A.M. Best Special Report: Medicare Drove Health Plans' Growth as M&A Climate Cooled in 2006.

OLDWICK, N.J. -- Medicare was the big event for health insurers in 2006. The implementation of Medicare Part D and the new Medicare Advantage products created significant growth in membership and revenue at many of the plans, according to a new special report from A.M. Best Co.

Membership at the publicly traded health insurance companies grew by 18 million, or 17.2%, during the year, and overall total revenues grew by 30.8% to $225 billion. Significant portions of this membership and revenue were in Medicare programs.

The Medicare and Medicaid companies experienced the largest growth in enrollment. For companies participating in Medicare, the growth was due to Medicare Part D and Medicare Advantage plans. UnitedHealth Group Inc. and Humana Inc. experienced the largest increases in the number of members as a result of Medicare. UnitedHealth enrolled 5.7 million members in stand-alone Medicare Part D and 260,000 new enrollees in Medicare Advantage plans. Humana added 3.5 million stand-alone Medicare Part D members and almost 445,000 Medicare Advantage enrollees. At year-end 2006, Medicare accounted for 40% of Humana's total enrollment and 55% of the company's total revenues.

For Medicaid companies, the growth was due to the implementation of several new programs in states such as Georgia and Ohio. The Medicaid-only insurers (Centene Corp., Amerigroup Corp., Molina, WellCare) all experienced double-digit growth of enrollment in 2006.

After several years of large-scale mergers and acquisitions among health insurers, 2006 was very quiet, with no major transactions. However, public companies focused on small, regional insurers in 2006, as well as on fee-based business that expanded a company's existing geographic reach or strengthened its presence in an existing market. The slowdown was the result of two large companies, UnitedHealth and WellPoint Inc., both integrating large transactions that closed at the end of 2005.

Medicare and Medicaid lines of business tend to have higher loss ratios and lower profit margins than commercial lines. As companies have changed the composition of their business mix and added more Medicaid and Medicare business, the average medical loss ratio increased by 90 basis points in 2006 to 81.3. As companies continue to enroll more Medicare and Medicaid members, A.M. Best would expect the average medical loss ratio to increase slightly in 2007.

A.M. Best remains concerned about companies with a concentration in government-funded business because of the uncertainty of future government funding. Medicare funding is expected to be sufficient through 2008, as the Centers for Medicare & Medicaid Services (CMS) has announced an average preliminary payment increase of 3.5%. However, the longer-term outlook is questionable as both the House and Senate evaluate the financial support provided to Medicare Advantage programs, particularly private fee-for-service plans.

The overall 2006 results for the publicly traded managed care organizations remained strong. While total net income grew by 17.8% year over year, the average EBITDA margin (earnings before interest, taxes, depreciation and amortization) declined slightly to 9.6% in 2006 from 10.2% in 2005, and the average return on revenue was 5.3% in 2006, compared with 5.9% in 2005.

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