Medicare fattens PacifiCare but gravy train may slow.

Medicare's been good for PacifiCare Health Systems Inc. of late.

The Cypress-based health plan operator upped its 2006 revenue projection, thanks to higher government payments to its Medicare plans for seniors.

The payments and other Medicare gains for PacifiCare stem from 2003's Medicare Prescription Drug, Improvement and Modernization Act, which earmarked billions in federal spending to PacifiCare and other Medicare plan providers.

PacifiCare's stock jumped on the positive guidance. But some wonder how long the Medicare party can go on--and if the government will be able to live up to what it's promised.

"The growth of these programs is simply unsustainable," Douglas Holtz-Eakin, head of the Congressional Budget Office, said in a speech before the World Healthcare Congress. "Big changes are coming regardless of what you might think at the moment."

Some analysts who follow PacifiCare also foresee cuts to Medicare as President Bush looks to rein in spending. "Beyond the (fourth-quarter 2004) earnings season, we see more downside than upside," Goldman Sachs & Co. analyst Matthew Borsch wrote in a recent report.

PacifiCare has been here before. The company got squeezed after former President Bill Clinton sought to balance federal spending in his second term. Investors soured on the company's reliance on the federal government for a good part of its revenue and profits.

These days, the push is to get more commercial business from employers. "We will never be overly dependent on Medicare again," PacifiCare spokesman Tyler Mason said. "We watch the trends, work with the (political) leaders and our providers and do the math."

Facing risks

As part of Chief Executive Howard Phanstiel's diversification efforts, the company has rolled out a preferred-provider organization and a "self-directed health plan" meant to tap into the nascent consumer-driven healthcare market.

Investors have applauded PacifiCare's efforts--the company's stock is up 50 percent over the past year. But Medicare still represents a big chunk of PacifiCare's business, making up 47 percent of revenues. And the possibility of another whack isn't far out of mind.

Borsch is cautious about PacifiCare's commercial business, noting that competition and price cuts from rivals--particularly from non-profit Blue Cross companies armed with surplus earnings--could drive down premiums.

Two CIBC World Markets analysts, Carl McDonald and James Naklicki, said the possibility of Medicare enrollees moving into HMO plans could be beneficial.

PacifiCare has a head start on private Medicare plans with more than 700,000 enrollees in its Secure Horizons Medicare Advantage HMO plans. The company also operates its own pharmacy, Prescription Solutions, which could benefit from the senior drug program that kicks in next year.

Still, McDonald and Naklicki wrote that the federal government's funding of Medicare HMOs, "has been unstable over the last decade, to say the least."

The program, formerly known as Medicare plus Choice, has seen "major reimbursement increases and program expansions in the late 1990s followed by decelerating rates and market exits for much of the early 2000s," they said.

Around 5.5 million seniors are enrolled in the program today, now called Medicare Advantage, down from 6.4 million in 1999, according to analysts.

Going private?

Medicare revenue dipped below the 50 percent mark for PacifiCare in 2002, roughly a year after Phanstiel switched from interim chief executive to the company's permanent leader.

In dollar terms, PacifiCare's 2004 Medicare revenue of $5.8 billion is about the same as in 2002. In 2000, Medicare revenue was $6.4 billion.

Borsch said PacifiCare and its rivals could double industry revenue if Republicans succeed in their bid to push Medicare enrollees into HMOs. But doing so could be like trying to get older Americans to quit Social Security for private retirement accounts, Borsch wrote.

"At this point, even with higher Medicare HMO benefit levels and ramped-up marketing, seniors appear reluctant to trade traditional Medicare for the added benefits but tighter restrictions of managed care," he said.

PacifiCare has been a pacesetter in Medicare, particularly during the 1990s when it and rivals signed up relatively healthy older people who were just entering the Medicare program.

Back then, PacifiCare and others greased the wheel for seniors with incentives such as health club memberships and drug plans. Reimbursements were high then. And there was a perception that the baby boomer generation would be lucrative for managed care.

The rush cooled after the Balanced Budget Act of 1997 capped Medicare reimbursements, leading to benefit cutbacks and exits. That led PacifiCare and others to lobby for restoring funding, which were included in the recent Medicare prescription drug and reform package.