Though the U.S. Health insurance industry continues to be
relatively immune to economic difficulties, it has been still
grappling with fundamental changes and consequent growth pangs. The
industry has been facing its share of problems related to a
sluggish economic recovery, uncertainty surrounding the health care
reform law and increased regulatory control.
Despite the odds, the industry remains profitable, with the top six
UnitedHealth Group Inc.
Coventry Health Care Inc.
) -- reporting year-over-year earnings growth in FY11.
About the Industry
The U.S. Health and Medical Insurance industry is an integral part
of the U.S. economy. According to the Centers for Medicare and
Medicaid Services, U.S. health expenditures account for about 18%
of the country's GDP. According to the World Health Organization,
health care expenditure per person is higher in the United States
than any other nation in the world.
Despite rapidly growing spending on health care over the past few
decades, the health insurance industry has been characterized by
growing premiums, limited policy choice and lack of transparency.
Over the past 10 years, health insurance premiums have increased
consistently, outpacing the growth of wages and cost of living.
Premium surge (owing to complex connections among health insurance
companies, health care providers, pharmaceutical manufacturers and
the medical technology industry) has been witnessed in both
employer-sponsored insurance as well as individual insurance.
Total premiums for employer-sponsored insurance doubled in the
period of 1999-2009. The individual market also saw rapid growth in
the cost of premium. As a result, only 5% of non-elderly Americans
were insured. According to the United States Census Bureau, in 2009
there were 50.7 million people in the U.S (16.7% of the population)
who were uninsured. The percentage of uninsured non-elderly
population has been on a continuous rise since 2000. Insurance
companies have also been known to deny coverage in case of
pre-existing diseases, and for charging higher premium in the
Increasing industry consolidation also limited insurance choice for
Americans, who were reeling under rising health care costs. Since
1996, the industry has witnessed acquisitions worth approximately
$90 billion, resulting in dominance by just a few players. During
1990-2000, the industry witnessed approximately 400 big and small
mergers and acquisitions (M&A).
Consolidation and market dominance consequently led to a decline in
competition. Big insurers dominating large markets hardly ever
bothered to provide even the basic information to consumers, such
as the performance of health insurance policies, procedures to
claim, the size of the provider network and cancellation
Moreover, in the absence of any reason to lower policyholders'
cost, insurance companies went on increasing profits year after
year. Recent economic data from HealthReform.gov showed that the
profits of the ten largest insurance companies increased 250%
between 2000 and 2009 -- ten times faster than inflation. Though
the industry saw lower enrollment (medical membership) due to the
latest recession, major health insurance companies managed to
remain profitable by increasing their insurance premiums.
Looking at the other end of the spectrum, health insurance
companies also benefited from low utilization amid recessionary
conditions. A high deductible and high out-of-pocket cost kept the
cash-strapped Americans away from the clinics, leading to lower
utilization of health care services. A recent analysis by the
Kaiser Family Foundation revealed that people with insurance opted
for medical checkups less frequently, with the number dropping
dramatically after the recession technically ended. The year 2011
saw suppressed utilization trends relative to historical levels.
This trend, witnessed over the past couple of years, has played a
prominent role in helping major players in the health insurance
sector to earn significant profits. Most of the carriers continued
to beat earnings estimates, benefiting from lower claim payments.
But recently insurers have started warning that they expect medical
utilization patterns to return to normal levels in 2012.
However, low medical utilization is a short-term factor affecting
the industry. Over the longer term, issues including the effects of
the Health Care Reform and the changing economy and demography will
revamp the industry.
Health Care Overhaul
The Patient Protection and Affordable Care Act was passed in 2010,
and marked the beginning of a multiyear implementation process. It
is the most substantial overhaul in the history of the nation's
health care sector.
The reform was intended to provide coverage to the 32 million
uninsured Americans, make health care facilities more affordable,
expand coverage for customers with pre-existing health conditions
and keep a check over health insurers. The legislation's detractors
contest many of its stated benefits and consider it another
entitlement program that the country can ill afford.
