Health plans weathering turmoil

Conservative investments help stave off big losses

While the bear market in the third quarter hammered investment income for each of the state's major health plans, all three insurers remain strong financially, according to their finance chiefs.

Analysts agreed, saying the companies are unlikely to be significantly hurt by the recent market turmoil. The drop in investment income is also not expected to force an increase in healthcare premiums, they said.

"Health plans' enrollment is holding, their margins are down but still in the black, and their investment income is down," said Robert Laszewski, president of Health Policy and Strategy Associates, a consultant to health insurers. "Compared to a lot of other industries, the health insurance industry is in fairly good shape so far."

Still, the reduced investment income could lead to cost-cutting at the plans.

"It's a very difficult environment from an investment perspective, and health plans are left with little practical alternative but to manage the costs under their own roofs," said Douglas Sherlock, whose firm, Sherlock Co., helps health plans manage finances.

Blue Cross and Blue Shield of Massachusetts saw the most dramatic decline in investment income. For the three months ended Sept. 30, it was $3 million, compared with nearly $28 million in the same period last year. Investment income also plunged at Tufts Health Plan, which posted income of $2.5 million this year, compared with $17.3 million in the third quarter last year. At Harvard Pilgrim Health Care, investment income fell by more than half, to $3.5 million this year from $7.5 million last year.

For many investors, earning any profit in the quarter would have been an achievement, given the precipitous decline in financial markets. Standard & Poor's 500 index of stocks dropped nearly 9 percent over three months. But the health insurers have largely been shielded from those dramatic losses because they employ conservative investment strategies that rely largely on bonds.

"We are in excess of 95 percent invested in bonds," said James DuCharme, chief financial officer of Harvard Pilgrim, the state's second-largest insurer with about 1 million members. Those high-quality bonds generate regular interest income, which more than makes up for losses from other holdings in Harvard Pilgrim's $700 million investment portfolio.

DuCharme said the remaining 5 percent of the portfolio includes stock mutual funds and high-yield bonds - also known as junk bonds. That part of the portfolio has lost about 30 percent of its value over the year, following the broader market decline in indexes such as the Dow Jones industrial average, he said.

Portfolio managers are required to periodically evaluate their investments and determine if any have lost value compared with their purchase price - an exercise known as mark-to-market. They also determine if any bonds are "impaired," which means they are not making interest or principal payments on time, and whether the bonds are "permanently impaired," or unlikely ever to recover.

For instance, Tufts Health Plan wrote off $1 million in Lehman Brothers bonds in the third quarter after the venerable investment bank declared bankruptcy in September. Tufts also wrote off about $600,000 in stocks. Chief financial officer Umesh Kurpad said Tufts expects annual investment income of $33 million this year, half of the $66 million it earned in 2007, barring further impairments in the $450 million portfolio.

Kurpad said one reason for the sharp drop is Tufts' investments performed extraordinarily well last year. "Interest rates were higher, and we had a lot of capital gains," he said.

The market decline is important to the health plans because they sometimes rely on investment income to tide them over when they are losing money in the health insurance side of their business. For instance, several years ago, Tufts experienced a steep decline in membership and relied exclusively on investment income. In 2004, the plan lost $3.8 million on operations but earned $28.5 million on its investments.

In addition to the decline in investment income, Blue Cross and Blue Shield of Massachusetts also saw operating income drop off in the third quarter - to $55.5 million from $94.5 million in the same period last year.

Allen Maltz, chief financial officer at Blue Cross-Blue Shield, said that because the healthcare giant aims for a narrow 1 percent margin on its health insurance business, small changes in claims patterns can lead to a big swing in operating income. As premiums rise, he said, companies have sought to control costs by moving to health plans with less extensive benefits. Those plans, in turn, generate slimmer margins for Blue Cross-Blue Shield.

About two-thirds of Blue Cross-Blue Shield's roughly $1 billion investment portfolio consists of cash and bonds. Stocks account for 14 percent, and commercial real estate investments make up 5 percent. Though more than $200 million of the bonds are classified in year-end financial statements as "mortgage-backed securities," Maltz said they do not include any subprime residential mortgages, which sparked the credit crisis earlier this year. The insurer's mortgage-backed securities are high-quality, he said, continue to perform, and do not face any impairment.

"We check for impairment every day," said Maltz. "We weren't holding any of these securities that were making news."

Maltz said Blue Cross-Blue Shield doesn't expect to make significant changes beyond a cost-cutting plan implemented earlier this year.

"At the end of this year, our margin is going to be about 0.5 percent compared to our 1 percent target," said Maltz. "We take a long-term view, not a quarter-to-quarter view. Our customers expect us to be there for them."

Jeffrey Krasner can be reached at krasner@globe.com.