The New York Times - USA (2020-08-06)

THE NEW YORK TIMES BUSINESSTHURSDAY, AUGUST 6, 2020 Y B5

shares.
In June, the government stood
by as Cerberus hounded the chair-
man and chief executive of Com-
merzbank from their jobs, criticiz-
ing them for incompetence in let-
ters to the board that were leaked
to the press. That seemed to set
the stage for bringing in new man-
agement more to the firm’s liking.
But on Monday, the govern-
ment backed a new chairman over
the vehement objections of Cer-
berus, which said the nominee,
Hans-Jörg Vetter, was not “the
right person for this job.”
The nomination of Mr. Vetter,
who has spent his career at pub-
licly owned banks, is a setback for
Cerberus as it tries to salvage
some of the big investment it
made in German banks in 2017. It
was also a reprieve for political
leaders fearful of severe job cuts.
Still unanswered is the question
of how Commerzbank will arrest a
long-term slide that mirrors the
decline of the banking industry in
Europe’s largest economy. Weak-
ened by the last financial crisis,
Commerzbank has struggled to
compete in the overcrowded Ger-
man banking market. And
Deutsche Bank, Germany’s larg-
est bank, in which Cerberus also
owns a stake, has fallen far behind
American rivals like Goldman
Sachs and JPMorgan Chase.
Germany has long had a com-
plicated relationship with private
equity. Sometimes politicians
have vilified buyout firms as “lo-
custs” stripping the German
economy; other times, private eq-
uity money has been a welcome
lifeline for troubled companies.
That was the case in July when
private equity firms Advent Inter-
national and Cinven bought
Thyssenkrupp’s elevator busi-
ness for 17.2 billion euros, or $20.2
billion.
Cerberus bought 5 percent of
Commerzbank and 3 percent of
Deutsche Bank in 2017, wagering
that the worst of their problems
were over and they were ripe for
turnaround. Commerzbank was
crawling out from under a pile of
bad loans to the shipping industry,
and digesting an ill-advised
merger with rival Dresdner Bank.
Deutsche Bank was whittling
down its holdings of high-risk de-
rivatives.
The optimism was premature.
The banks’ shares have since lost
half their value, wiping out hun-
dreds of millions of euros of Cer-
berus’s investment. An attempt to
merge the two banks failed last
year.
Cerberus’s attempt to wring
some profit out of the two banks
pits it against a German banking

system structured to provide

cheap credit to industry, not re-

turns for investors.

Germany has more banks than

it needs, and lending is dominated

by quasi-public savings institu-

tions and cooperative banks driv-

en as much by political impera-

tives as commercial interests.

Strict labor laws and powerful un-

ions make it difficult to lay off

workers and cut costs. Change

does not happen quickly.

This year, Commerzbank and

Deutsche Bank, like most Euro-

pean and American banks, have

had to set aside hundreds of mil-

lions of euros to cover losses from

problem loans. Low interest rates

have made it difficult for them to

make money issuing loans. On top

of that, Deutsche Bank is still re-

covering from past wrongdoing,

including rigging interest rates,

laundering money and violating

United States sanctions against

countries like Iran.

On Wednesday Commerzbank

reported a net profit of 220 million

euros ($260 million) for the sec-

ond quarter, down 20 percent from

a year earlier. The bank said it

would end the year in the red be-

cause of restructuring measures

that it did not specify, but are

likely to include job cuts and clos-

ing of branch offices.

Deutsche Bank, Germany’s

largest bank, reported last week

that it eked out a net profit of 61

million euros, or $72 million, in the

quarter.

Cerberus has also pushed for

change at Deutsche Bank. Under

pressure from the firm, the bank

has sped up efforts to cut costs

and taken Cerberus’s advice on

how to run operations like cash

management. The bank hired a

unit of Cerberus to provide advice

on how to make its operations

more efficient, though it ended the

relationship last year after other

investors complained about po-

tential conflicts of interest. Any

friction between Deutsche Bank

and the firm has been kept out of

public view.

Commerzbank was not so co-

operative. By Cerberus’s count, its

banking specialists met with top

executives of Commerzbank 70

times to offer suggestions for im-

proving operations and profit, but

was ignored.

“Unfortunately, it is a matter of

fact that Commerzbank has not

yet embraced or executed on any

of our suggested actions,” Cerber-

us wrote to management in June.