Certain significant provisions of the legislation pertain to
mandated coverage requirements, rebates to policyholders based on
minimum benefit ratios (which measures underwriting profitability
and is computed by taking the total benefit expenses as a
percentage of the premium revenues), adjustments to Medicare
Advantage premiums, the establishment of state-based exchanges,
greater investment in health IT and an annual insurance industry
premium based assessment. The individual mandate requirement of the
legislation is being contested in the courts, with the final
outcome of that adjudication process far from certain at this
Possible Outcomes of the Reform
The proponents of the legislation claim that upon its full
implementation in 2018, the reform will end discrimination policy
of insurance companies, create competition amongst insurers through
healthy exchange, add value to the overall health care system and
Some of the provisions and their possible effects on health
insurers are as follows:
- According to the law, any proposed rate
increase above 10% will be reviewed more closely by both the
state and federal governments, and approval will be granted only
if the increase seems justified. This is expected to slow down
insurers' premium escalation, thereby restricting top-line
- Beginning in 2011, the provision of
maintaining 80% of minimum loss ratio (
) on individual policies became effective. Also, the requirement
of 85% MLR for Commercial policies will be effective from 2012.
These provisions will lead to limited bottom-line growth as
carriers will be forced to spend a minimum amount on the insured.
A failure to abide by the MLR rule will force carriers to rebate
the excess cash back to the insured or to lower premiums.
- The law also requires insurance coverage
for people with pre-existing conditions at the standard rates.
This will lead to lower profit per policy compared to earlier
where individuals with pre-existing conditions were charged two
to five times more than people with average health for the same
While the federal government has issued a number of regulations,
implementing Health Care Reform, many significant parts of the
legislation, including health insurance exchanges ("Insurance
Exchanges"), premium rate review, the scope of "essential health
benefits," employer penalties and the implementation of minimum
medical loss ratio ("MLRs"), requires further guidance and
clarification at the federal level. As a result, the impact of the
Health Care Reform will not be evident in the near term.
Nevertheless, the range of possible changes due to the Health
Insurance Reform Legislation could change the way insurance
companies do their business. This will potentially impact pricing,
product mix, geographic mix and distribution channels. The
fundamental and potentially game-changing developments could
threaten carriers' ability to achieve top and bottom-line growth.
Recent Issues Concerning the Sector
The sector is currently being subjected to both legislative and
- Legislative - Certain aspects of the
Health Reform Legislation have been challenged in the federal
courts, with detractors attempting to challenge the scope of the
law or even declare some parts of it unconstitutional. The United
States Supreme Court heard arguments on certain aspects of these
cases in March 2012, including the constitutionality of the
individual mandate and expansion of Medicaid in 26 states. Both
these provisions are scheduled to be implemented in 2014.
According to the individual mandate provision, which will be
effective since 2014, all individuals will have to purchase a
minimum level of health insurance coverage or pay a financial
Those debating against the law opine that the individual mandate is
unconstitutional and thus a violation of the fundamental rights of
Americans. A three-day session was conducted in the Supreme Court
debating the provisions of the law. The final ruling is expected in
There were uncertainties surrounding the Court verdict regarding
the legislation. In the buildup to the event, there is a lot of
speculation about the final outcome.
The legislation may either be revoked or upheld in its entirety.
There are chances that the individual mandate and other
controversial provisions are omitted or the legislation passed with
Each of these outcomes will affect the insurance companies in
varying degrees. In the event of the individual mandate being
declared unconstitutional or repealed without corresponding changes
to other provisions of the Health Reform legislation, players will
face the risk of adverse selection.
Provisions that require revision include the guaranteed issue and
renewal requirements, prohibition on pre-existing condition
exclusions and rating restrictions. If, however, the provisions are
left unchanged, insurers will see an increase in medical claims.
Insurers will lose the opportunity to serve the targeted 32 million
If the entire law is passed without any amendments and subsequently
implemented, then insurers will have to shell out a huge sum to
align their business with the changed landscape.
