Health Insurance: Reinvention Through Obamacare

Zacks Equity Research

The health insurance industry has been going through a number of challenges. Of these, federal state legislative and regulatory reforms, demands of more price- and service-conscious consumers, fierce competition, shift of customer mix and uncertain economic conditions in the U.S. and abroad are to name a few.

Yet the industry is “thriving under stress.” Big players -- CIGNA Corp. (CI), WellPoint Inc. (WLP), Humana Inc. (HUM), Health Net, Inc. (HNT), UnitedHealth Group Inc. (UNH) and Molina Healthcare, Inc. (MOH) -- have reported unfaltering growth in premium as well as fees and other income over the years. In the first quarter of 2014, a 14% increase in revenues came from these insurers on a combined basis.

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, health expenditures account for approximately 18% of the country's annual gross domestic product. The World Health Organization has stated that healthcare expenditure per person in the United States is the highest in the world.

Despite the large amount of money spend on health care, the quality of care was inferior and millions of Americans lacked health insurance coverage or were underinsured. This was mostly due to a dysfunctional system that was in place for several years previously. To expand coverage, President Obama introduced drastic health care reforms in March 2010, which besides bringing down the country’s uninsured rate was also aimed at reining in medical-cost inflation.

Health Care Overhaul

One of the biggest factors that has been changing the face of the health insurance industry was the Patient Protection and Affordable Care Act (:PPACA) which was passed in 2010 and marked the beginning of a multi-year implementation process. It is the most substantial overhaul in the history of the nation's health care system.

The reform was aimed at offering coverage to the 32 million uninsured Americans, affordable health care facilities, expanded coverage for customers with pre-existing health conditions and a check on health insurers.

Significant provisions of the legislation mandated coverage requirements; rebates to policyholders based on minimum benefit ratios; adjustments to Medicare Advantage premiums; 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 lifetime maximum limits.

The reform had a rocky start, with opponents challenging its individual mandate and Medicaid expansion clause and dragging it to court. Insurers lobbied against most of the provisions and political opposition swore to repeal the whole law if they were elected. But the law survived the challenges with the Supreme Court upholding the constitutionality of individual mandate -- the core of the reform.

Restriction on Players

Numerous ACA mandates that have been chalked for insurers place restrictions on the players. Here are those with the greatest impact:

The act imposes strict limitations on insurers’ ability to discriminate price: The ACA allows insurers to only charge limited differential prices on certain factors. Although insurance companies can rate on age, the oldest adult in the risk pool cannot be charged more than three times as much as the youngest adult. Similarly, smokers can be charged no more than 1.5 times as much as non smokers. The end price discrimination would lead to healthy competition between players.

Medical Loss Ratios mandate of ACA caps insurers’ profits: Medical Loss Ratio (MLR) is a measure of the share of premiums that an insurer actually spends on delivering care to policyholders, rather than on administrative costs, marketing, and profits. The minimum MLR mandate established by ACA aims to control the portion of premium that goes toward non-medical expenses such as administration, marketing, overheads and profits. The MLR is set at 85% for the large group market and at 80% for the small group market.

This provision will lead to limited bottom-line growth as carriers will be forced to spend a minimum amount on the insured. Failure to abide by the MLR rule will force carriers to rebate the excess cash back to the insured or to lower the premium.

Insurers cannot reject coverage on the basis of pre-existing disease: Earlier, it was common among insurers to deny coverage to applicants with a pre-existing disease. As the insurers sieved the healthy population and rejected the less favorable, claim payments were kept at bay. With this new policy, insurers must cover individuals irrespective of their pre-existing condition. This would lead to lower profit per policy as previously, individuals with pre-existing conditions were charged two to five times higher than those with average health.

State-based rate reviews for unreasonable increase in insurance premium: Increase in premium of more than or equal to 10% is subject to expert evaluation to ensure reasonable cost assumption and solid evidence. This mandate put a check on unbridled rate increases by players.

The Changing Face of the Health Insurance Industry

Most of the reform’s provisions have been implemented in phases. So far, the carriers have handled the impact 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.

Now, 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 for 2014 with increasing annual amounts thereafter, will affect the industry. Investor sentiment toward the reform this year and beyond will be the driving factor for managed care stocks.

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 will increase insurers’ operating costs.

In the fourth year of its implementation uncertainty relating to the ACA reform seems a lot ironed out. Insurers are, however, seeking new ways to prosper in the changing industry.

Insurers Expanding Global Reach

Confined to national boundaries until recently, this industry is now flocking to international markets. Lesser regulations, higher margins, greater demand and lower competition are the key foreign attractions.

Companies like Cigna and Aetna, with a wide overseas presence, view their international business as a positive differentiator and key driver of higher-than-peer growth rates. Both companies intend to penetrate deeper into the emerging economies of Asia and the Middle East. In April 2014, Aetna bought U.K.-based InterGlobal, which offers private medical insurance to groups and individuals in the Middle East, Asia, Africa and Europe.