Typically Cerberus works be-

hind the scenes. But its frustration

with Commerzbank broke into

public view after it savaged the

two highest-ranking managers in

letters that were leaked to the

press.

“Management’s ill-conceived

and poorly executed attempts to

prevent Commerzbank’s demise

display a level of negligence and

arrogance we are no longer will-

ing to tolerate,” Cerberus wrote in

June to Stefan Schmittmann,

chairman of the bank’s supervi-

sory board.

That letter and a second a week

later were signed “Cerberus Capi-

tal Management” rather than by

any employee of the firm, which

was founded by billionaire

Stephen Feinberg. Cerberus de-

clined to comment.

Cerberus’s sharp tone was a

shock to Frankfurt’s insular bank-

ing community, as was its cheeky

demand to be able to name two

members of the Commerzbank

supervisory board. That would

give the firm as much clout on the

20-member board as the German

government.

Mr. Schmittmann and Martin

Zielke, the chief executive, an-

nounced their resignations weeks

later. Both men insisted that Cer-

berus had not driven them out, but

acknowledged they had lost the

support of shareholders.

Commerzbank’s strategy “was

perceived as not being ambitious

enough,” Mr. Schmittmann said in

a statement to bank employees.

“Martin Zielke and I take respon-

sibility for this.”

Score one for Cerberus. But

then, on Monday, the supervisory

board nominated Mr.

Schmittmann’s replacement: Mr.

Vetter, former chief executive of

Landesbank Baden-Württem-

berg, which is owned by state and

local governments in southwest-

ern Germany. Cerberus did not re-

gard him as having the experience

to fix Commerzbank.

Mr. Vetter will oversee selection

of a new chief executive for Com-

merzbank, reducing the chances

that the person will meet the ap-

proval of Cerberus.

The government holds two

seats on the Commerzbank board,

and one of its representatives,

Jutta Dönges, led the search for a

new chairman. The federal gov-

ernment “exerts no influence over

Commerzbank decisions on busi-

ness policy,” the German Ministry

of Finance said in a statement.

Cerberus’s investment in Com-

merzbank and Deutsche Bank

was a departure for the firm. Like

most private equity companies, it

typically buys controlling stakes

in troubled companies and installs

its own management team. A

mere 5 percent stake would not

normally give Cerberus the clout

it is used to.

Cerberus’s losses on Com-

merzbank forced it to copy the

hardball tactics used by activist

investors. Firms like Elliott Man-

agement typically buy enough

shares in a company to make trou-

ble, then agitate unrelentingly for

changes. Attacks on the compe-

tence of top executives are part of

the playbook.

Cerberus is one of several pri-

vate equity companies that have

increasingly been adopting such

methods, according to a report

this month by investment bank

Lazard. Because private equity

shareholders are relatively new to

the game, managers may have

been caught off guard by the new

tactics, said Rich Thomas, a man-

aging partner at Lazard who is

head of a team in Europe that ad-

vises companies on how to deal

with activist investors. He is not

advising Commerzbank.

Activist investors, including

private equity firms, Mr. Thomas

said, “are highly engaged and

have to be taken seriously when

they voice concerns.”

U.S. Private Equity Pressuring Commerzbank Runs Into Resistance

Any friction between Deutsche Bank, above, and Cerberus has been kept out

of public view. Left, top Commerzbank executives Martin Zielke and Stefan

Schmittmann both resigned, saying they had lost shareholders’ support.

