For Subscribers

Get the complete article now!

TWST: Joe, what stands out for you when you look back at the performance of these stocks over the past year? And what in your view separated the better performers from the weaker players?

Mr. France: As much as anything, last year’s strong performance owed to very low expectations for the group going into the year. Market rotation also played a big role. In the fourth quarter of 1999, the market was obsessed with litigation and afraid the companies would all go out of business. Many investors and analysts said the industry couldn’t survive. This depressing mood pushed the stocks to lows in February and March of 2000, and they only started to recover meaningfully after the NASDAQ peaked in April. From then on the stocks did extraordinarily well, considerably better, quite frankly, than was warranted by the fundamentals.

TWST: Joe, in a slower economy, if corporate profits decline, do you expect to see employers resisting double-digit price increases in 2002?

Mr. France: Absolutely. One of the major factors behind the remarkable resurgence of the health insurance business over the past couple of years has been the relative absence of benefit buydowns. It’s very easy to expand underwriting margins when employers aren’t pushing back, but if the economy slows, particularly at its recent pace, employers will start resisting big rate increases. This is, in the end, the greatest fundamental challenge facing the industry; it hasn’t been able to handle this process of benefit buydowns in the past. When the insurer walks in and asks for a 15% rate increase, the employer says, “Yeah, right. What can I get for 5% or 6%?” The insurer then adds deductibles and co-payments, and shrinks benefits to come up with a cheaper product. The problem is, this process is rarely margin-neutral for insurers. Keep in mind that most of these companies started out as HMOs, with very small networks and not a lot of choice for beneficiaries, and they traditionally have had difficulty cutting and pasting deductibility, co-payments and benefits, without hurting margins. Everyone is excited about the latest big price increases, but pricing power is not the ability to raise prices. That’s been a pretty easy thing to do the past couple of years, because some very big players like Kaiser have been trying to recover from losing giant bucks in the mid-1990s. Pricing power is the ability to expand margins, and there is little historical evidence to support the argument that the industry can do this for an extended period of time.

TWST: Joe, are there any other companies that you’d like to highlight? Any other companies that you would like to bring to the table?

Mr. France: RightCHOICE (NYSE:RIT), a Blue based in St. Louis, is our favorite small cap name. It’s sort of a mini-WellPoint. RightCHOICE is a remarkable story in that you rarely see such a complete turnaround in performance as we’ve seen at the company over the past two years without bringing in a whole new management team. RightCHOICE turned the company by promoting people internally, and they have done an incredible job.