ANALYSIS: Health insurance companies are on a stock buyback binge

Introduction

Ever wonder what happens to the premiums you pay for your health insurance?

You might be surprised to learn that more and more of the dollars you pay for coverage are being sucked into a kind of black hole.

It doesn’t really disappear, of course. It just doesn’t do you a bit of good—unless, of course you believe it is to your advantage that it ultimately winds up in the bank accounts of a few investors and insurance company executives, including those who have to power to deny coverage for potentially life-saving care.

If you’ve been paying attention to what health insurance company CEOs have been saying to Wall Street over the past several months, you will know that they are spending more and more of their firms’ cash—which comes from you, of course—to “repurchase” their firms’ stock. And Wall Street absolutely loves that.

I once handled financial communications for CIGNA. So I knew that whenever the company could tell its shareholders that the amount of money it earned on a per share basis during the preceding three months was more than expected, those shareholders and other investors would likely show their appreciation by offering to buy even more shares of the company’s stock. When more investors are buying stock in your company than are selling it, the stock price will go up. And when that happens, everybody who owns stock or can cash in a bunch of stock options—including you, if you are a senior manager or a health plan medical director—will suddenly be richer.

Being very familiar with how and why this happens, your company’s top executives will do whatever they can make sure the earnings per share (EPS) exceeds Wall Street’s expectations. One of the ways they do this is by joining the investors in buying shares of the company’s stock. They are actually repurchasing or buying back those shares because it was the company that initially put the shares on the market in the first place.

When CIGNA announced on May 5 that its adjusted income from operations for the first quarter of 2011 was $1.37 per share compared to $1.01 per share during the same quarter in 2010, the company’s stock price hit a 52-week high. The EPS was way more than investors had expected.

You had to read all the way to the bottom of page two of CIGNA’s earnings release, however, to learn that one of the ways the company was able to achieve such an impressive increase in the EPS was by buying back a whole lot of the company’s shares.

CIGNA’s net income for the first quarter of this year was $429 million. So what did the company do with its wealth? Well, between January 1 and May 4, the company repurchased approximately 4.9 million shares of its own stock for $210 million.

The magic works like this: when you buy back shares of your own stock, those shares are “retired,” meaning that there are fewer shares outstanding. Reducing the number of shares available for purchase changes the mathematical equation used to determine the EPS. The reduction gives the EPS a boost. The more shares you buy back, the bigger the boost.

All of the big for-profit insurers have been on a buyback binge lately. Humana executives announced a few weeks ago that it would be buying back $1 billion of its own shares between now and June 2013. That’s a lot of money, of course, but nothing compared to what UnitedHealth said it plans to do. UnitedHealth’s executives said the company plans to repurchase up to 110 million shares in the coming months. If UnitedHealth were to buy all those shares today, while the stock price is trading at around $50 per share, it would be spending $5.5 billion (of money that came from you, if you are a UnitedHealth policyholder) to make all those shares of stock go poof.

Stock options increase in value as long as the price per share goes up. Inflating the EPS by reducing the number of shares outstanding is almost always a sure-fire way to make sure executives have stock options with considerable value.

U.S. executives are as rich as they are primarily because of stock grants and stock options they are awarded by their companies. They love buybacks because, even though the cash deployed that way cannot be used for purposes that might be of greater value to the company as a whole and its customers, buybacks can increase their net worth dramatically.

In 2007, American companies spent 12 percent more on repurchases than they spent to improve their businesses, according to Fortuna Advisors, a financial consulting firm. The buybacks slowed after that year as a result of the economic downturn but are back in favor. According to data from Standard & Poors, U.S. companies bought about $86 billion of their own stock in the fourth quarter of last year, compared to $47.8 billion in the same quarter in 2009.

The advocacy group Health Care for America Now (HCAN) discovered while compiling data of health insurers’ earnings that between 2003 and 2010, the five largest for-profit insurance firms spent $64.1 billion on share buybacks.

As HCAN president Ethan Rome testified earlier this month before the House Energy and Commerce Subcommittee on Health: “Buybacks don’t improve operations, make the health system run more efficiently or reduce premiums. Their sole purpose is to boost stock prices” for the benefit of investors and executives.

Meanwhile, 51 million Americans are uninsured and another 25 million are underinsured, largely because of the actions insurance company executives take to enhance their firms’ bottom lines, and to line their own pockets.

News analyst Wendell Potter , a former insurance company executive, is the author of “Deadly Spin: An Insurance Company Insider Speaks Out on How Corporate PR Is Killing Health Care and Deceiving Americans.”