Saturday, September 26, 2009

A Look at Aetna's (AET) Q2 Income Statement

One of the primary pillars which underpin arguments in favor of health insurance reform is the idea that health insurance companies earn "fat" profits, and it is these profits which stand in the way of an equitable health care system in this country. I feel that this concept has not been properly examined to determine it's validity, a surprising state of affairs considering we are mere weeks away from a possible overhaul of the entire health care system. Below I'll briefly walk through Aetna's (AET) income statement for the three months ended June 30th, 2009. I chose Aetna because it is sufficiently large - it's membership is greater than 45M across the medical,dental, and pharmacy network - to provide a representative view of the industry. The Company also operates in each of the 50 states in the US.

For the three months ended June 30th, 2009, Aetna reported revenues totaling $8,657.6M. I'd like to focus on a top line number that's more applicable to it's core business though - Health Care Premium Revenue - which totaled $7,030.5M for the quarter. During the same period, Aetna incurred Health Care Costs of $6,102.4M. Health Care Costs are essentially what the Company paid out in claims throughout the quarter. Using this measure alone, one might conclude that the difference between what Aetna received in premiums and what it paid out in claims - $928.1M - represents a relatively "fat" 13.2% profit margin. This sort of analysis ignores the fact that Aetna must pay it's 35,500 employees to administer this entire operation; this expense shows up in the General and Administrative expenses line item, which totaled $1,160.2M for the quarter.

You might be saying "what a second, based upon Aetna's three most core measures of revenues and expenses, it appears that they are $232.1M to the negative." This observation would be correct: Aetna is spending more on health care costs and salaries etc. than it is bringing in via premium revenues. We know however, that Aetna reported net income of $346.6M for the quarter; how do we reconcile this?

When you really get down to it, Aetna is relying on fees and investment income to break into the positive. These two items totaled $1,151.2M for the quarter. Once you add in one more revenue item - Other Premiums ($475.9M) - and net out Selling Expenses ($303.8M), Current/Future Benefits ($503.8M), Interest Expense ($60.7M) and Income Taxes ($168.8M), you are left with only $346.6M in Net Income.

What this means is that Aetna's Net Income ($364.6M) represents just 3.997% of it's total revenue ($8670.8) for the quarter. That ratio for Exxon (XOM) during Q2 was 5.3%, for Microsoft (MSFT) it was 23.2%, for Nike (NKE) it was 7.24%, for McDonalds (MCD) it was 19.3%, and for General Electric (GE) it was 7.3%. These figures actually defy some conventional wisdom, as most of the comparison companies own significant amounts of depreciable assets. Depreciation is recorded as an expense against net income, but it is not an event which affects cash flows. This accounting rule often leads to reported net income which is substantially lower than cash flow from operating activities (CFFO). Aetna's business however, deals in the somewhat intangible realm of insurance; thus, they do not benefit - from a taxable income standpoint - from the depreciation charges enjoyed by firm's having large amounts of physical assets.

Let's be honest here. If the government somehow forced Aetna to operate as a non-profit corporation, it would only allow the company to pay out an additional $515.4M (net income before taxes assuming non-profit status) in claims. This would only represent a 7.8% increase in quarterly claim payouts. This calculation of course assumes that the "new" Aetna would have an identical cost of capital to the "old" Aetna. The money just isn't there.

*long GE Sphere: Related Content

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