The sector will not be spared even if most of the provisions of the
Reform are held back. The health insurance sector will continue to
be under tight observation and scrutiny. Some new rules will
definitely come into effect to rein the exorbitant rise in health
care costs, due to unfair practices adopted by many of the
insurance companies over the past several years.
Opponents to the legislation claim that the clauses concerning
Medicaid expansion will create a burden on the states, in violation
of the Congress' power as per the Spending Clause and the Tenth
- Political - The forthcoming November
presidential election will see Congress struggling with its own
legislation. The new Republican majority in the House and
increased membership in the Senate may cause incremental changes
to a complete revocation of the health care reform.
To sum up, the U.S. health insurance sector, as a whole, is in a
state of flux and the situation will not see much improvement until
final regulations fall into place.
Meanwhile, the carriers continue to invest through the development
of new products, strategic acquisitions and new business alliances
to reshape and restructure their business.
Aiming for Global Markets
Carriers in the health insurance sector are also focusing on
international markets, which specifically appear attractive on
account of lesser regulations. Additionally, pressure on social
health care systems along with increasing wealth and education in
emerging markets are leading to higher demands for health insurance
and financial security. This provides carriers with a vast market
Companies like Cigna and Aetna, which have an active presence
overseas, believe that their international business is a positive
differentiator and a key driver of the higher-than-peer growth
Cigna's recent acquisition of UK-based First Assist, a joint
venture with TTK Group for selling health insurance products in the
Indian market, reflects the company's urge to grow its
international business. Last year, the company acquired Vanbreda
International, which makes it a global leader in providing
Aetna recently finished a two-year licensing process to begin
selling policies in Shanghai. In June, the company entered the
Indian market by acquiring Indian Health Organization, a
fast-growing medical discount card provider. The Indian company
serves approximately 80,000 individuals in 18 major cities.
Both the companies are targeting growth mainly in the emerging
economies of Asia and the Middle East.
Recently, UnitedHealth also made an effort to expand into the
Middle East via an agreement with Sagr National Insurance Co.
Though the U.S. health insurance industry currently has little
presence internationally, we expect the presence to grow as players
pursue global expansion opportunities.
Health Insurers Spending More on Technology
Following the implementation of The American Recovery and
Reinvestment Act of 2009 (ARRA), or "Recovery Act," which contains
the Health Information Technology for Economic and Clinical Health
Act, or the "HITECH Act," there has been unprecedented spending on
Health Information technology (
) in the sector.
The HIT includes electronic health records (EHRs), health
information exchanges (HIEs) and other (
) initiatives. The federal government's emphasis on the use of
health IT, which helps providers communicate better with each other
about patient care, reduces medical errors, paperwork, and needless
duplicate screenings and tests, leading to better coordinated
patient care and lower health care costs. These have increased
current health care information technology (
Financial incentives offered by regulators to providers and
hospitals for the implementation of the meaningful use of health
care IT products are primarily driving huge IT spending.
- According to Health Data Management, 100
HIT acquisitions were recorded from May 2010 to April 2011,
compared with 76 during the same period in 2009-2010. Some of
these include the acquisition of Picis, an acuity information
systems vendor, A-Life Medical, computer-assisted coding software
and Axolotl Corp., a health-data network, by
) and Aetna's buyout of Medicity.
- Approximately $89 billion was spent by
providers in 2010 on developing and implementing electronic
health records (EHRs), health information exchanges (HIEs) and
Medicare Advantage: A Favorite Market
According to U.S. Census data, the population of Medicare
beneficiaries will grow by 36% by the end of this decade as the
massive baby boomer generation ages into the nation's largest
health insurance program. In fact, in the next 25 years, compounded
annual growth rate of the Medicare population is expected to
increase to 2.7% from 1.5% at present.
Revenue from managed-care plans of Medicare Advantage is expected
to grow significantly as baby boomers retire. Medicare Advantage is
a privately-run version of the government's Medicare insurance
program for the aged and disabled.
