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 U.S. GDP. Money spent per person on healthcare in the United States is more than in any other nation in the world, according to the World Health Organization.
Despite rapidly growing spending on healthcare over the past few decades, health insurance industry has been characterized by growing premium, limited policy choice and lack of transparency.
Over the past 10 years, health insurance premiums have persistently increased, outpacing the growth of wages and cost of living. The surge in premiums -- due mostly to complex connections among health insurance companies, health care providers, pharmaceutical manufacturers and the medical technology industry -- has been witnessed in both employer-sponsored insurance as well as individual insurance.
Total premiums for employer-sponsored insurance doubled in the 1999-2009 period. The individuals market also saw rapid growth in the cost of premiums. Insurance companies have also been known to denying coverage because of pre-existing conditions, and for charging higher premium in the individual market.
Increasing industry consolidation also left lesser insurance choice for Americans, who were reeling under rising health care costs. Since 1996, the industry has witnessed acquisitions worth about $90 billion, resulting in dominance by just a few players.
Consolidation and market dominance consequently led to a decline in competition. Big insurers dominating large markets hardly ever bothered to provide even the basic information to consumers, such as the performance of health insurance policies, procedures to claim, the size of provider network and cancellation procedure.
Moreover, in the absence of any reasons or incentives to lower policyholders' cost, insurance companies went on making increasing profits year after year. According to HealthReform.gov, profits of the ten largest insurance companies increased 250% between 2000 and 2009 -- ten times faster than inflation. Though the industry saw lower enrollment (medical membership) due to the latest recession, major health insurance companies managed to remain profitable by increasing their insurance premiums.
Looking at the other end of the spectrum, health insurance companies also benefited from low utilization amid recessionary conditions. A high deductible and high out-of-pocket cost kept the cash-strapped Americans away from the clinics, leading to lower utilization of health care services. A recent analysis from the Kaiser Family Foundation revealed that even people with insurance are opting for medical checkups less frequently, with the number actually dropping most dramatically after the recession technically ended. Patients made 17% fewer doctor visits in the second quarter of 2011 than in the second quarter of 2009.
Over the past couple of years, lower utilization has played a very prominent role in helping the profitability of the major players in the health insurance sector. Most of the carriers continued to beat earnings estimates in recent quarters, benefiting from lower claim payments.
According to insurance majors like Aetna Inc. ( AET ), WellPoint Inc. ( WLP ) and CIGNA Corp. ( CI ), medical utilization trends haven't moved much. Since these insurers hold major market share, any indication from them confirms the fact. But, some uptick in utilization rate can be expected in data for the final quarter of the year as policyholders try to go for the long delayed checkups.
However, low medical utilization is a short-term factor affecting the industry. Over the longer term, issues including the effects of health care reform and negative economic consequences will reshape the industry.
Health Care Overhaul
The year 2010 marked the passage of the Patient Protection and Affordable Care Act, and the beginning of a multiyear implementation process. It is the most substantial overhaul in the history of the nation's health care system.
The primary stated goals of the reform were to provide coverage to the 32 million uninsured Americans, make healthcare facilities more affordable, expand coverage for customers with pre-existing conditions and keep a tougher oversight over the health insurers. The legislation's detractors contest many of its stated benefits and consider it another entitlement program that the country can ill afford.
Certain significant provisions of the legislation pertain to mandated coverage requirements, rebates to policyholders based on minimum benefit ratios (which measures underwriting profitability and is computed by taking the total benefit expenses as a percentage of the premium revenues), adjustments to Medicare Advantage premiums, the establishment of state-based exchanges, greater investment in health IT and an annual insurance industry premium based assessment. The individual mandate requirement of the legislation is being contested in the courts, with the final outcome of that adjudication process far from certain at this stage.
Possible Outcomes of the Reform
The proponents of the legislation claim that upon its full implementation in 2018, the reform will end discrimination by insurance companies, create competition amongst insurers through health exchange, ensure value in the overall healthcare system and lower the premium.
Some of the provisions and their possible effect on the health insurers are as follows:
- According to the law, any proposed rate increase above 10% will be reviewed more closely by both state and federal governments, and approval will be granted only if the increase seems justified. This is expected to slow down insurers' premium escalation, thereby restricting top-line growth.
