The health insurance industry has confronted many external
challenges in the recent past, such as federal, state legislative
and regulatory reforms, inability to meet the demand of more
price- and service-conscious consumers, a fiercely competitive
market, shift of customer mix and uncertain economic conditions
in the U.S. and abroad, just to name a few.
Notwithstanding the headwinds, the industry is thriving under
stress. Most of the top six players --
UnitedHealth Group Inc.
Coventry Health Care Inc.
) -- ended 2012 on a high note with impressive earnings growth in
the final quarter. Most of the carriers even raised their 2013
About the Industry
The 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 annual GDP. According to the World Health
Organization, health care expenditure per person in the United
States is the highest in the world.
Despite huge sums of money spent on health care, millions of
Americans lack health insurance coverage or are underinsured.
This was largely attributed to a dysfunctional health care
system, which was working for the past several years. To rein in
the wastage and make health care more accessible effective and
affordable, President Obama came out with the Health Care Reform
in an attempt to overhaul the nation's ailing health care system.
Health Care Overhaul
The Patient Protection and Affordable Care Act (PPACA), which was
passed in 2010, 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. The primary focus was to make health care
facilities more affordable, expand coverage for customers with
pre-existing health conditions and keep a check on health
Certain significant provisions of the legislation were: mandated
coverage requirements, rebates to policyholders based on minimum
benefit ratios, adjustments to Medicare Advantage premiums, the
establishment of state-based exchanges, greater investment in
health IT, annual insurance industry premium-based assessment,
reduction in Federal assistance on Medicare Advantage,
restriction on rescission of policies and elimination of annual
as well as life time maximum limits.
The Reform had a rough patch since inception with opponents
challenging its individual mandate and Medicaid expansion clause
as well as dragging it to court. Insurers lobbied against most of
its provisions and opposition political parties swore to repeal
the whole law if they were elected. But the law survived the
challenges with the Supreme Court upholding the constitutionality
of its individual mandate - the core of the reform.
Also, the re-election of Barack Obama provides the necessary
ratification to the health care reform. That said, the full
implementation of the reform is far from guaranteed given the
substantial leeway states enjoy in enforcing key parts of the
legislation, particularly the setting up of exchanges and
expansion of Medicaid.
The Changing Face of the Health Insurance
Obama's second term of presidency will see implementation of key
provisions across the industry. However, a vexing problem in the
short- to mid-term is the uncertainty over how regulatory reform
will play out. So far, the carriers in the industry have handled
the impact of implementation of some of the less onerous
provisions of the reform (relating to MLR requirements, ban on
denial of coverage due to pre-existing ailment, dependent
coverage up to age of 26, annual rate review) relatively well.
For the moment, however, the biggest wild card in the regulatory
reform is how the law's biggest and most impactful provisions
(relating to setting up of insurance exchanges, individual
mandate, ICD-10 requirements, pre-existing conditions, Medicaid
expansion, an annual insurance industry assessment of $8 billion
in 2014 with increasing annual amounts thereafter), which are due
to be implemented in 2014, will effect the industry. Investor
sentiment toward the implementation in 2014 and beyond will be
the key driving factor for managed care stocks.
Exchanges will act as an online marketplace where consumers who
are underinsured or uninsured will be able to shop for subsidized
coverage and small businesses can buy more affordable plans for
their workers. A key risk to insurers is that insurance exchanges
will lead to commoditization of insurance products, making
product offerings highly standardized. This product
standardization along with a framework for strong government
price regulation will expectedly lead to very low profit margins
for the carriers in the long run.
While the individual mandate provision will bring into loop
approximately 32 million of the uninsured, the gain in revenues
due to increasing industry enrollment is expected to be offset to
a large extent by the costs to realign their business to comply
with the new rules (ICD-10 coding) and deal with other
Several provisions in the Health Reform Legislation - excise tax
on medical devices, annual fees on prescription drug
manufacturers, enhanced coverage requirements and the prohibition
of pre-existing condition exclusions - will likely increase
insurers medical cost trends.
Moreover, the annual insurance industry assessment ($8 billion to
be levied on the insurance industry in 2014 and it will increase
to $14.3 billion by 2018 with increasing annual amounts
thereafter) will increase premium cost. Also the temporary
reinsurer's fee ($25 billion to be levied on all commercial lines
of business including insured and self-funded arrangements, over
a three-year period starting 2014) will increase insurers'
In the meantime, rules of the road remain uncertain. Insurers do
not know what exactly will be expected of them, what changes they
will be forced to implement, or what expenses they might have to
incur to meet new data and regulatory demands. Carriers may see
potentially game-changing developments threatening their ability
to achieve top- and bottom-line growth.
However, insurers are being proactive, trying very hard not just
to survive but to prosper.
Aiming Global Markets
With organic growth remaining challenging, carriers in the health
insurance sector are flocking toward the international markets,
which specifically appear attractive on account of lesser
regulations, higher margins and lower competition. 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 opportunity.
