PacifiCare Halts Enrollment in 2 States

In a further blow to seniors who count on HMOs for comprehensive care, the nation’s largest Medicare HMO said Tuesday it is refusing to accept new patients in parts of Texas and Washington, and is considering doing the same in all but three counties in California.

The move comes as PacifiCare Health Systems Inc., which operates the Secure Horizons managed Medicare program, struggles to regain financial health in the face of low Medicare reimbursement rates and higher expenses. The Santa Ana-based company said it might lose up to 10 cents per share in the third quarter ended Sept. 30.

“The company has reached a turning point,” said PacifiCare President and Chief Executive Robert O’Leary. “It’s a moment of important concern.”

The announcement sent PacifiCare shares down $11.63, or 36%, to $21 in after-hours trading, after closing at $32.63, down 88 cents, on Nasdaq before the earnings warning was released.

In order to return the company to profitability, O’Leary said, he will examine every aspect of its business, including its involvement in Medicare, but will make no precipitous moves.

PacifiCare will also decide over the next several months whether to freeze enrollment in other areas, but it will not do so in Los Angeles, Orange and San Diego counties, O’Leary said.

Some of the areas under consideration are places where other health maintenance organizations are planning to exit the Medicare business next year. PacifiCare executives are worried that they do not have enough doctors and hospitals under contract to absorb all of the potential new members, O’Leary said.

The decision to halt enrollment is also the result of continued financial trouble at PacifiCare, O’Leary said, much of which has been caused by low rates paid for Medicare members by the government.

At best, the company will just break even in the third quarter to a loss of as much as 10 cents, O’Leary said. By contrast, Wall Street analysts had anticipated earnings of $1.90 per share, according to First Call/Thomson Financial.

“I am surprised at the magnitude, but I am not at all surprised that there is a shortfall here,” said Todd Richter, a Banc of America Securities analyst.

PacifiCare, he said, has relied too heavily on outmoded methods of paying doctors and hospitals and on the federal Medicare program, which is chronically underfunded. It will take years, he predicted, for the company’s new management team to repair the damage.

In large part, PacifiCare’s troubles stem from its recent move away from a method of paying doctors and hospitals known as capitation, in which the HMO paid a specific amount of money each month--whether or not the amount was enough to cover the actual costs of caring for a patient.

PacifiCare clung to the capitation method, which basically shifts the financial risk for health care from a health plan and puts it on doctors and hospitals, long after other health plans had abandoned it.

But hospitals and some doctor groups rebelled, and now more than half the facilities where PacifiCare patients are treated demand that the HMO pay higher rates.

That, according to O’Leary, resulted in $70 million to $75 million in increased costs during the second quarter alone.

“The move away from capitation has had to be devastating for health plans that practiced it,” said Sheryl Skolnick, analyst at Robertson Stephens. “PacifiCare was especially at risk because they were the biggest practitioner.”

Meanwhile, as many physician organizations in California are on the verge of bankruptcy, PacifiCare has set aside $25 million to take care of patients if the groups falter or go under.

PacifiCare said higher costs will cut $120 million to $130 million off its third-quarter pretax earnings.

An equally powerful factor in PacifiCare’s financial situation is its dependence on Medicare.

Many HMOs have dropped out of the Medicare business, as has PacifiCare’s Secure Horizons in many parts of the country. But with 1.1 million members in the Western United States, the company remains deeply invested in Medicare--a commitment that has earned it disdain on Wall Street and now, financial troubles. The company expects its profit margin from Medicare to decrease in the third quarter, with about 93 cents of every premium dollar going to pay for care, up from 89 cents last year.

Bloomberg News contributed to this report.