Managed-care is expected to get a lot more attention as the federal
and state governments try to reduce costs. The now unsuccessful
Congressional "Super-Committee" looked into trimming some of the
funds out of the federal health care programs, but failed to reach
a bi-partisan agreement. Major cuts to the Medicare program,
whenever it happens, will have to shift some of the costs to
This could, in turn, be good for health insurers, making their
Medicare Advantage plans more attractive than traditional Medicare
plans. Moreover, many individuals would look forward to supplement
government coverage with private insurance, boosting demand for
Medicare Advantage plans. But reforming the government health care
program has proven to be very difficult politically.
Until now, only two of the public providers -- UnitedHealth and
Humana -- controlled more than 10% of the market. However, we
expect sharp consolidation here. Carriers in the health insurance
sector are in a race to win Medicare Advantage market share and the
fastest way of doing this is to acquire a company in the same
business. Following are some of the recent M&A activities in
- Cigna acquired HealthSpring Inc. for $3.8 billion in January
- UnitedHealth's acquisition of XLHealth Corp, a sponsor of
Medicare Advantage health plans in November 2011, is the next big
deal worth $2 billion. The acquisition of Preferred Care Partners
(Preferred Care) and Medica HealthCare Plans (Medica) are
pending. Earlier in 2011, UnitedHealth acquired Inspiris, which
serves patients in Medicare, Medicaid and commercial insurance
- On October 1, 2011, Aetna closed its acquisition of
Genworth Financial Inc.'s
) Medigap business for $290 million.
) also announced the purchase of Health Plus from Lutheran
HealthCare for $85.0 million in October 2011.
- Similarly, Humana struck two deals for small Medicare
Advantage plans: it acquired Arcadian Management Services and MD
Care during the third quarter 2011.
- In August 2011, WellPoint successfully culminated the
acquisition of CareMore Health Group.
Some investors think that smaller companies like
Coventry Health Care Inc.
Health Net, Inc.
) along with Medicaid specialists like
Molina Healthcare Inc.
) and Amerigroup may soon become takeover targets.
Emerging Dual Eligibles Opportunity
Health Insurance Reform Legislation created a federal
Medicare-Medicaid Coordination Office to serve dual eligibles. This
Medicare-Medicaid Coordination Office has initiated a series of
state demonstration projects to experiment with better coordination
of care between Medicare and Medicaid.
Dual eligibles (8.3 million individuals according to CMS) attracted
government attention in the recent times as they drive up
government costs. Federal and state governments spend approximately
$300 billion annually on the dual eligible population. According to
the Centers for Medicare and Medicaid Services, they make up 17% of
Medicaid enrollees but incur 39% of its expenses.
It is imperative to enhance care options for dual eligibles as the
numbers are expected to shoot up with an aging population and
increased life expectancy amongst Americans with disabilities. As
such, dual eligibles have become an immediate target for spending
reductions and quality improvements in care.
America's Health Insurance Plans ("AHIP"), the insurers' trade
group, estimates that better management of duals by engaging
managed-care plans can save approximately $125 billion from the
government exchequer during the next decade.
Presently, only about 12% to 15% of the duals are covered by
private health plans. Federal and state governments are looking to
place them into managed care to improve coverage and cut down on
unnecessary spending and duplicate tests for a population that
generates a lot of medical claims.
The acquisition of XL Health by UnitedHealth was one of the most
notable events in this space recently.
Though the health insurance industry has been witnessing mergers
and acquisitions for the last several years, the landscape created
by the health care reform has significantly increased the pace of
consolidation. In the changed environment, small insurers are
becoming inefficient. The inability to achieve the required scale
to be profitable is forcing these small institutions to get
Moreover, a continued low interest rate environment is encouraging
health insurers to seek more acquisitions as they prefer to keep
money away from their investment portfolio.
Over the next few years, growth opportunity for the players in the
health insurance sector will be driven by:
- Higher health expenditures and increased
reliance on managed care. According to the government, national
health spending is expected to touch $4.6 trillion by the end of
this decade from $2.6 trillion currently, representing a CAGR of
nearly 7%. This clearly points to the fact that the health care
industry will most certainly outstrip broader economic growth.
