Description

CIGNA is second largest healthcare provider in the U.S. behind AEtna. CIGNA’s estimated EPS is $6.66 for Calendar 2000 and $7.45 for 2001, imputing 12% in earnings growth. They have $2.2 billion in cash and $1.3 billion in long-term debt. For 1st Quarter 2000, CIGNA repurchased $521 million in stock, generated $448 million net cash from operations on over $4 billion in premiums and fees.

Many people view CIGNA as an HMO, now that they’ve sold their Individual Life, Property & Casualty and most recently, their Reinsurance business. But what differentiates CIGNA is their mix and types of business they are in. A rough breakout of their income from continuing operations shows 5% from International, 25% from Retirement and 70% from Group Life, Disability, and Healthcare (GLDH). Let’s analyze the 70% some more.

CIGNA’s GLDH business is written three different ways. One way is Guaranteed Cost (GC), which is true insurance, the second is Experience Rated (ER), which adjusts premium based on loss experience, and finally there is Administrative Services Only (ASO), where the employer fully funds the plans with CIGNA acting as the administrator and claims payer. As a percentage of premiums and fees, the percentages are GC – 55%, ER – 35% and ASO - 10%, but those numbers are misleading. While GC and ER are recorded with premiums and losses, ASO only reflects fees as premium and no losses.

With ASO, CIGNA will pay $100 in claims and, in turn, bills the employer $108 (8% fee is only as an example). CIGNA records just $8 as “premiums” and $0 for losses (ignoring expenses). However, $8 of ASO “premiums” is more profitable than $8 of GC, so CIGNA usually converts the ASO fees to premium equivalents. In my example the $8 ASO fee would become $108 in premium equivalents. Doing this conversion provides a clearer breakdown of CIGNA’s business: GC - 25%, ER - 15% and ASO - 60%. Apply those percentages to GLDH’s 70% income, and this gives us a better idea of how the income might be generated: GC – 18%, ER – 10% and ASO 42%. Factor out the life and disability for GC and ER, and you realize that less than 25% of CIGNA’s income from continuing operations is at “risk” from healthcare reform.

Catalyst

Gore has made healthcare a campaign issue, and an over-reaction from the market may drop CIGNA’s stock price further. It has already dropped 15% since its pre-DNC August high of $105.938; the fear of HMO class action lawsuits in 1999 drove it from $100 down to $60. Also, due to one-time charges and sales of its P&C and Reinsurance businesses, CIGNA’s trailing twelve months (TTM) earnings appear to be decreasing and its PE too high; hence, many stock screens might miss it. Using an estimated 2001 PE of 12 and EPS of $7.45, a fair price would be $89.40, but don’t buy it at that price! Watch the stock, and see if fear presents a better buying opportunity at $70 or under.