Companies like Cigna and Aetna, which have active presence
overseas, believe that their international business is a positive
differentiator and a key driver of higher-than-peer growth rates.
Both companies are targeting to penetrate deeper mainly in the
emerging economies of Asia and the Middle East.
UnitedHealth is another case in point. The company already has a
presence in Australia, the Middle East and UK. In Oct 2012, it
expanded its portfolio with the purchase of a controlling stake
in Amil Participacoes, Brazil's biggest health insurer and
hospital operator, for $4.9 billion. The deal will give it access
to a fast-growing health insurance market with rising middle
Though U.S. health insurers had little international presence
until the recent past, they are fast catching up. We expect to
see more international deals going forward.
Health Insurers Investing in New Technologies
There has been unprecedented spending on health information
technology (HIT). 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. Financial incentives offered by
regulators to health care providers and hospitals for meaningful
use of health care IT products are primarily driving huge IT
Starting 2013, all hospitals serving Medicare patients with the
most common conditions will be paid for the quality of care they
provide in addition to the number of services offered by them. We
expect the trend to continue as pay-for-performance takes root.
Reimbursement Cuts to the Medicare Advantage
Medicare Advantage plans are privately run versions of the
federally funded Medicare program for the elderly and disabled
people. The Centers for Medicare and Medicaid Services recently
announced that it expects costs per person for Medicare Advantage
plans to fall more than 2% in 2014, which is a cause of worry for
insurers as it can result in significant payment cuts.
Medicare Advantage plans also face cuts from the health care
overhaul and from the steep federal budget cuts. Insurers'
profits are also expected to be pressured by the growing cost of
care and a premium tax imposed to fund the overhaul.
Medicare Advantage Still Remains a Preferred
Despite reimbursement cuts to Medicare Advantage, insurers remain
attracted to this line of business as they expect to recover the
revenues lost due to payment cuts from the significant increase
in enrollment for the Medicare Advantage program. Enrollment in
such plans is expected to increase in 2013 compared to 2012.
According to U.S. Census data, the population of Medicare
beneficiaries will grow 36% by the end of this decade, led by a
vast baby boomer population. Until recently, only two of the
public providers -- UnitedHealth and Humana were the primary
market share holders. However, consolidation in this market is
scrambling market share ratios.
Carriers in the health insurance sector are in a race to win
Medicare Advantage market share and the fastest way of achieving
the target is to acquire a company in the same business. Some of
the examples are Cigna's acquisition of HealthSpring Inc.,
UnitedHealth's acquisition of XLHealth Corp., Aetna's pending
acquisition of Coventry Health Care Inc.
Notwithstanding the fact that the health insurance industry has
been witnessing copious mergers and acquisitions for the last
several years, the landscape created by Health Care Reform has
set the stage right for further consolidation. In the changed
environment, small insurers are becoming inefficient. The
inability to achieve the required scale to be profitable is
forcing these small players to get acquired.
Over the next few years, growth opportunities for the players in
the health insurance sector will be driven by the following
- Gradually increasing health expenditure and reliance on
managed care. Centers for Medicare and Medicaid Services total
health care spending is projected to grow from an estimated
$2.8 trillion last year to $4.8 trillion by 2021, an increase
of 70%. 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 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.
- Recent 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 costs. We expect most
of the companies within our coverage to benefit from the trend.
Among others, Cigna Corp. with a Zacks Rank #2 (Buy) and
UnitedHealth Group Inc., Humana, WellPoint, Aetna Inc. and
Amerigroup with a Zacks Rank #3 (Hold) will offer good
investment opportunities in the upcoming years.
Let's have a quick look at some of these companies:
CIGNA Corp. remains attractive given its strong growth profile in
the industry with its International segment growing in double
digits, significant presence in Medicare Advantage book as well
as self insured business. The company has been putting up strong
earnings performances and the trend is expected to continue. We
are more optimistic about the company as it has reduced exposure
to its run off portfolio, which had traditionally been imparting
volatility to its earnings.
Aetna has been performing favorably over the past several
quarters. The company is also making strong progress in its
Medicare business. It is also growing its international business
for diversification benefits. A solid balance sheet,
well-controlled debt and adequate liquidity will provide overall
UnitedHealth has also been showcasing a favorable earnings
performance for the past many quarters. In all likelihood, it
will outperform in a rapidly changing industry environment given
its best-in-class execution and management, product positioning,
scale and technology. We also see the company's exposure to
health reform downside risks as somewhat more contained than what
was perceived before.
Though none of the health insurance stocks under our coverage
hold a Zacks Rank #5 (Strong Sell) or even a Zacks Rank #4
(Sell), we expect the following factors to negatively impact the
- Health insurers are expected to face challenges related to
medical-cost inflation. The Centers of Medicare and Medicaid
Services expects U.S. health expenditures 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 control
- The U.S. economy continues to experience a period of slow
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 still high unemployment rate will
adversely affect medical membership, operations, financial
position and cash flows.
The overall thrust of healthcare reform and regulatory changes
will most definitely change the face of the industry over the
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