- Beginning 2011, the provision of maintaining 80% of minimum loss ratio ( MLR ) on individual policies became effective. Also, the requirement of 85% MLR for commercial policies will be effective from 2012. These provisions will lead to limited bottom-line growth as carriers will be forced to spend a minimum amount on insured. A failure to abide by the MLR rule will force carriers to rebate the excess cash back to the insured or to lower the premium.
- The law also requires insurance coverage for people with pre-existing conditions at the standard rates. This will lead to lower profit per policy compared to earlier where individuals with pre-existing conditions were charged two to five times more than people with average health for the same policy.
The breadth of possible changes due to the legislation could change the way insurance companies do their business. This will potentially impact pricing, product mix, geographic mix and distribution channels. The fundamental and potentially game-changing developments could threaten carriers' ability to achieve top and bottom-line growth.
While the law has put some restrictions on the insurers, other provisions of the law provide them with new business opportunities. Health insurers are looking forward to the entry of millions of new customers into the market place. Emphasis on the use of health IT opens a new complimentary business for the carriers.
Consequently, Electronic Health Records and Health Information Exchanges have become an attractive area for the carriers. The recent string of acquisitions of Picis, an acuity information systems vendor, A-Life Medical, Computer-assisted coding software and Axolotl Corp. a health-data network, by UnitedHealth Inc. ( UNH ) and Aetna 's buyout of Medicity, a provider of information technology, reflect the growing potential of this health service area among the insurers.
Aiming for Global Markets
Carriers in the health insurance sector are also focusing on international markets, which specifically appear attractive because of lesser regulations. 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 is providing carriers with a vast market opportunity.
Companies like Cigna and Aetna, which have an active presence overseas, believe that their international business is a positive differentiator and is a key driver of the higher-than-peer growth rates.
Cigna's recent acquisition of UK based First Assist, a joint venture with TTK Group for selling health insurance products in the Indian market, reflects the company's urge to grow its international business. Last year, the company acquired Vanbreda International, making it a global leader in providing expatriate benefits.
Aetna recently finished two-year licensing process to begin selling policies in Shanghai. Further, in June, the company entered the Indian market by acquiring Indian Health Organization, a fast-growing medical discount card provider. The Indian company serves approximately 80,000 individuals in 18 major cities.
Both the companies are targeting growth mainly in the emerging economies of Asia and the Middle East. Though the U.S. health insurance industry currently has little presence internationally, we expect the presence to grow as players pursue global expansion opportunities.
Medicare Advantage: A Favorite Market
With the first group of Baby Boomers turning 65 this year, health insurers see expanding opportunities in this area over the next few years. In fact, in the next 25 years, compounded annual growth rate of Medicare population is expected to increase to 2.7% from 1.5% at present.
Revenue from managed-care plans of Medicare Advantage is expected to increase significantly over the next few years as baby boomers retire. Medicare Advantage is a privately run version of the government's Medicare insurance program for the aged and disabled.
Managed-care is expected to get a lot more attention as the federal and state governments try to reduce costs. The now unsuccessful Congressional "Super-Committee" looked into cutting some of the funds out of federal health care programs, but failed to achieve a bi-partisan agreement. Major cuts to the Medicare program, whenever it happens, will have to shift some of the costs to the seniors.
This could, in turn, be good for the health insurers, making their Medicare Advantage plans more attractive than traditional Medicare plans. Moreover, many individuals would look forward to supplement government coverage with private insurance, boosting demand for Medicare Advantage plans. But reforming the government healthcare program has proven to be very difficult politically.
Until now, only two of the public providers -- UnitedHealth and Humana Inc. ( HUM ) -- controlled more than 10% of the market. However, we expect a sharp consolidation in this market. Carriers in the health insurance sector are in a race to win Medicare Advantage market share and the fastest way of doing this is to acquire a company in the same business. Following are some of the recent M&A activities in this arena:
In late October, Cigna announced its intention to acquire HealthSpring Inc. for $3.8 billion.
UnitedHealth's acquisition of XLHealth Corp, a sponsor of Medicare Advantage health plans in November, was the next big deal in this area worth $2 billion. Earlier during the year UnitedHealth acquired Inspiris, which serves patients in Medicare, Medicaid and commercial insurance populations.
On October 1, Aetna closed its acquisition of Genworth Financial Inc.'s ( GNW ) Medigap business for $290 million.
AMERIGROUP Corp. ( AGP ) also announced to buy Health Plus from Lutheran HealthCare for $85.0 million.
