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PacifiCare Payment Shift Worries Wall St.

Health care: As the company pays more for patient care, analysts fear earnings could suffer.


A decision by PacifiCare Health Systems Inc. to pay doctors and hospitals more to cover the cost of patient care has pleased health-care providers, but it is raising concerns on Wall Street.

On Thursday, shares of the Santa Ana-based company dropped 14.3% on the Nasdaq Stock Market, falling $9.63 to close at $57.56 even though the company posted quarterly earnings late Wednesday that beat analysts' projections.

By comparison, shares of UnitedHealth Group, which has consistently reduced the amount of financial risk it takes on as an insurer, rose $1.31 to close at $84.94 on the New York Stock Exchange, as United reported a 26% increase in second-quarter net income. Shares of many other health maintenance organizations also rose Thursday, with the major exception of Humana Inc., which fell 3% after reporting a 47% drop in quarterly earnings.

PacifiCare is "entering a period where we're going to see higher volatility on medical costs," said health-care analyst John Rex at brokerage Bear Stearns in New York, who downgraded the stock to a "neutral" rating Thursday.

Strategically, Rex said, PacifiCare is doing the right thing by backing off from its model of forcing hospitals and doctors to pay for all aspects of patient care out of a fixed monthly fee. Such a policy--once rewarded by Wall Street as a way to provide health coverage without taking on a lot of financial risk--is now blamed for the financial strains besetting doctors and hospitals, and for causing uncertainty for risk-averse investors.

But the change caused the company to pay about a penny more of each premium dollar for medical care last quarter. And that amount is likely to rise even further by year's end, Rex said.

Robert O'Leary, who took over as PacifiCare president just last month, said Thursday he believes the firm will show Wall Street over the next two quarters that it can manage the new payment system well without damaging earnings.

"We have to prove to Wall Street that we can do it," acknowledged O'Leary, a longtime hospital industry executive who made the jump to managed care.

But analyst Todd Richter at Banc of America Securities said PacifiCare's troubles with investors are more complicated.

For one thing, he said, although the company has significantly reduced the number of patients whose hospital care must be paid for entirely by providers--from more than 80% to about 60%--most are still covered under the fixed-fee arrangement. And the company has reduced the number of patients whose doctors are on such arrangements only from 96% to 90% since the beginning of the year.

PacifiCare is also suffering from investor skittishness about its new management, and from the continuing perception that it is too heavily invested in the federal Medicare program.

Other HMOs have steadily quit Medicare--dropping nearly 1 million seniors just this year. They cite low federal reimbursements, saying the government does not pay enough to cover the cost of providing comprehensive care for seniors.

But PacifiCare, while it dropped tens of thousands of seniors in the last two years, has steadfastly remained in the program in many areas, including California.

Company officials have maintained that the federal government will soon offer relief to health plans in the form of increased payments.

But Sheryl Skolnick, analyst at Banc Boston Robertson Stephens, said it is unlikely in an election year that Congress or the Clinton administration will be willing to be viewed as offering money to managed-care companies.

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