Humana's Hurting

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Humana's (NYSE: HUM) chart looks like steps in the Grand Canyon that go down to the Colorado River.

A day after the health-insurance provider took a 24% drop based on WellPoint's (NYSE: WLP) reduction of its 2008 guidance, Humana dropped another 14% yesterday on news that it would nearly halve its own guidance for the first quarter.

While WellPoint blamed its woes on higher-than-expected medical costs, Humana's gloomier outlook owes to a miscalculation in setting up its Medicare prescription-drug plans.

When Humana set up the plan, the Centers for Medicare and Medicaid Services (CMS) rules required it to lower the copayments on drugs because members are allowed to pay only a certain percentage of the total costs. But the company overestimated the use of high-cost drugs, when it should have assumed that members would substitute the lower-cost drugs that require lower copayments.

By lowering the copayments on drugs, Humana shifted more of the costs onto itself. That's bad enough, but the situation gets worse. Seniors who were taking high-cost medicines and looking for a deal found one in Humana's plans, which further increased its costs.

For Humana, the good news is that the problem is limited to this year. The Medicare plans reset every year, so it'll only have to carry the high costs of the plans for the rest of 2008. Hopefully, its 2009 plan is better constructed.

For the industry, the problem appears limited to Humana. The bigger issues surrounding rising health-care costs and lower member retention could still affect other companies in the industry. While Aetna (NYSE: AET) has reaffirmed its guidance, UnitedHealth Group (NYSE: UNH) was a little wishy-washy, saying "there may be pressure on first quarter and full year 2008 results" but that it was "premature to draw adverse conclusions."

Time will tell whether the industry is entering a small valley or the Grand Canyon, but one thing's for sure: First-quarter results for health-care companies will be interesting.

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