FELIX SCHMITT FOR THE NEW YORK TIMES

RALPH ORLOWSKI/REUTERS

FROM FIRST BUSINESS PAGE

pharmacy benefit manager and a
drugstore chain, said net income
for the second quarter reached $3
billion, about $1 billion more than
it reported for the same period of
2019, on revenues of $65 billion.
Others had already trumpeted
blockbuster results, ensuring that
their stocks weathered swings in
the markets. Anthem’s net income
soared to $2.3 billion for the sec-
ond quarter, from $1.1 billion in
2019, while UnitedHealth re-
ported net earnings of $6.7 billion,
compared to $3.4 billion for the
same three months last year.
Although many hospitals have
been overwhelmed by the coro-
navirus outbreaks raging from
state to state, insurers have
shelled out billions of dollars less
in medical claims in the last three
months because expensive, elec-
tive surgeries have been post-
poned in many places. Moreover,
people have steered clear of doc-
tors’ offices and emergency
rooms in fear of contagion.
The companies’ staggering
pandemic profits stand in stark
contrast to the scores of small
medical practices and rural hospi-
tals that are struggling to stay
open. And the earnings are
putting a spotlight on the big in-
surance companies at a time
when government officials in
many states are facing massive
budget shortfalls as businesses
collapse, unemployment rises and
tax revenues plummet. Some
states are discussing cutting pay-
ments to insurers that offer Med-
icaid plans to their residents.
“This could tilt the politics
against insurers on a whole num-
ber of fronts,” said Larry Levitt,
the executive vice president for
health policy for the Kaiser Fam-
ily Foundation, a nonpartisan re-
search group.
And in this presidential election
year, the companies’ overly buoy-
ant position could also reignite a
discussion among Democrats
about “Medicare for all,” a pro-
posal that would replace the cur-
rent private health care system
with a government one that guar-
antees coverage for all U.S. resi-
dents.
“We’re looking at the fact that
health care can’t be regulated by

the marketplace,” said Represent-

ative Pramila Jayapal, the Wash-

ington State Democrat who is a

strong proponent of Medicare for

all.

“Who knows what’s going to

happen by January?” Ms. Jayapal

asked. “It’s entirely possible that

everything shifts on health care,

within weeks or months after the

election.”

Some lawmakers may also try

to revive proposals to cap insur-

ers’ profits even more, like one

that Senator Elizabeth Warren,

the Massachusetts Democrat, has

suggested.

“There is that money sitting

there,” said Dan Mendelson, the

founder of Avalere Health, a con-

sulting firm.

Among the companies with ro-

bust earnings is Humana, which

reported Wednesday that its net

income rose to $1.8 billion for the

second-quarter, compared to $940

million for the same three months

of 2019. The profits for Cigna,

which also owns a large pharmacy

benefit manager, were also higher.

Under the federal health care

law, insurers are required to use a

fixed percentage of the money

they take in from premiums for

their customers’ medical ex-

penses. The companies must

spend at least 80 cents of every

dollar they collect in premiums

from small businesses and indi-

viduals on health care, and 85

cents per dollar for large employ-

ers. The remaining 15 to 20 per-

cent is all they are allowed under

the Affordable Care Act to spend

on administrative costs like over-

head and marketing and to keep

as profit. Any additional revenues

are to be returned to consumers in

the form of rebates.

Insurers are currently spend-

ing a far lower portion of premium

revenue on their customers’

health care costs. CVS said its

medical-benefits ratio was 70 per-

cent for the quarter, compared to

84 percent in the same period of

2019.

That translates into millions of

dollars that some lawmakers in

Congress and advocates say

should wind up in the pockets of

consumers.

In recent years, insurers have

paid out billions of dollars in re-

bates, said Cynthia Cox, one of the

authors of a recent Kaiser Family

Foundation analysis that estimat-

ed employers and individuals

would receive $2.7 billion this year

in rebates required under Oba-

macare. That figure does not in-

clude 2020 amounts.

People who had health insur-

ance through the A.C.A. last year

could receive an average of $420 a

person, she said.

“For any given customer, it’s

not going to be a lot of money,” said

Mr. Mendelson of Avalere. “It will

always feel underwhelming.”

Eventually consumers should

get some of this year’s money

back. The insurers “are not just

able to profiteer,” said Katherine

Hempstead, a senior policy advis-

er for the Robert Wood Johnson

Foundation who studies health in-

surance markets.

Even though the federal gov-

ernment is now encouraging in-

surers to turn over excess funds to

consumers more quickly this year,

the Obamacare law gives compa-

nies a three-year window to calcu-

late how much to return as a way

to offset any mistakes they made

in setting rates or if they experi-

enced unexpected expenses.

“There’s a cushioning effect for

swings,” said Mark Hall, the direc-

tor of the health law and policy

program at Wake Forest Univer-

sity.

So no one should count on get-

ting money from this year’s boom-

ing insurance profits anytime

soon.

And the financial outlook for the

year is still uncertain, given the

rising number of Covid-19 cases

shifting from state to state and the

longer term costs of caring for

Covid-19 patients, with potentially

expensive new vaccines or treat-

ments around the corner. Con-

versely, the many people who

postponed getting medical atten-

tion could flock back to doctors’ of-

fices and submit more bills for

coverage.

