The health insurance industry has confronted many external
challenges in the recent past 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.
Notwithstanding the headwinds, the industry is "thriving under
stress." Big players - including
Health Net, Inc.
) - reported third quarter earnings ahead of the Zacks Consensus
UnitedHealth Group Inc.
) reported in line.
Following third quarter results, most of the carriers raised their
2013 earnings estimates, reflecting a favorable operating
environment. We, however, expect narrower margins in 2014 compared
to 2013, as favorable claim development and continued
lower-than-expected utilization helped the industry witness strong
margins in the prior year. Margins are anticipated to decline in
2014 and beyond as medical costs will likely return to more normal
levels and pricing may not increase to that extent.
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
approximately 18% of the country's annual gross domestic product.
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 being spent on health care, millions of
Americans lacked health insurance coverage or were underinsured.
This was largely attributed to a dysfunctional health care system
in place for the past several years. To rein in the wastage and
make health care more accessible, effective and affordable,
President Barack Obama introduced the Health Care Reform in an
attempt to overhaul the nation's ailing health care system.
Industry Ranking - Positive
Within the Zacks Industry classification, Health Insurance is
grouped under the Finance sector (one of the 16 Zacks sectors).
We rank all the 260 plus industries in 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 #6. This indicates that the overall outlook is
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 Earnings ESP or
expected surprise prediction helps in predicting the probability of
Currently, we are approaching the end of the third quarter 2013
earnings season with results from nearly 88% of the S&P 500
companies already available.
Among the finance companies that have already reported, the
'earnings beat ratio' (percentage of companies with positive
surprises) was 58.2% while the 'revenue beat ratio' was 50.6%.
Total earnings for this sector were up 9.9% year over year,
moderating from the 32.4% growth in the second quarter. Total
revenue moved north 0.6% versus 7.9% growth in the prior quarter.
Looking at the consensus earnings expectations for the rest of the
year, we are encouraged by the estimated 32.3% growth for the
sector in the fourth quarter and full-year 2013 growth of around
For a detailed look at the earnings outlook of this sector and
others, please read our
Zacks Earnings Trends
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 faced a rough patch since its inception, with opponents
challenging its individual mandate and Medicaid expansion clause
and dragging it to court. Insurers lobbied against most of its
provisions and opposition 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 for a second presidential
term provided the necessary ratification to the health care reform.
But recent implementation challenges, particularly the botched
launch of the website, has continued to cloud its outlook.
The Changing Face of the Health Insurance Industry
So far, the carriers 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 the age of 26, annual rate
review) relatively well.
For the moment, however, the biggest question is how the most
impactful 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), which
are due to be implemented in 2014, will affect the industry.
Investor sentiment toward the reform implementation in 2014 and
beyond will be the driving factor for managed care stocks.
Insurance Exchanges, which came into effect from Oct 1, are acting
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 low profit margins for the carriers in the long run.
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 to realign their business 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.
Aiming for Global Markets
With organic growth remaining challenged, carriers in the health
insurance sector are flocking to 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 intend to penetrate deeper mainly in the emerging
economies of Asia and the Middle East.
UnitedHealth 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.
Focus on Health Insurance Exchanges
The 2010 Affordable Care Act established online health insurance
marketplaces, also known as exchanges, to enable individuals and
small businesses to shop for coverage.
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.
Overall, the exchanges are likely to be a major opportunity for
large insurers over the coming years. Insurance companies are
taking different strategies in approaching the exchanges. We
believe WellPoint remains best positioned on the exchanges, given
its strong branding and conservative pricing. Another player
) is likely to accumulate significant market share within its
states, driven mostly by the Coventry brand. Others like Centene
and Humana are quite active in bidding, while United and Cigna are
The health insurance exchange with its comparative shopping options
and easy availability of consumer information is expected to
increase competition among private insurance providers. But before
the process could start, consumers will need an easy-to-use and,
not to mention, functioning web-based interface to make use of it.
The inability to do that thus far has been very embarrassing for
the law's proponents and a boon for its opponents.
Health Insurers Investing in Technology
The country's seismic shift toward a more digitized way of life was
noticed by the health industry. There has been unprecedented
spending on health information technology (HIT). HIT includes
electronic health records (EHRs), health information exchanges
(HIEs) and other initiatives.
Health IT, which helps providers communicate better with each other
about patient care, reduces medical errors, paperwork and needless
duplicate screenings and tests, leads to better coordinated patient
care and lower health care costs. These have increased current
health care information technology spending. Financial incentives
offered by regulators to providers and hospitals for the meaningful
use of health care IT products are primarily driving huge IT
From 2013, all hospitals serving Medicare patients with the most
common conditions are being paid for the quality of care they
provide in addition to the quantity of services offered. Some
of the companies are also sharing data. We expect the trend to
continue as pay-for-performance takes root.
Reversal of Reimbursement Cuts to the Medicare Advantage
Medicare Advantage plans are privately run versions of the
federally funded Medicare program for the elderly and disabled. In
Feb 2013, the U.S. Centers for Medicare & Medicaid Services
proposed to reduce reimbursement payments by 2.3%. This worried
insurers so much so that they lobbied against the rate
Following the widespread lobbying The Centers for Medicare &
Medicaid Services announced in April that it will increase the rate
by 3.3% in 2014, reversing the rate cut announced in February. The
originally proposed 2.3% cut, along with other headwinds, would
have translated into a 7% to 8% decline in revenues, leaving a
majority of insurers unprofitable.
Medicare Advantage Remains a Preferred Market
Insurers remain attracted to this line of business as they expect
increasing number of seniors to opt for the Medicare Advantage
program. Enrollment in such plans is expected to increase in
According to U.S. Census data, the number of Medicare beneficiaries
will increase 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
However, consolidation in the market has led to a scramble for
market share. 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.
This is evident from instances like Cigna's acquisition of
HealthSpring Inc, UnitedHealth's acquisition of XLHealth Corp.,
Aetna's acquisition of Coventry Health Care Inc. and WellPoint's
acquisition of Amerigroup 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 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:
- 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.
We expect most of the companies within our coverage to benefit
from the trend. Specifically Cigna with a Zacks Rank #2 (Buy) and
Health Net, WellPoint, Molina Healthcare, Aetna, 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:
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.
Aetna remains uniquely poised to benefit from the changing health
insurance market. The company has made huge investment in IT and is
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 provide
UnitedHealth has also been performing well for the past many
quarters. We are optimistic that it will outperform in a rapidly
changing industry environment, given its industry-best execution
and management, product positioning, scale, and technology.
Contrary to earlier conjecture, the company has limited exposure to
the downside risks associated with the health reform.
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 expenditure to increase at an
average annual rate of 5.8% from 2012-2022. 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 costs.
- 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 a sluggish unemployment rate will adversely
affect medical membership, operations, financial position and
The overall thrust of healthcare reform and regulatory changes will
certainly change the face of the industry in the long run.
AETNA INC-NEW (AET): Free Stock Analysis Report
CIGNA CORP (CI): Free Stock Analysis Report
HUMANA INC NEW (HUM): Free Stock Analysis
UNITEDHEALTH GP (UNH): Free Stock Analysis
WELLPOINT INC (WLP): Free Stock Analysis Report
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