Moreover, over the same time frame, managed care penetration is
expected to grow to about 1/2 of the total national health care
spending, up from approximately 1/3rd at present, driven by
increased reliance on insurers in managing government's
fee-for-service Medicare and Medicaid products.
- 2010 Census figures show that seniors
constitute a larger share of the American population than ever
before. The trend will only gain steam in the years ahead.
Consequently, the aging population is expected to drive industry
demand as they would aim to reduce their health-related
We expect most of the companies within our coverage to benefit
from the trend. Among others, Aetna with Zacks #1 Rank,
UnitedHealth with Zacks #2 Rank, Cigna, Humana, WellPoint,
Amerigroup each with Zacks #3 Rank will offer good investment
opportunities in the upcoming years.
) has been beating our estimates for the past several quarters, on
the back of declining utilization, strong performance across all
the product lines, disciplined pricing and medical cost trends. The
company is also making strong progress in its Medicare business.
The lifting of sanctions from the Center of Medicare and Medicaid
Services and the acquisition of Genworth's Medicare Supplement
business will upgrade its Medicare platform.
The company is also aggressively looking to generate incremental
fee revenues by managing the infrastructure necessary for care
organizations. It is growing its international business for
diversification benefits. Moreover, its deployment of $1.2 billion
for acquisitions will position it well to deal with the
consequences of the Health Care Reform. A solid balance sheet,
well-controlled debt and adequate liquidity will provide overall
Our next pick would be
). Though the company was heavily biased towards commercial
business, it made timely acquisitions to ramp up the government
business, placing itself amongst the top five providers of Medicare
products. Its unique and growing international presence is also a
positive differentiator. A strong balance sheet and adequate
liquidity will further lead to continued share buybacks, thereby
contributing to the bottom line.
) comes next in line. With over 34 million members, the company is
a dominant player with a vast provider network. WellPoint has
strengthened its portfolio through the acquisition of CareMore
Health Group in order to expand its presence in the U.S. government
program for the elderly.
The company has been witnessing substantial earnings growth over
the past few quarters, spurred by membership gains, improvements in
operating cost structure, strategic acquisitions and capital
transactions. The company is also well poised to benefit from
economies of scale and favorable demographic trends.
Being the second-largest provider of Medicare Advantage plans,
) also offers potential for solid growth going forward. The company
has been surpassing earnings estimates for the past several
quarters and management raised its fiscal year 2012 guidance,
citing better-than-expected operating trends.
) has also been beating the Zacks Consensus Estimate for the past
several quarters and has recently raised its fiscal year 2012
guidance. It has strengthened its position in the Medicare
) market with the acquisition of XLHealth.
We believe the company's diversified business model in the managed
care industry, with a leading market share in the Commercial,
Medicare and Medicaid markets, a solid balance sheet, a highly
conservative investment portfolio and expansion into higher margin
Health Services segments (Optum) will provide investors with a high
risk -- return investment opportunity over time.
Though none of the health insurance stocks under our coverage hold
a Zacks #4 Rank or even a Zacks #5 Rank, we expect the following
factors to negatively impact the industry:
AETNA INC-NEW (
- Health insurers are expected to face
challenges related to medical-cost inflation. The Centers of
Medicare and Medicaid Services expects U.S. health expenditure to
increase at an average annual rate of 5.7% to $3.3 trillion
during the next five years. Furthermore, the demand for Medicare
is expected to increase as the baby-boomer generation goes into
retirement. Consequently, insurers will likely face increased
pressure to maintain medical-benefit ratios due to the lack of
funds for these programs along with government's initiatives to
- The U.S. economy continues to experience a
period of slow economic growth and high unemployment. Workforce
reductions have caused corresponding membership losses in
insurance companies' fully-insured commercial group business.
Continued weakness in the U.S. economy, and any continued high
unemployment, will adversely affect medical membership,
operations, financial position and cash flows.
- The U.S. "Super-Committee" is working on
reducing overall budget by $1.2 trillion. This will keep state
budgets under pressure, leading to very low rate increases for
managed care providers.
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