U.S. health insurers ended 2013 on a strong note despite facing
pressures pertaining to funding and government-sponsored benefits
along with three calendar quarters of sequestration in Medicare.
The health insurance industry is confronted by many external
challenges such as federal, state legislative and regulatory
reforms; a challenge 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.
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
approximately 18% of the country's annual gross domestic product.
According to the World Health Organization, healthcare expenditure
per person in the United States is the highest in the world.
Despite a huge sum of money being spent on healthcare, millions of
Americans continued to lack health insurance coverage or remained
underinsured. This was largely attributed to a dysfunctional health
care system in place. To rein in the wastage and make health care
more accessible, effective and affordable, President Obama
introduced health care reform in an attempt to overhaul the
nation's ailing health care system.
Within the Zacks Industry classification, Health Insurance is
grouped under the Finance sector (one of the 16 Zacks sectors).
We rank 260-plus industries within the 16 Zacks sectors based on
the earnings outlook for the constituent companies in each
industry. The ranking is available on the Zacks Industry Rank page.
As a point of reference, the outlook for industries with Zacks
Industry Rank #88 and lower is 'Positive,' between #89 and #176 is
'Neutral' and #177 and higher is 'Negative.'
The health insurance industry features in the top 1/3rd with a
Zacks Industry Rank #100. This indicates that the overall outlook
Please note that the Zacks Rank for stocks, which is at the core of
our Industry Outlook, has an impressive track record, verified by
outside auditors, to foretell stock prices, particularly over the
short term (1 to 3 months). The rank, along with the Earnings ESP
or Expected Surprise Prediction helps in predicting the probability
of earnings surprises.
Currently, we are almost about to end the fourth quarter and full
year 2013 earnings season with results from nearly 98% of the
S&P 500 companies already released.
Every finance company has reported earnings. The 'earnings beat
ratio' (percentage of companies with positive surprises) was 72.2%
while the 'revenue beat ratio' was 64.6%. Total earnings for this
sector were up 22.8% year over year, compared with 10.5% in the
third quarter. Total revenue declined by 7.5% versus flat results
in the prior quarter.
We are encouraged by the projected 6.2% growth for the sector in
full-year 2014 compared with 8.3% growth for the S&P 500.
For a detailed look at the earnings outlook for this sector and
others, please read our
Earnings Trends report
Health Care Overhaul
U.S health insurers have always been criticized for welcoming the
healthiest and shunning the sicker population. In order to put a
check on this ('cherry picking and lemon dropping' policy of these
insurers), the health care reform was introduced in 2010.
The Patient Protection and Affordable Care Act (PPACA) passed in
2010 marked the beginning of a multiyear implementation process. It
was the most substantial overhaul in the history of the nation's
health care sector. The reform faced huge opposition from the
health insurers which fiercely lobbied against most of the
provisions of the act. Finally, the majority of health insurers
have accepted the reform.
The reform was intended to provide coverage to the 32 million
uninsured Americans, 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.
2014 - A Water Shed Year for Insurers
2014 stands as a year of transition for all the insurers. So far,
the carriers have handled the impact of implementation (from
2010-2014) 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 the age of 26,
annual rate review) relatively well.
For the moment, however, the biggest question is how the most
arduous provisions of the law (relating to 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) will
affect the industry. Some of these have already come into effect in
2014 and the rest will be realized in the course of the year.
Investor sentiment toward the reform implementation in 2014 and
beyond will be the driving factor for managed care stocks.
While the individual mandate provision will bring into loop
approximately 32 million uninsured people, the gain in revenues due
to increasing industry enrollment is expected to be offset to a
large extent by the costs incurred by the insurers to realign their
businesses to comply with the new rules (ICD-10 coding) and deal
with other challenges.
Several provisions in the Health Reform -- 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 costs.
Moreover, the annual insurance industry assessment ($8 billion to
be levied on the insurance industry in 2014, increasing to $14.3
billion by 2018 with increasing annual amounts thereafter), which
is not deductible for income tax purposes, and the temporary
reinsurer fee ($25 billion to be levied on all commercial lines of
business including insured and self-funded arrangements, over a
three-year period starting in 2014), will increase insurer
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 amid such changing circumstances.
U.S. Insurers Aim for Global Markets
With organic growth remaining challenged at home, carriers in the
health insurance sector are flocking the international markets,
which specifically appear attractive on account of lesser
regulations, higher margins and lower competition. Additionally,
pressure on social healthcare 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.
), 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 intend to
penetrate deeper mainly in the emerging economies of Asia and the
UnitedHealth Group Inc.
) is another instance. 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
AmilParticipacoes, Brazil's biggest health insurer and hospital
operator, for $4.9 billion. The deal will give it access to a
fast-growing market bolstered by a rising middle class.
This acquisition attests the fact that insurers are desperately
seeking to graze international pastures. The company already has a
significant presence in Portugal, India and the Middle East through
Though the U.S. health insurance industry currently has little
international presence, insurers are fast catching up. We expect to
see more international deals going forward.
Insurers Diversifying to Provide Health Services
Leading U.S. health plans are now realizing that their core
business is necessary but not sufficient. Players are increasingly
feeling that their business models need to change significantly to
position them suitably in the transforming health insurance
industry. No longer seeing commercial medical membership as an
option for substantial growth, they are thus diversifying into
health services businesses such as technology, health-care
delivery, physician management, workplace wellness and financial
services that are "much less regulated" than insurance plans.
Sensing the tough industry environment, one of the largest health
insurers in the country, UnitedHealth Group, espoused the strategy
to grow its health services business, branded as Optum, in 2011.
