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PacifiCare’s stock price has rebounded, but its new CEO still has work to do

Howard Phanstiel will have to contend with a lot of things beyond his control as he looks to reinvent Santa Ana-based PacifiCare Health Systems Inc.

But, so far, the healthcare insurer’s new president and chief executive is getting plaudits from Wall Street for how he’s dealing with what he can control.

PacifiCare’s stock, which bottomed out at around 10 in late October, has surged. Last week, it was trading at about 35,or back to where it was before Oct. 10, when PacifiCare warned that higher costs were eating into profits. As of last week, PacifiCare counted a market capitalization of $1.3 billion, up from $345 million on Nov. 1.

The company got a big boost earlier this month after reporting better than expected fourth-quarter profits. And Phanstiel has laid out plans to augment PacifiCare’s core health maintenance organization business. In the works: a preferred-provider organization, a Medicare supplemental insurance offering and expanding the reach and breadth of its pharmacy benefit management subsidiary.

The moves are designed to cut PacifiCare’s reliance on Medicare, which may or may not see additional funding from Congress. The company also is looking to better compete with rivals, which have gained subscribers,and bolstered profits,by offering a variety of products and services.

Phanstiel, who previously served as PacifiCare’s chief financial officer, is looking to expand into new areas not traditionally covered by health insurance. Those could encompass services that help senior citizens live at home independently, and “lifestyle” items such as laser eye surgery, teeth whitening, cosmetic procedures, sexual dysfunction treatments and sports medicine.

“We want to expand the company’s offerings to become a leading health and consumer services organization,” Phanstiel said.

Phanstiel’s plan to broaden the company beyond its core Medicare business into a more diversified insurer gets good marks from one analyst.

“Howie’s done a fabulous job getting his hands around a very troubled situation,” said Todd Richter of Banc of America Securities. “Howie knows that the company must dramatically decrease its dependence on Medicare.”

Still, PacifiCare’s near-term future stands to be driven more by what the government does with Medicare, particularly in terms of reimbursement changes and a prescription drug benefit, according to Richter. He said he hasn’t changed his cautious outlook on PacifiCare in the near term because “a lot of things are out of Howie’s control.”

For now, PacifiCare derives most of its profits from Medicare. “If the government cuts reimbursement, I don’t care how good (Phanstiel is), they’re going to have problems,” Richter said.

Phanstiel said he recognizes the uncertainty surrounding Medicare and the uneasiness that creates with investors.

“Wall Street does not place a high multiple on the Medicare business, which represents 60% of our profits and balance sheet,” he said. “There is simply not a clear line of sight in regard to stability of federal funding in the Medicare Plus Choice program.”

A result of the Balanced Budget Act of 1997, Medicare Plus Choice gives seniors options in how they receive government-backed healthcare, including through PacifiCare and other HMOs.

Phanstiel said he feels the government must find a more stable source of funding for Medicare HMOs. But he’s not betting on it. If that doesn’t happen, he said, “We’ve got to be positioned to disengage from the Medicare Plus Choice program.”

But Phanstiel said he thinks the Bush administration is “much more favorably disposed toward Medicare Plus Choice” and would like to see the private sector play a greater role in delivering traditional, fee-for-service Medicare.

“Given that we have a more civil tone in Washington and a more moderate climate, we’re excited about the possibilities,” he said. “But you won’t see that reflected in our share price until legislation gets enacted, hopefully in 2001 or 2002.”

Meanwhile, Prudential Securities Inc. analyst David Shove,who downgraded PacifiCare about a week before its October profit warning,upgraded the company’s stock from hold to a strong buy earlier this month. Shove wrote his decision was “based on the excellent fourth-quarter results, the apparent progress being made in the turnaround and the new strategy outlined by management.”

PacifiCare’s fourth-quarter earnings of 35 cents per share after a restructuring charge easily beat the consensus of 20 cents a share, Shove wrote.

“The quarter is best characterized by demonstrating that the problems at the company are lessening and earnings visibility is improving,” he said.

Shove’s report noted that PacifiCare’s premium increases were exceeding expectations and medical costs were appearing to stabilize. “We expect that the aggressive pricing and market exits will improve margins sharply in 2001.”

PacifiCare has said it expects its commercial HMO pricing to go up between 10% and 25% this year, with an average increase of 13%. Additionally, it has frozen some enrollment in its Secure Horizons Medicare HMO.

Phanstiel came to PacifiCare from ARV Assisted Living Inc. of Costa Mesa, where he was chairman and chief executive. The Syracuse University alumnus was named acting president and chief executive in October, after Robert O’Leary resigned. The board affirmed Phanstiel in December.

At the time of his departure, O’Leary and analysts said PacifiCare needed a leader with a managed healthcare service background. Phanstiel’s resume includes a stint as executive vice president of finance and information services for Thousand Oaks-based WellPoint Health Networks Inc., owner of Blue Cross of California.

Phanstiel joined PacifiCare at a time of turmoil for the company, which grew rapidly during the 1990s. PacifiCare’s growth included 1997’s merger with rival FHP International Corp.

In October, PacifiCare and other HMOs had a well-publicized falling out with Orange-based St. Joseph Health System (see story below) over contract rates and the sharing of insurance risks.

At about the same time, former chief executive O’Leary surprised analysts by announcing that PacifiCare might break even or report a loss of up to 10 cents for the quarter ended Sept. 30. The company attributed the grim projection to a mix of lower Medicare reimbursements and higher healthcare costs. PacifiCare eventually reported earnings of 15 cents a share for that quarter.

“In California, we’ve had a rather dramatic shift in our provider networks from what we call capitation to shared-risk,” Phanstiel said. “That has caused instability in our healthcare costs, which we are making progress in managing, but that’s what fundamentally caused the earnings surprise.”

In 1999, most of PacifiCare’s commercial HMO members were covered under contracts that gave hospitals set amounts of money per patient per month for treatment,known as capitation. With those models, hospital officials accepted the financial risk of actual healthcare costs being higher than the allotted payments.

By contrast, PacifiCare shoulders more financial responsibility when its members’ healthcare costs increase under shared-risk arrangements. That shift came about in part because hospitals and doctors’ groups were complaining about not getting enough money from the HMOs and threatening to cancel their contracts,but it also happened at a time when both costs and members’ hospital usage grew.

PacifiCare isn’t totally stepping away from capitation even though it’s jumping into the shared-risk market. Phanstiel said approximately 35% of the company’s California membership now is covered under full-risk arrangements.

Capitation isn’t for every hospital or doctors’ group, Phanstiel said, noting that it doesn’t work for providers that don’t have the ability to manage risk.

“On the other hand, particularly with the right price point, capitation can work very well,” he said.

PacifiCare has taken other steps besides the contract changeovers and the Medicare enrollment freezes. In December, the company laid off 550 employees, or about 6% of its workforce, mainly in administrative and regional HMO operations positions.

“First of all, you never look forward to having to implement layoffs, particularly when you’re letting go some very good people who have worked hard to do their job well,” Phanstiel said. “But I think we have to look at the situation from the standpoint that we have a fiduciary responsibility to the 4 million members and 8,000 other employees. By taking timely action today, which resulted in roughly a 6% reduction in our workforce and a 10% reduction in our officer corps, we’ve been able to stabilize our balance sheet and profitability so that we’re positioned for growth in the future.” n

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