Health insurers have had a rough 2008. Health-care costs rose faster than the companies were banking on, which caused earnings to plummet and their stock prices to follow.

Just when the companies looked like they were in for a comeback, they've been hit with more than their fair share of collateral damage this week.


Year-to-date price change on 9/12/08

Price change this week through 9/18/08

UnitedHealth Group (NYSE:UNH)



Aetna (NYSE:AET)



Cigna (NYSE:CI)



WellPoint (NYSE:WLP)



Humana (NYSE:HUM)



Coventry Health Care (NYSE:CVH)



Source: Capital IQ, a division of Standard & Poor's

Considering that the S&P 500 fell just 7.6% this week, it seems that most health insurers are getting punished more than they deserve, especially considering that they're already at beaten-down levels.

Collateral damage
There's no clear reason why investors in health insurance companies should be panicking -- at least no greater reason than investors have for every other industry. Sure AIG (NYSE:AIG) was taken over by the government, but all insurers are not the same. In fact, it wasn't even AIG's insurance business that got it into trouble in the first place.

Health insurers make money the same way every other insurance company brings in the profits. They take premiums from customers, invest it in conservative investments, and then pay for services when they're rendered (or well after the fact if the insurer is trying to make an extra buck and doesn't mind ticking off doctors and hospitals).

The biggest ways insurers can get into trouble is if they underestimate their exposure to costs or if they make inept investments and lose their financial reserves. Rising health-care costs have put a lot of pressure on insurers this year, but there's not much evidence that the companies have made substantial poor investments.

OK, maybe just a little
The companies do keep some of their investment portfolio in bonds in other companies, and this can cause problems if the companies go belly up. Aetna reported this week that it's holding $132 million in debt from bankrupt Lehman Brothers and $102 million in AIG bonds. That might sound bad, but combined, they make up less than 2% of Aetna's holdings.

Humana also has $25.7 million worth of Lehman's bonds that make up about 0.5% of its portfolio and another $4.9 million secured by AIG. It also loaned out some of its investments and took $29.2 million worth of loans to Lehman as collateral. The securities swap is a short-term obligation, so hopefully it'll be able to get back its security and get rid of the now less-valuable collateral.

In any case, remember that these are bonds not equity. The companies should be able to get something out of them, although they may have to write down some of the investment.

This probably isn't the first time that health insurers have bought bonds in companies that have gone bankrupt, and it probably won't be the last. That's the price of investing, and it’s a further lesson that diversification is a key principal of investing -- whether it’s a large corporation or Joe Fool.

Buying opportunity
Before this brouhaha stated, health insurers were priced for very little growth. While the outlook for the rest of 2008 looked bleak as insurers were still catching up with the higher than expected health-care costs, eventually the companies' premiums should catch up to costs, and growth in the bottom line could continue.

This week's events have brought uncertainty to the health care companies, but at least some of the panic is probably unwarranted. Investors with the guts to buy could do well with a long-term investment at these beaten-down levels.

UnitedHealth Group and Coventry Health Care are Motley Fool Stock Advisor picks. Click here to start a 30-day risk-free trial of the newsletter and see all the Gardner brothers' current recommendations.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. UnitedHealth is a Motley Fool Inside Value recommendation. The Fool owns shares of UnitedHealth Group. The Fool's disclosure policy never panics.