The company maintains that its future growth would come from
offering services that are much less regulated than health
Major companies have been making acquisitions aimed at growing
their health services businesses. Aetna acquired Medicity, a
business that helps hospitals share patient information.
) acquired Concentra, a Texas-based urgent- and occupational-care
provider with clinics in 40 states.
) also started diversifying more heavily into consumer-oriented and
health IT businesses in 2011 and is continuing with the strategy.
At Aetna, Chief Executive Mark Bertolini is implementing strategies
that will see the insurer get more deeply into health-information
technology and run the back-end operations of the new
accountable-care organizations, or ACOs.
Debut of Health Insurance Exchanges: Are Insurers Wary
Health Insurance Exchanges, known as pillars of Obamacare, became
operational on Oct 1, 2013. These online health insurance
marketplaces were set up to provide subsidized insured plans to the
Per data from Kaiser Family Foundation and the Congressional Budget
Office (CBO), the exchange market is expected to grow quickly, with
approximately 22 million purchasing coverage on the individual
exchanges by 2016. By 2023, an estimated 24 million will buy their
insurance on individual exchanges.
Despite widening the insurance net, insurers remain wary of these
online market places as they expect that the exchanges will
initially attract a greater population of people who have been most
sick and lacked insurance. Insurers fear that this adverse mix of
members would jack up claims bills, rendering their business
unprofitable. As such, most of them have taken a cautious approach
by limiting participation at the moment, waiting to see how these
would work going ahead.
Another 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 low profit margins for the carriers in the long run.
Nevertheless, it is believed that over the coming three to four
years, employers might increasingly drop their coverage of workers,
which in turn would flood the exchanges with more healthy
customers, thus generating profitable mix of business for health
Sequestration Harming the Insurers
Simply put, sequestration means reduction in government funding in
order to reduce the budget deficit. The sequestration imposes
reimbursement cuts on Medicare Advantage (MA) payments to the
insurers. Cuts to MA plans are part of the $716 billion in Medicare
spending reductions that the health law requires over the next
Insurers fear that Medicare Advantage reimbursement cut will erode
their bottom-line margins. UnitedHealth Group expects funding
pressure to drain the company's earnings by more than $1.50 per
share in 2014. Rate pressure in this business will force players in
the industry to make business modifications in order to protect MA
margins to some degree and maintain program sustainability. These
changes would include exiting certain markets, reducing plan
offerings, slashing benefits, and narrowing some networks.
Consumer Gaining Prominence
The reform has introduced a sea of changes within the operations of
the industry. While traditionally the insurers have dictated
policy, this has gone into the hands of the consumers now. A
changing landscape (shift from employer-sponsored health coverage
to individuals directly buying coverage) is putting pressure on
healthcare organizations to introduce customer-centric
The market is forcing insurers to design products for consumers
as customers are actively engaging themselves using information to
compare and shop. Players have also realized the urgent need to
implement changes fearing that if they do not make the requisite
changes, consumers may graze away elsewhere.
Notwithstanding the fact that the health insurance industry has
been witnessing copious mergers and acquisitions for the last
several years, the landscape created by the 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
- Health expenditure and reliance on managed care are gradually
increasing. According to the new estimates from the Office of the
Actuary at the Centers for Medicare and Medicaid Services (CMS),
aggregate health care spending in the United States will grow at
an average annual rate of 5.8% for 2012-22, or 1.0% faster than
the expected growth in the gross domestic product (GDP). The
health care share of GDP by 2022 is projected to rise to 19.9%
from its 2011 level of 17.9%. 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 50% of the
total national health care spending, up from approximately 33% 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.
Though the journey may remain bumpy over the near term, in the
longer term, most of the companies within our coverage are expected
to benefit from the changing trends. Specifically Aetna with a
Zacks Rank #2 (Buy), and
Health Net Inc.
Molina Healthcare Inc.
), UnitedHealth Group all with a Zacks Rank #3 (Hold) will offer
good investment opportunities going forward.
Let's have a quick look at some of these companies:
Aetna remains uniquely poised to benefit from the changing health
insurance market. The company has made huge investments in IT and
is making strong progress in its Medicare business. It is also
augmenting its international business for diversification benefits.
A solid balance sheet, well-controlled debt and adequate liquidity
provide overall strength.
Cigna remains attractive given its strong growth profile,
significant presence in Medicare Advantage and a growing commercial
self-insured business. Its International segment has also been
growing at a double digit rate. The company has been delivering
solid earnings and the trend is expected to continue. We are more
optimistic about the company now that it has shed its exposure to
its run off portfolio, which had traditionally been imparting
volatility to its earnings.
UnitedHealth has also been performing well for the past many
quarters. The company has developed a distinctive health services
platform with Optum which is expected to generate long term growth.
The company's international expansion which provides higher margin
will also lead to margin contribution over the coming quarters. A
solid balance sheet with strong cash flows and moderate leverage,
disciplined capital management strategy are other positives.
Apart from the regulatory hurdles, the industry will continue to
suffer from tepid growth in the U.S. economy. Workforce reductions
have caused corresponding membership losses in insurance companies'
fully-insured commercial group business. Continued weakness in the
U.S. economy and a sluggish unemployment rate will adversely affect
medical membership, operations, financial position and cash flows.
AETNA INC-NEW (AET): Free Stock Analysis Report
CIGNA CORP (CI): Free Stock Analysis Report
HEALTH NET INC (HNT): Free Stock Analysis
HUMANA INC NEW (HUM): Free Stock Analysis
MOLINA HLTHCR (MOH): Free Stock Analysis Report
UNITEDHEALTH GP (UNH): Free Stock Analysis
WELLPOINT INC (WLP): Free Stock Analysis Report
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