“They don’t actually know

what’s coming around the corner,”

said Dr. Sanjay Saxena, a manag-

ing director for the Boston Con-

sulting Group. “They can’t just

write checks and give away the

money.”

Insurers say that they are using

their financial strength to help

customers as well as hospitals and

doctors. “From the very begin-

ning, health insurance providers

have focused on being part of the

solution,” said Matt Eyles, the

chief executive of America’s

Health Insurance Plans, a trade

group. As examples, he cited

waiving co-payments for testing

and treatment for coronavirus

and paying for telemedicine visits,

some of which the government

has mandated be covered.

The companies also say they

are spending billions of dollars on

efforts that range from giving

small businesses a break on their

monthly premiums to paying phy-

sicians in advance to help keep

practices afloat.

On conference calls with Wall

Street analysts, executives were

quick to point out steps they have

taken to assuage the worries of

Americans overwhelmed by the

virus outbreaks.

“We took action to commit $2.5

billion in financial assistance to

ease the burden of Covid-19

among our members, employer

customers, care providers and

nonprofit partners,” said Gail K.

Boudreaux, the chief executive of

Anthem. She listed several initia-

tives, including giving customers

a premium credit and donations to

a food charity. “The needs are on-

going, and I’m proud of the way

Anthem has responded quickly to

provide needed support,” she said.

Nonprofit insurers, including

most of the Blue Cross plans of-

fered in individual states, are also

experiencing much higher profit

margins. While they too are sub-

ject to the A.C.A. rules and must

pay out required rebates, they can

plow any additional surplus into

their capital reserves, Mr. Hall

said. “They never feel that they

have enough reserves, and the

regulators don’t really require in-

surers to spend down their re-

serves,” he said.

But the companies may have

even higher profits than is appar-

ent. Some, like UnitedHealth,

have large networks of doctors

and other health care businesses,

in addition to owning giant phar-

macy benefit managers. There

are no limits on how much these

units can make, and many of the

units sell their services directly to

the insurer.

The profits being reported don’t

“give an accurate picture of how

much money they are making for

the insurers,” said Michael

Turpin, a former insurance execu-

tive and an executive vice presi-

dent at USI, an insurance broker-

age. “You’re not going to negotiate

with your sister company very ro-

bustly.”

Some hospital executives and

doctors say that the insurers

should do much more. “Everyone

should be playing a part as it re-

lates to the pandemic, and insur-

ers are no exception,” said Colleen

M. Blye, the chief financial officer

for the Montefiore Health System,

a large hospital group in the Bronx

that has treated more than 10,000

Covid patients.

“The government has been

funding the providers signifi-

cantly,” she said, referring to the

$175 billion in funds Congress has

allocated to date for hospitals and

doctors. “The insurers should be

sharing that burden, and they ha-

ven’t been.”

Insurers say they have been

strong advocates for providers

like the hospital systems. “We’ve

consistently supported their ef-

forts,” said Mr. Eyles.

So far, investors are not con-

cerned about the political risks of

the insurers’ high profits, said Les

Funtleyder, who is a health care

portfolio manager for E Squared

Capital Management, which owns

shares of UnitedHealth.

Even if former Vice President

Joseph R. Biden Jr., the Democrat-

ic presidential candidate, wins in

November, he is unlikely to push

for anything close to Medicare for

all. Mr. Biden favors revamping

Obamacare and offering a public

option, a government-run alterna-

tive to private insurance.

But the calculation could

change, depending on his choice

of vice president, Mr. Funtleyder

said. Senator Warren, who has

called for a sweeping health care

overhaul, is one of several names

on a long list of potential female

running mates for Mr. Biden.

“If Warren was vice president,

it would definitely spook Wall

Street,” Mr. Funtleyder said.

Big U.S. Health Insurers Report Big Profits, Benefiting From the Pandemic

The nation’s largest insurers, like Anthem and UnitedHealth, had profits so

large that they will have to pay back some earnings to consumers.

MICHAEL NAGLE/BLOOMBERG

FROM FIRST BUSINESS PAGE

Postponed elective

surgery as coronavirus

raged has been a boon.

$1B

Increase in net income for CVS

Health in the second quarter.

FINANCE | VIRUS FALLOUT