A.M. Best Special Report: Consolidation, Medicare Prescription Plan Shaped Cost-Conscious Health Insurance Market in 2005.

OLDWICK, N.J. -- The new stream of revenue for health insurers from Medicare prescription-drug plans carries a risk, as slender profit margins could hurt the capitalization of some players in the market, according to a new special report from A.M. Best Co.

The beginning phases of implementing the new Medicare prescription-drug product, Medicare Part D, were among several important events that occurred in the health insurance industry in 2005. These events also included two large acquisitions of publicly-traded health insurers.

While Medicare Part D was not effective until January 1, 2006, the players were established in 2005, and insureds began enrolling in mid-November. Health insurers participating in Medicare Advantage, especially Part D, had incurred higher expenses due to the ramp-up of marketing and administration in the second half of 2005, and expenses are expected to remain high for the first quarter of 2006.

A.M. Best also expects to see strong growth in revenues related to the Medicare Prescription Drug Plan as companies add members beginning with January 1, 2006 effective dates. While the growth in revenues from Medicare Part D is projected to be significant, the impact on overall profitability is expected to be much smaller, as profit margins are projected to be in the low single digits. With low profit margins expected, A.M. Best has concerns whether companies' growth in capital will keep pace with the increase in premiums. If premiums should rise more than capital, there could be deterioration in the level of capitalization of some of the players.

The year ended with the completion of two large acquisitions, UnitedHealth Group Inc.-PacifiCare Health Systems Inc. and WellPoint Inc.-WellChoice Inc. As a result of these and other smaller transactions, goodwill and intangibles increased by 37%, and total debt outstanding grew by 36% year over year. These transactions were financed with a combination of debt, cash and common equity. However, due to the increased amount of equity at these new, larger consolidated organizations, combined with how the acquisitions were paid for, the debt-to-capital ratio increased by less than 2% during the year.

A.M. Best does expect the industry consolidation to continue; however, some of the larger companies may focus more on smaller plans and specialty companies, which may allow for market expansion in both product offerings and specific geographic areas.

While cost trends and rate increases appear to have stabilized, the cost of health insurance is still a key issue for both employers and employees.

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A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at www.ambest.com.