The HMO (Almost) Nobody Hates UnitedHealth can't really be this good--can it?
By David Stires

(FORTUNE Magazine) – Sitting in his pristine office overlooking a hilly Minnesota campus, Bill McGuire furrows his brow. A visitor has just referred to his company, UnitedHealth Group, as a "health insurer." And though the firm is, in fact, the largest provider of medical coverage in the U.S.--bigger than Aetna, or WellPoint, or Humana, or Cigna--being called a health insurer clearly irks this CEO. When asked what McGuire's biggest contribution to the world of health insurance has been in his 12 years as boss, the bearlike 55-year-old doctor fires back: "Not thinking of it as health insurance."

Poke into McGuire's $25-billion-a-year empire and you can see why he's touchy. Though UnitedHealth is a defendant with other big insurers in a class-action suit in Miami federal court (more on that later), the company has otherwise largely distanced itself from its rivals. Unlike Aetna, it has never made headlines because hundreds of disgruntled physicians fled its network in protest over slashed reimbursement rates. Unlike WellPoint Health Networks and others, UnitedHealth has never received a failing grade on one of its health plans from the National Committee of Quality Assurance, the leading HMO watchdog group. And unlike Humana, it has never had a case--a horror story in which a patient died after a medical reviewer denied a heart transplant--made into a movie, as Humana did with Showtime's recent Damaged Care.

Even industry critics tend to like UnitedHealth's style. "United's health plans are delivering superior care and service," says NCQA spokesman Barry Scholl. Adds Ron Pollack, executive director of Families USA: "They certainly have the reputation of being one of the more thoughtful companies."

UnitedHealth has made itself different--and dominant--by boldly abandoning some of the most despised practices of managed care. It won national praise in 1996 by rolling out a plan that lets HMO members see a specialist without obtaining a referral from a primary-care doctor. It scored again in 1999 by giving doctors--not administrators--final say on what treatment or test a patient needs. Such patient-friendly innovations have been a powerful magnet for customers. UnitedHealth has steadily increased the number of Americans it insures, now 18 million. In the past five years it has added four million members, by far the strongest organic growth rate in the industry, according to Merrill Lynch analyst Roberta Goodman. And though its plans are more expensive than average, the company provides coverage for employees of approximately half of FORTUNE 500 companies.

That's just for starters. UnitedHealth has bolstered its performance by pushing into businesses that have nothing to do with deductibles or co-pays, all driven by McGuire's vision that the corporate mission is to improve access to all health services, not simply to provide insurance. UnitedHealth coordinates organ transplants, runs clinical trials for drug and medical-device companies, and provides home-care services to the elderly.

Put it all together, and the number of Americans the company touches totals 50 million. Such diversification pays. UnitedHealth's $22 billion health-care-services segment, which includes the core health plans, has increased revenues a steady 7% to 8% a year for three years; with operating margins of about 5%, in line with its peers, the unit accounts for 60% of UnitedHealth's operating earnings. But the $1.5 billion specialized-care-services unit, which provides everything from dental benefits to organ-transplant assistance, has been growing between 20% and 34% a year. With its outsized 18% margins, it accounts for 13% of earnings.

The company's vast reach has undeniably been good for shareholders. Last year UnitedHealth earned $1.4 billion, making it the most profitable major health insurer. During McGuire's tenure, the stock has increased an average of 29% a year, beating the 9% return of the S&P 500 by a huge margin. And UnitedHealth sports a spectacularly high 30%-plus return on equity, a figure it shares with blue-chip firms like Coca-Cola and Procter & Gamble. Its P/E ratio, though, is far lower--17 times this year's projected earnings, vs. 23 for Coke and 22 for P&G.

So what's not to like? For one thing, employers are struggling; how can insurers keep passing along soaring health-care costs? Heavy consolidation in the managed-care sector means fewer acquisition candidates; Congress is weighing in on prescription drugs; the states are buckling under the costs of Medicaid; presidential hopefuls are making universal health coverage a central theme--the list goes on and on. And UnitedHealth has its own size to contend with as it tries to grow. Says industry expert Ken Abramowitz of the Carlyle Group: "They're running into the law of big numbers." To every challenge, McGuire's answer is the potent medicine he has always prescribed: stubborn go-your-own-way innovation.

UnitedHealth was a poky little $440-million-a-year regional HMO when Bill McGuire arrived in 1988. But innovation was in the company's DNA. The business traced its roots to Dr. Paul Ellwood, the health-policy guru who coined the term health maintenance organization in the 1960s and helped entrepreneur Richard Burke found UnitedHealth in 1977. A Troy, N.Y., native who earned his medical degree at the University of Texas, McGuire had worked as a researcher and practiced pulmonary medicine. In 1985 he joined an HMO as medical director and soon became CEO. UnitedHealth bought the company, and in three years McGuire rose to the top.

From the start, McGuire envisioned a company that was about much more than the dull tasks of collecting premiums and paying out benefits. He likes to view UnitedHealth as a force to transform medicine. "We are trying to make the system work better," he says. He made the company a trailblazer in part by resisting fads in managed care. In the early 1990s a trendy way to rein in costs was with the "staff model" HMO, a health plan that owns medical centers and staffs them with doctors as direct employees of the plan. McGuire bucked the fad in part because it limited patient flexibility.

Instead, UnitedHealth developed practices that would boost its appeal to patients and benefits managers. In 1992 the company was the first to issue "consumer report cards" on its plans, surveys that rated quality, cost, and other factors. That jolted competitors, yet like many UnitedHealth initiatives, the practice soon became an industry standard. In 1997, UnitedHealth implemented the first "tiered" drug-benefit plan, in which patients pay less for generic drugs and more for brand-name prescriptions.

