Health Insurance Stocks Gain As Humana Says Government Cuts Won't Be As Bad As Feared

Feb 25 2014, 1:03pm CST | by

UnitedHealth Group’s stock gained 3% on Monday after peer Humana announced that the government’s cuts to the Medicare program would not have as severe an effect as earlier estimated. Humana’s stock surged 11% following the announcement while Aetna gained 2%.

The Medicare program provides healthcare services to individuals aged 65 or older and younger people with disabilities. It is run by the Centers for Medicare and Medicaid Services, with companies like UnitedHealth assuming health care insurance coverage in return for a fixed monthly premium per member served from CMS. There are close to 50 million Americans enrolled in the Medicare program, of which around 21% are enrolled through UnitedHealth, making it the largest provider in the country. More than 30% of the company’s revenues and EBITDA come from this division.

Our $74 price estimate for UnitedHealth’s stock is in line with the current market price.

See Full Analysis For UnitedHealth Group Here

Medicare funding comes from the Hospital Insurance Trust Fund and the Supplementary Medical Insurance Trust Fund, held by the U.S. Treasury. The funds utilize payroll taxes paid by employees and employers as well as other sources such as income taxes paid on Social Security benefits and premiums from people who aren’t eligible for premium-free Medicare coverage. Total government expenditures on the Medicare program are around $550 billion per year.

However, following the implementation of the Protection and Affordable Care Act and the online health insurance exchanges, the government has decided to cut Medicare payments to insurance companies by nearly 30% in the next 10 years. UnitedHealth has been preparing for the rate reductions and has resorted to cost cutting and fraud prevention measures in the past, but its bottom line has been affected by the government funding cuts; the United HealthCare division’s EBITDA margin dropped from 9% in 2012 to 7.6% in 2013, partly because of the aforementioned cuts.

Humana has announced that the proposed funding cuts will lead to a funding decline of 3.5% to 4% instead of the 6% to 7% range it had earlier expected. This will also have a positive impact on UnitedHealth, which has a share of more than 20% in the U.S. Medicare market. However, we still expect a slight decline in margins in the coming years. More than 80% of UnitedHealth’s operating expenses are medical costs, and the company has maintained a medical care ratio of 80% for the last few years. However, the PPACA mandates a minimum medical care ratio (medical costs divided by premiums) of 80% for individual and small group plans, and 85% for large group plans. The impact of this was observed in 2013 earnings, as the medical care ratio increased from 80% in 2012 to 82% and could still increase further.

Other Factors

Another mitigating factor is the so-called “adverse selection death spiral.” The PPACA requires policies to be issued regardless of community rating or medical condition, with insurers offering the same premium to all insured parties of the same age and location, regardless of gender or pre-existing condition. The act also offers subsidies to low income individuals and families with income below the federal poverty level. This means that the cost of health insurance will increase for young and healthy citizens who might be disinclined to opt for the plans. Younger and healthier citizens are likely to visit medical providers less frequently, which could benefit health insurers.

We expect UnitedHealth’s margins to fall to around 6.7% by the end of the decade, but there is a 10% upside to our price estimate if the company can maintain its current EBITDA margin of 7.6%. The potential upside is around 20% if the company can maintain an EBITDA margin close to the historical average (from 2010 to 2012) of 9%, though that is unlikely.

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Source: Forbes Business

 
 

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