Market forces may lead HMOs to split off drug units

NEW YORK (Reuters) - U.S. health insurers staunchly defend hanging on to their sizable pharmacy benefit units, but the blunt realities of the stock market are making it tougher to justify not splitting them off.

Shares of the major national health insurers -- UnitedHealth Group Inc UNH.N, WellPoint Inc WLP.N, Aetna Inc AET.N and Cigna Corp CI.N -- have tumbled between 22 percent and 42 percent in 2008 amid sluggish membership growth, high medical costs and general fear of an industry downturn.

By comparison, independent pharmacy benefit managers are beloved by investors. The share prices of the major PBMs -- Medco Health Solutions Inc MHS.N and Express Scripts Inc ESRX.O -- have nearly doubled since the start of 2007. And their valuations, based on their price-to-earnings ratios, are twice that of the insurers.

With such a premium on PBMs, pressure may be building on the four big insurers to divest their in-house pharmacy units to placate sour shareholders.

Indeed, one major UnitedHealth shareholder brought up the idea of selling its PBM during the company’s earnings conference call last month.

“I think that the boards are going to give these companies a little bit more time to see if the strategy works and then take action, depending on how it goes,” said Edward Jones analyst Aaron Vaughn. “They can only be patient for so long.”

The fate of these drug-benefit units strikes at the heart of a national debate over how to control health care costs and deliver the best medical outcomes -- while the resolution could generate some blockbuster deals.

According to an analysis by Citigroup last month, WellPoint’s PBM had a value of nearly $11 billion, UnitedHealth’s was $8.4 billion, Aetna’s $3.3 billion, and Cigna’s nearly $2 billion.


Health insurers have given no indication they are planning to divest their PBMs. They tout the potential of the units and say they are critical to their overall strategies, as they offer integrated benefit packages to customers and seek to combine medical and drug data to gain better health outcomes.

But Citigroup analyst Charles Boorady says owning PBMs has weakened health insurers strategically, causing them to drop the ball on their main mission: managing medical costs.

“My view on what managed care plans should be focused on is gaining scale through merging with each other,” said Boorady, who has argued for a year that health insurers should divest their PBM units.

“It’s really an existential question for the health plans: Can they do a better job of managing healthcare, providing better outcomes in healthcare at a lower cost?” Boorady said.

“They could better achieve that goal if they focused on the 85 percent of health care costs that are doctors and hospitals and leave the 15 percent that’s drugs to companies that are already much better at it,” he said.

Boorady said the idea of splitting off the PBMs has picked up steam as many health insurers have posted poor results and cut their profit outlooks.

“There’s increasing interest on the part of shareholders whom I speak with in light of the fact that it’s become much clearer now to investors that the managements have not been effectively running their core business of managing hospital and other medical costs effectively,” Boorady said.

Of the insurers, Boorady said it makes the most sense for WellPoint to divest its drug unit, which is the fourth-largest overall PBM.


In the past, said BMO Capital Markets analyst Dave Shove, where pharmacy benefit managers have been “foster children” of healthcare -- operated under parent companies in various industries -- they have established that they can function successfully on their own.

“I believe that these foster children are now grown up and they don’t need parents any more,” Shove said. “Because drug pricing in America is so obtuse, the corporate customer wants his PBM to be independent. He wants the most transparency he can get.”

Others see drawbacks to insurers divesting the units. Jack White, director of research at Todd Investment Advisors, which owns UnitedHealth shares, said such focus would distract from UnitedHealth at a time it desperately needs to worry about lackluster enrollment growth in its core health care plans.

“I could see where activist shareholders would be rattling management’s cage and saying, ‘let’s do this, guys,’” White said. “It would probably help the stock price over the short term but the question is, are they getting their ship righted for the long term?”

The insurers also would likely lose economic benefits they derive from having the drug units, said David Heupel, a portfolio manager with Thrivent Investment Management.

“It all in theory sounds good, but these are fairly strategic assets the company feels they want to own and hold,” Heupel said.

But, Heupel added, “It’s going to be a topic we’ll discuss in these stocks for quite some time if the core business remains in a difficult environment.”

Editing by Brian Moss