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HMO stocks: Case critical?
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October 1, 1999: 2:01 p.m. ET
For investors, class-action threat has made healthcare stocks a lot riskier
By Staff Writer Martha Slud
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NEW YORK (CNNfn) - Health maintenance organizations, already battling earnings woes, federal budget cuts and a much-maligned public image, are facing a new threat: Some of the country's best-known trial lawyers are on the warpath.
And for investors, Wall Street experts warn, this is an already volatile sector that virtually overnight has become a whole lot riskier.
Healthcare stocks plummeted this week in the wake of news that some of the most powerful plaintiffs' lawyers in the U.S. are shifting their focus from multibillion-dollar lawsuits against the tobacco industry to class-action cases against HMOs on behalf of millions of patients.
Charging that the managed care industry has sacrificed quality care for profits and hasn't passed savings on to consumers, these attorneys plan to test the waters in what previously had been an industry considered virtually immune from class-action suits.
The sector lost billions of dollars in market capitalization Thursday after reports of the planned litigation broke, and stocks continued their slide Friday. Stocks that have been hit hard include Aetna (AET), the largest HMO with about 22 million people enrolled in its plan, Humana (HUM), PacifiCare Health Systems (PHSY), WellPoint Health Networks (WLP), Cigna (CI) and Oxford Health Plans Inc. (OXHP).
While healthcare stocks have been especially volatile over the past few years amid earnings troubles and a fight with Washington over Medicare reimbursement cuts, this news hit the sector especially hard.
That's because the development was unexpected - and it also adds multitudes of uncertainty to the future of the industry if these suits proceed, analysts said. Some experts said the entire managed-care industry could be jeopardized if a "Pandora's box" of class-action litigation is unleashed.
"There are good HMOs that promote quality care and lower cost and there are bad HMOs that make bad care decisions for bad reasons," said Robert Hoehn, health-care analyst at ING Barings. "When you`ve got 650 HMOs, what you need to do is eliminate the bad ones without ruining the economics of the good ones."
Already, many HMO stocks are considered trading vehicles more than long-term investments. Several brokerages slashed their outlook on these stocks in the wake of Thursday's sell-off, and are advising investors that they could be in for a rough ride for the foreseeable future.
"This injects a whole new element to the situation -- the involvement of the trial lawyers," said Edmund Kroll, a heath services analyst at SG Cowen & Co. He said that investors are starting to view the sector with the unease associated with tobacco stocks, which have priced the threat of multibillion dollar damages into share prices and whose investors continually have an eye on litigation.
Wall Street unnerved
Wall Street is particularly wary of the situation because no one knows what strategy the plaintiffs' lawyers will take and what the potential damages could be if they prevail, said William McKeever, an analyst at PaineWebber.
"This is new information," he said. "There has not been a group of determined lawyers coming after them like this, and I think that, combined with what's going on in Washington, there's too much risk for a lot of investors."
The trial lawyers reportedly crafting cases include Mississippi-based Richard Scruggs, who helped win a landmark settlement at the state level against the tobacco industry, and the firm of David Boies, the lawyer who currently is representing the government in the antitrust case against Microsoft Corp. A Washington law firm that helped win a record settlement from Texaco Inc. in a discrimination case, Cohen Milstein Hausfeld & Toll, also says it is gearing up to file a case.
HMOs have faced a slew of malpractice cases filed by individuals, but up until recently the companies were seen as virtually immune from major, class-action cases through a quarter-century-old federal law that protected them from such suits.
But earlier this week, the Supreme Court agreed to rule on whether a patient may sue a health-care provider under the federal law when cost-cutting policies by HMOs determine treatment. The case involves an Illinois woman whose doctor, acting out of an effort to reduce costs, delayed performing tests that may have revealed appendicitis. The woman's appendix burst before the tests were performed.
In addition, there's uncertainty in Washington over what Congress will do over various proposals on the table to expand patients' rights to sue their HMOs. A debate is scheduled to take place next week in the House of Representatives.
"I think perhaps the trial lawyers smell blood in this industry," said Kroll. "We don't know what their tactics may be."
Bright spots?
While Kroll has cut his ratings on several of the major HMO stocks, including Aetna, Foundation, PacifiCare and Humana, he said that for long-term investors there are a few companies to consider that may be relatively unharmed by any potential litigation.
He has kept a "strong buy" rating on United Healthcare Group (UNH) despite its sharp drop the past two days, saying that the company gets as much as 40 percent of its earnings from non-HMO businesses, including its medical information systems unit and disease management division.
Another of Kroll's choices is First Health Group (FHCC), which isn't an HMO in the traditional sense but instead manages care on behalf of large-self-insured businesses. Because this type of managed care business does not take on underwriting risk, he says, he doesn't think the company would be the target of lawsuits.
Meanwhile, Hoehn recommends investors take a look at United, as well as Foundation Health and CIGNA.
McKeever, who has retained his ratings on the stock despite this past week's turmoil, recommends United, Cigna and WellPoint. He has neutral ratings on Aetna, PacifiCare and Humana.
He thinks the worst of the sell-off likely is over, though he said the upcoming debate in Congress next week is a cause for concern. Plus, he said, investors are awaiting more information about these lawsuits, which are expected to be filed in the next few weeks.
"There's a lot of legal issues that have to be sorted out," he said. "There's been a void of information." 
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CIGNA
Aetna
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