Management at health-care provider Healthways (Nasdaq: HWAY ) finally got around to recognizing what we've been saying all along: The smiley face it was putting on its earnings forecasts would have to be changed to frowns because the company's participation in the Medicare cost-reduction program was going to hurt.
Healthways has been participating in the Medicare Health Support (MHS) pilot program, which seeks to improve the quality of care and life for people living with multiple chronic illnesses.
According to the Center for Medicare and Medicaid Services (CMS), only about 14% of Medicare patients have heart failure, but they account for 43% of Medicare spending. Similarly, about 18% of Medicare beneficiaries have diabetes, but they account for 32% of Medicare spending. Healthways was awarded contracts for services to 20,000 people in Washington, D.C., and Maryland. It has also subcontracted with CIGNA (NYSE: CI ) to administer its program in Georgia.
However, the program requires that Healthways, a Motley Fool Stock Advisor selection, achieve an average of 5% improvement in cost containment for the population over the life of the contract, which is three years. The fees that Healthways is paid are fully at risk because it had to guarantee net savings to Medicare to participate, and it has already suffered several million dollars' worth of revenue reversals. Healthways has noted that initial savings are usually minimal but expand as the program ages. The interim report released in January, however, suggests that the savings have not been what was anticipated and the cost per participant to Healthways was more expensive than forecast.
Even so, Healthways has been maintaining a rosy earnings forecast by including the benefits to be derived from successful inclusion in the program, despite evidence to the contrary that it was costing the company money each quarter. Until this quarter, that is, when management acknowledged at last that while still expecting to be successful, it would be dramatically scaling back full-year guidance to reflect a hit of $0.45 per share from the program.
Healthways also announced that it was going to continue in the program despite the gloomy outlook because the risk-reward ratio was tilted heavily in favor of "reward." Or so management says. There are a potential 42 million lives to be serviced, generating more than $22 billion if they're included in the second phase of the program.
The company has been trying to renegotiate its contract with HMS to reflect the fact that the population it's serving may have more intractable lifestyle choices that don't lend themselves to the interventions necessary to realize the savings originally outlined. There are other subsets of the population that are achieving the desired results, so the company believes pockets of the population represent a unique situation. There's been no change thus far in the MHS position for 2007, according to the company, or for next year, either, which is why it has finally revised its guidance.
The not-so-strange thing is that Healthways' core commercial business remains not only sound, but robust as well. Billed lives increased to 27.1 million in the quarter, and revenues increased 60% over the previous year, helped along by the company's acquisition of Axia this past December.
With existing contracts with WellPoint (NYSE: WLP ) and Humana (NYSE: HUM ) , and a new 10-year contract with Wellmark Blue Cross/Blue Shield, the commercial business remains the main provider of growth opportunities. It's just the huge question mark hanging over its participation in the Medicare program that causes me to hesitate advocating putting any new investment dollars into this company now.
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Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
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