Similarly, Humana struck two deals for small Medicare Advantage plans -- it acquired Arcadian Management Services and MD Care during the third quarter 2011.
In August 2011, WellPoint successfully culminated the acquisition of CareMore Health Group.
Some investors think that smaller companies like Coventry Health Care Inc. ( CVH ) and Health Net, Inc. ( HNT ) along with Medicaid specialists like Centene Corp. ( CNC ), Molina Healthcare Inc. ( MOH ) and Amerigroup may soon become takeover targets.
Though the health insurance industry has been witnessing mergers and acquisitions for the last several years, the landscape created by the health care reform has significantly increased the pace of consolidation. In the changed environment, small insurers are becoming inefficient. The inability to achieve required scale to be profitable is forcing these small institutions to get acquired.
Moreover, a continued low interest rate environment is encouraging the health insurers to seek out more acquisitions as they prefer to keep money away from their investment portfolio.
Over the next few years, growth opportunity for the players in the health insurance sector will be driven by:
- Higher health expenditure and increased penetration of managed care. According to government estimates, national health spending is expected to grow to $4.6 trillion by the end of this decade from $2.6 trillion currently, representing a CAGR of nearly 7%. Going by this forecast, it becomes clear that the health care industry is very much likely to outstrip broader economic growth. Moreover, over the same time period, managed care penetration is expected to grow to about 1/2 of the total national healthcare spending, up from approximately 1/3rd at present, driven by increased role of insurers in managing government's fee-for-service Medicare and Medicaid products.
- 2010 Census figures show that seniors make up 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, Aetna with Zacks #1 Rank, WellPoint, Cigna, Humana, Amerigroup each with Zacks #2 Rank and UnitedHealth with Zacks #3 Rank will offer good investment opportunities in the upcoming years.
Let's have a quick look at some of these companies:
Aetna has been beating our estimates for the past several quarters, due to 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. The lifting of sanctions from Center of Medicare and Medicaid Services and the acquisition of Genworth's Medicare Supplement business will upgrade its Medicare platform.
The company is also aggressively looking to generate incremental fee revenues by managing the infrastructures necessary for care organizations. It is growing its international business for diversification benefits. Moreover, its deployment of $1.2 billion for acquisitions will position it well to deal with the consequences of the Health Care Reform. Besides, a solid balance sheet, well-controlled debt and adequate liquidity will provide overall strength.
Our next pick would be Cigna. Though the company was heavily biased towards commercial business, it made timely acquisitions to ramp up the government business, placing itself in the top five providers of the Medicare products. Its unique and growing international presence is also a positive differentiator. A strong balance sheet and adequate liquidity will further lead to continued share buybacks, thereby contributing to the bottom line.
WellPoint comes next in line. With over 34 million members, the company is a dominant player with a vast provider network. WellPoint has strengthened its portfolio through the acquisition CareMore Health Group in order to 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.
Being the second-largest provider of Medicare Advantage plans, Humana also offers a solid growth going forward. The company has been surpassing earnings for the past several quarters and management raised its FY11 guidance, citing better than expected operating trends.
UnitedHealth has also been beating Zacks Consensus estimates for the past several quarters and recently raised its FY11 guidance. It has strengthened its position in the MA market with XLHealth acquisition. We believe the company's diversified business model in the managed care industry with leading market share in the Commercial, Medicare, and Medicaid markets, along with a solid balance sheet, a highly conservative investment portfolio and expansion into higher margin Health Services segments (Optum) will provide investors with a high risk - return investment opportunity over time.
Though none of the health insurance stocks under our coverage hold Zacks #4 Ranks or even Zacks #5 Ranks, 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 underfunding of these programs and the government's initiatives to control costs.
- Weakness in the U.S. economy could lead to medical cost inflation, leading the employers to exit rapidly from sponsoring employee health-benefits.
- The U.S. "Super-Committee" is working on reducing overall budget by $1.2 trillion. This will keep state budgets under pressure leading to muted rate increases for managed care providers.
With the health care reform standing challenged in the Supreme Court, there remains an element of uncertainty on the entire sector. However, the carriers are taking a mid-way approach, gearing up for remodeling their business. This will lead the nation to have a stronger and more sustainable healthcare system that provides expanded access, superior quality, and better health outcomes for millions of citizens while reducing costs.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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