A.M. Best Special Report: Sustainability of Increased Health Premiums Is Questionable.

OLDWICK, N.J. -- The closing of the Anthem/WellPoint merger was the noteworthy event during the fourth quarter of 2004. Otherwise, earnings, margins and capital within the top publicly traded group of health insurance companies performed as expected.

Premiums increased 14% in 2004. However, a recurring question remains whether these premium increases are sustainable and how the industry will be impacted, according to a special report released by A.M. Best Co., "Sustainability of Increased Health Premiums Is Questionable."

For the past two years, industry analysts have predicted a downturn in the underwriting cycle. A.M. Best firmly believes 2005 will be the year of margin constriction and heightened competitive pressure. The downturn is imminent. How deep it will go remains to be seen.

The various acquisitions completed in 2004 by UnitedHealth and the merger between Anthem and WellPoint caused goodwill at these companies to increase substantially. The total increase in goodwill in 2004 over 2003 was almost 20%. Debt as a percentage of tangible capital also increased in 2004 by almost 11%. A.M. Best expects another jump in these ratios in 2005 when the Coventry/First Health merger is included. While it appears that leverage decreased by 1.2%, operating cash flow to total debt decreased by 40 basis points.

Factoring in the effects of the Anthem/WellPoint transaction, medical expenses in 2004 increased approximately 12% over 2003, while premium revenue increased by 14%. Approximately 7% of the increase in health care costs is attributable to the progress in medicine and medical technology. This percentage is more than double the general rate of inflation.

In the current business environment, most companies cannot afford to pass these increased costs along to their customers. While companies have shifted medical costs to employees and explored new strategies to contain rising health care costs, opportunities for further tightening are diminishing. As health care inflation continues to outpace the growth of corporate earnings and employee wages, more businesses--small and large--are priced out, and their employees join the ranks of the uninsured. In a statement Karen Davis, president of Commonwealth Fund, a New York-based health care think tank, said, "The evidence is that increased patient cost-sharing leads to under use of appropriate care." The report found that people with high-deductible plans had medical debts and many did not seek the care they needed. This could lead to poorer quality health care and more financial problems for patients and the industry.

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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 http://www.ambest.com.