But the medical giant's most significant innovation was to abolish the practice of requiring doctors to ask permission when ordering treatments. Known as prior authorization, the policy is one of the most fundamental--and detested--mechanisms whereby HMOs try to contain costs. But by mining its case-history database, UnitedHealth discovered that the cost savings were an illusion: Though the company had spent millions of dollars each year to scrutinize doctor decisions, pressure from doctors and patients was so great that its examiners had ended up approving 98% of the requests. McGuire axed the policy in 1999; in its place, UnitedHealth pushes doctors to practice better medicine by meeting nationally accepted benchmarks for recommending mammograms, prescribing beta blockers for heart-attack survivors, and so on. Consumer advocates hailed the change as a milestone.

As McGuire pursued his vision, he also developed a taste for acquisitions. In 1994 he sold UnitedHealth's pharmacy-benefit manager unit, Diversified Pharmaceutical Services, to a drug company for $2.3 billion--an astounding sum that was nearly 29 times the unit's $80 million in annual sales. He put the cash to work a year later by purchasing MetraHealth, a joint venture owned by Metropolitan Life Insurance and Travelers Group, for $1.6 billion. As a provider of health insurance to nearly half of all FORTUNE 100 companies, MetraHealth gave McGuire immediate national clout.

That leap positioned UnitedHealth to go after what would be one of McGuire's biggest victories: a blockbuster contract with AARP, the nation's largest organization for seniors, to offer supplemental health benefits such as Medigap insurance to its 35 million members. The ten-year deal, signed in 1997, gave UnitedHealth not only $4 billion or so in added annual revenue but also entree into the rapidly growing market of health care for the elderly. UnitedHealth has rolled out new offerings to expand that franchise, such as Evercare, a $600-million-a-year program that coordinates home care and other services for frail seniors. President Bush hailed it in a speech on Medicare reform last year.

Life as a health insurer isn't all sweetness and light and Presidential "attaboys," of course. Virtually the entire managed-care industry is the target of a massive class-action lawsuit in which UnitedHealth and more than a dozen rivals are accused of shortchanging some 700,000 doctors on payments and denying millions of Americans promised medical care. The litigation, which began as separate suits in the late 1990s in various state and federal courts, was consolidated and is now making its way through a federal court in Miami. UnitedHealth and others recently settled the patients' case for token amounts, but the doctors have begun to wrest major settlements. In May, Aetna agreed to a $450 million settlement in which it will pay doctors $100 million and reform its business practices. UnitedHealth has vowed to keep fighting.

McGuire and his lieutenants also have come under fire for their lofty pay. His total compensation last year approached $25 million, and he holds over $500 million in options; Steve Hemsley, his COO, made more than $11 million and holds over $200 million in options. Says McGuire: "I'm not apologetic for the company's performance, or the fact that I or anyone else has become well-off." Besides, he says, "if you go to Silicon Valley, we're paupers."

Whether he ends up being remembered more for accomplishments or greed will depend largely on whether McGuire can keep UnitedHealth growing. Investors lately have become a bit leery. Stocks across the industry dipped in August when Cigna, Oxford, and others announced that they had lost members during the second quarter. UnitedHealth said in July that its membership, too, had fallen--a rare slip for the company, even though the decline was a scant 0.5%. Big employers, including Costco, Deere, and Verizon, have said health costs are hurting earnings, prompting some analysts to speculate that they will get more aggressive negotiating next year's rates.

Despite such concerns, UnitedHealth foresees nothing but growth. Medical costs will rise 10.5% to 11.5% next year, it predicts, and, thanks to the popularity of its plans, it expects to be able to raise premiums slightly more than costs. Overall, McGuire sees earnings per share growing by 18% to 20% next year. That's way off from their 30%-plus growth in each of the past three years, but well above the expected industry gain of 15%. The increases he expects should come in part from entering new markets. Opportunity No. 1, in McGuire's mind: America's 41 million uninsured. He has written every member of Congress calling for a minimum health-benefit package to be made available to all Americans and funded by both the government and private sources. Not surprisingly, McGuire says the private sector should offer the packages, and you can bet he is lobbying hard to promote this idea. UnitedHealth is one of the top political contributors in health care--and by far the largest donor among health insurers--with contributions totaling more than $2 million during the 2000 and 2002 elections.

The company isn't waiting on Congress to help it grow. Taking advantage of its Dell-like $2.4 billion a year in positive cash flow, it is on the acquisition trail--last year it paid $530 million for AmeriChoice, a $900 million-a-year leader in Medicaid health insurance. UnitedHealth is also counting on expanding its market share--despite its size, it is still a minor player in many sectors. In health insurance to small and midsized employers, for instance, it serves eight million people, only a 7% share nationally. The company likes to point out it currently manages less than 3% of the $1.5 trillion Americans spend on health care each year.

To help change that, McGuire is continuing to roll out new products. Over the next 18 months UnitedHealth will distribute a novel consumer ID card to all of its members. By swiping a patient's card through a regular MasterCard reader, doctors will immediately be able to tap into benefit and eligibility information, thereby eliminating expensive phone calls to the company. Members may eventually be able to use the card to pay for medical services from an employer-funded health savings account--and inevitably, more and more of that $1.5 trillion a year would flow through UnitedHealth. Even for an innovator like McGuire, it's hard to imagine a better kind of growth insurance.