The health insurance industry has confronted many external
challenges in the recent past, such as an uncertain regulatory
environment, a challenge to meet the demand of more price- and
service-conscious consumers, a fiercely competitive market, shifts
in customer mix and a slowly recovering economy, just to name a
Notwithstanding the headwinds, the industry continued to remain
profitable with the top six players --
UnitedHealth Group Inc.
Coventry Health Care Inc.
) -- reporting earnings growth and delivering positive earnings
surprises in the third quarter of 2012.
The earnings performance at each of these players were primarily
driven by industry-wide factors like higher enrollment, increasing
premium, lower-than-expected medical care utilization and improving
commercial insurance pricing. Most of the carriers even raised
their 2012 earnings estimates, which reflect optimism for the
fourth quarter results as well.
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. To
rein in the waste and make health care more accessible effective
and affordable, President Obama pushed 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) 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, 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 has endured rough patches since its inception, with
opponents challenging its individual mandate and Medicaid expansion
clause and dragged it to the courts. Insurers were lobbying 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 Supreme court upholding
the constitutionality of its individual mandate -- the core of the
reform. Also, Obama's re-election provides 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 Industry
The re-election of President Obama means his signature Health Care
law is likely here to stay, putting behind the major ambiguity
prevailing over the industry. Obama's second term will see major
implementation of key provisions. However, in the short- to
mid-term there is some uncertainty over how regulatory reform will
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 conditions, dependent coverage up to age 26 and annual
rate review) relatively well.
For the moment, 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.
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 the loop
approximately 32 million uninsured, the gain in revenue 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
trends. Moreover, the annual insurance industry assessment, which
is not deductible for income tax purposes, will increase their
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, the insurers are being proactive, trying very hard not
just to survive, but to prosper.
Aiming Toward Global Markets
With organic growth remaining challenging, carriers in the health
insurance sector are flocking toward international markets, which
specifically appear attractive on account of lesser regulations,
higher margins and lower competition. Additionally, pressures 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 penetrating deeper mainly in the
emerging economies of Asia and the Middle East.
UnitedHealth's recent big acquisition of Brazil-based Amil
Participacoes for $4.9 billion attests the fact that insurers are
actively seeking international exposure. The company already has a
significant presence in Portugal, India and the Middle East through
Though the U.S. health insurance industry currently had little
international presence until the recent past, insurance firms are
fast catching up. We expect to see more international deals going
Medicare Advantage: A Preferred Market
According to U.S. Census data, the population of Medicare
beneficiaries will grow by 36% by the end of this decade, led by a
vast aging baby boomer population. In September 2012, CMS projected
that the entire Medicare Advantage market would grow 11% in 2013.
Until now, 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 acquisition of HealthSpring Inc.,
UnitedHealth's acquisition of XLHealth Corp., Aetna's pending
acquisition of Coventry Health Care Inc. and WellPoint's pending
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 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 become acquired.
Over the next few years, growth opportunities for the players in
the health insurance sector will be driven by:
- Health expenditure and reliance on managed care gradually
increasing. 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 compounded annual growth
rate 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 1/3 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. This trend
will 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,
) with a Zacks #2 Rank (Short-term Buy) and
UnitedHealth Group Inc.
) with a Zacks #3 Rank (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 double-digit growing International
segment, significant presence in Medicare Advantage book as well as
a growing book of commercial self insured business. The company has
been putting strong earnings performance and the trend is expected
Aetna has been beating earnings expectations 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. It is also growing its international business for
diversification benefits. A solid balance sheet, well-controlled
debt and adequate liquidity will provide overall strength.
WellPoint, a dominant player with a vast provider network, is also
poised for solid growth over the longer term. The recent
announcement to acquire Amerigroup will make it a top player in the
Medicaid business. Other acquisitions in this area include the
buyout of CareMore Health Group, which will further 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.
UnitedHealth has also been showcasing a favorable earnings
performance for the past many quarters. It has strengthened its
position in the Medicare Advantage market with the acquisition of
XLHealth. The company's diversified business model, with a leading
market share in the Commercial, Medicare, and Medicaid markets, a
solid balance sheet, a highly conservative investment portfolio,
expansion into higher margin Health Services segments (Optum) and
penetration into international markets 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 #5 Rank (Strong Sell) or Zacks #4 Rank (Sell), we expect
the following factors to negatively impact the industry:
AETNA INC-NEW (AET): Free Stock Analysis Report
AMERIGROUP CORP (AGP): Free Stock Analysis
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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- 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 high unemployment rate will adversely affect
medical membership, operations, financial position and cash
- The overall thrust of healthcare reform and regulatory
changes is expected to lower the industry's profitability in the