UnitedHealth is also following the same growth path. The company has expanded its reach from Australia, the Middle East and U.K. to Brazil with its buyout of AmilParticipacoes. We expect to see more international deals going forward.

Establishment of Health Insurance Exchanges (HIEs)

One of the milestones of the reform was to set up online health insurance marketplaces, or exchanges, where individuals and small businesses can shop for coverage.

HIEs are likely draw a greater number of uninsured Americans, thus expanding overall business. Data from Kaiser Family Foundation and the Congressional Budget Office indicates rapid growth in individual exchange markets, with approximately 22 million purchasing coverage online by 2016 and 24 million by 2023.

The exchanges seem to have been well received as the first enrollment session saw a better-than-expected eight million online coverage. Moreover, 35% of new HIE insurers below 35 years of age led to a favorable mix in coverage as companies want more young and healthy people to sign up. This would cover the costs and risk involved with providing coverage to the old and sick.

Insurers initially averse to participating on exchanges are now planning to jump on the bandwagon for 2015 and beyond. However, with comparative shopping options and easy access to consumer information, HIEs are likely to heighten competition among private insurers.

Accountable Care Organizations (:ACO) Wave

ACOs -- groups of doctors, hospitals and other health care providers coming together to provide the full range of cost-effective medical care -- are an outcome of the health care reform act.

The Health Care Reform was aimed at eliminating inordinate expenses associated with lack of coordination between multiple physicians and health care providers. Insurers are keen on forming ACOs to share expenses and generate extra earnings in the form of cost savings. The latest moves by some of the big players in the industry confirm the trend.

The country’s largest insurer, UnitedHealth Group, unveiled plans to double its accountable care contracts over the next five years through employer-sponsored, Medicaid and Medicare plans. Wellpoint bought clinic operator CareMore for $800 million in 2011, to transition to the ACO business.

At Cigna, ACO contracts serve 1.3 million customers in 31 states. The same dynamics hold true at Aetna, which had 30 ACOs with 550,000 members at 2013 end and expects 60 ACOs with 850,000 members by this year end.

Industry Rank

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 2/3rd range with a Zacks Industry Rank #103. This indicates that the overall outlook is ‘Neutral.'

Please note that the Zacks Rank for stocks, which is the core of our Industry Outlook, have 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 helps in predicting the probability of earnings surprises.

Earnings Trends

The broader Finance sector, of which Health insurance is part, should see negative growth rates in Q2 after suffering earnings decline in the first quarter.

Total earnings for the sector are expected to decrease 2.9% in the second quarter on revenue decline of 6.3%. In the first quarter, earnings fell 7.2% due to a 1.1% decline in revenues.

For a detailed look at the earnings outlook of this sector and others, please read our Zacks Earnings Trends report.

Consolidation Continues

Not discounting the copious mergers and acquisitions over several years, the Health Care Reform has set the stage right for further consolidation. With small insurers turning inefficient, following their inability to achieve the required level of profitability, big-ticket acquisitions have become rampant since 2011.

WellPoint bought Amerigroup to expand its supplement lines business. UnitedHealth acquired AmilParticipacoes and XL Health for a wider base and new product lines. Other significant examples are Cigna’s buyout of Healthspring and Aetna’s acquisition of Coventry.


Over the next few years, growth opportunities for the players in the health insurance sector will be driven by greater reliance on managed care. According to 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 GDP growth. 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 outstrip broader economic growth. Moreover, over the same timeframe, managed care penetration is expected to grow to about 50% of the total national health care spending, up from approximately 33% at present on increased reliance on insurers for Medicare and Medicaid products.

Moreover, recent census shows that seniors constitute a larger share of the American population than ever before. The aging population is thus expected to drive industry demand over the coming years.

We expect most of the companies within our coverage to benefit from the higher number of the aged. Specifically, Molina Healthcare Inc. with a Zacks Rank #1 (Strong Buy), Aetna, Health Net Inc. and Humana with a Zacks Rank #2 (Buy) as well as WellPoint, UnitedHealth Group and Cigna with a Zacks Rank #3 (Hold) offer good investment opportunities.


None of the health insurance stocks under our coverage hold a Zacks Rank #5 (Strong Sell) or even a Zacks Rank #4 (Sell). 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 would face increased pressure to maintain medical-benefit ratios due to the lack of funds for these programs along with government's initiatives to control.

WELLPOINT INC (WLP): Free Stock Analysis Report
CIGNA CORP (CI): Free Stock Analysis Report
HUMANA INC NEW (HUM): Free Stock Analysis Report
MOLINA HLTHCR (MOH): Free Stock Analysis Report
HEALTH NET INC (HNT): Free Stock Analysis Report
UNITEDHEALTH GP (UNH): Free Stock Analysis Report

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