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 insurers.
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
The Changing Face of the Health Insurance Industry
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
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 challenges.
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
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' operating costs.
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 class.
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
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
- 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 strength.
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
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 industry:
- 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
The overall thrust of healthcare reform and regulatory changes will
most definitely change the face of the industry over the long run.
AETNA INC-NEW (AET): Free Stock Analysis Report
CIGNA CORP (CI): Free Stock Analysis Report
COVENTRY HLTHCR (CVH): Free Stock Analysis
HUMANA INC NEW (HUM): Free Stock Analysis
UNITEDHEALTH GP (UNH): Free Stock Analysis
WELLPOINT INC (WLP): Free Stock Analysis Report
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