealth decided to back a government database plan.  While the contract is supposed to be up for appeal, it seems that the government is telling these firms to play by their new rules or face the consequences.

Based on what we have been able to garner from this, this may be more of a blow to HealthNet and then to Humana more than it is a huge win for UnitedHealth and Aetna.  Big insurers and providers of health care services have to be paying close attention to this case, because there is always the notion that this could become the norm.  If the government wants to drive down the costs of health care but wants to still work through the insurers and the large health care systems, then one of the first steps might be using a ‘Last Look’ lesson in more of a stringent and harder Dutch auction process.  The term “shadow pricing” has been used in the industry for years and this would be customer-generated “reverse shadow pricing.”  That can save the government up front, but if he profits are entirely killed out of the sector then there is no incentive to stay in that business.

Our take is that is a huge blow to Health Net first and a secondary blow to Humana.  It is very possible that other agency contracts could go the opposite direction or if there will be more awards to those deemed to be playing under the new administration’s rules.  It is also too soon to know from the outside if today’s losers will be tomorrow’s winners on other contracts as they come up for bid, or if these firms are being targeted or singled out.

No industry can profitably drive costs down to zero.  But large customers have been able to drive down supplier costs for years in years in many manufacturing and service operations.  This may be the start of a new twist to the health care model.  Pitting the competition against each other is not new and not new in health care, but with a new sheriff and a new administration it could become much more bloody than before.

What does that tell you about profit margins?  At least the upside notion for today is that at these contracts still include the private health care providers.

Even after the day is half over, Health Net shares are down over 14% at $12.10.  Humana is down 6% at $28.75.  In support of the ‘race to zero’ thought, Aetna shares are now down 0.5% at $26.20 after having been up 2% earlier.  Ditto for UnitedHealth, whose shares are down 1.3% after being up 2% earlier today.

If the race to cut costs does becomes a charade for an ultimate race to zero, it is not too bold of a statement to say that even the winners become losers.

JON C. OGG
JULY 14, 2009

Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.