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Demographic Changes, Diversification Aid Health Insurers

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Health insurer stocks have performed strongly so far this year despite persistent policy uncertainty. The near-term driver helping these stocks appears to have been the markets’ skepticism about the GOP’s ‘repeal & replace’ effort, which has been borne out by the slow progression of the second ‘repeal & replace’ effort (Graham - Cassidy) which looks as if it will not even be brought up for a vote in the U.S. Senate.

The health insurance group also appears to be well placed as a result of a number of secular favorable factors, including rising enrollment and top-line growth, development of ancillary businesses, product modifications, favorable demographic changes, expansion of international operations, better claims handling, M&A and a strong capital position.

Some recent weakness notwithstanding, the industry’s stock market performance this year has been very impressive, outperforming the S&P 500 index in the year-to-date period: +23% for the industry vs. +11.6% for the large-cap index.

Large diversified insurers like UnitedHealth Group Inc. (UNH - Free Report) , Aetna Inc. AET, Cigna Corp. (CI - Free Report) , Humana Inc. (HUM - Free Report) and Anthem Inc. (ANTM - Free Report) are well-placed, given that their earnings are buffered to a large extent from industry disruption.

Let’s take a look at how insurers fared recently:

Decline in Uninsured Rates

Over the past six years, the nation’s uninsured rate has gone down to single digits, thanks to the Affordable Care Act mandates. According to the Centers for Disease Control and Prevention, in 2016 the uninsured rate was around 9% compared with 16% in 2010. The decline since 2010 corresponds with the passage of the Affordable Care Act, also known as Obamacare.

Health insurers have capitalized on this surge in insured rates by raking in members, who added to their top-line growth. Most of the insurers have reported a secular rise in enrollment and revenues since 2010, confirming the fact.

Booming Medicare Business

Demographic changes in the United States have fueled growth of Medicare.Revenues from the managed-care plans of Medicare Advantage are expected to grow significantly as baby boomers retire. Medicare Advantage is a privately run version of the government's Medicare insurance program for the aged and disabled.

The Kaiser Family Foundation states that since the ACA was passed in 2010, Medicare Advantage enrollment grew 71% as of Mar 31, 2017. Medicare Advantage enrollment is projected to continue to grow over the next decade, rising to 41% of all Medicare beneficiaries by 2027.

While two public providers, UnitedHealth and Humana, are the biggest players in this space, others are in a race to win Medicare Advantage market share. The fastest way of achieving this is by acquiring a company in the same business.

Players have been resorting to mergers and acquisitions, joint ventures and partnerships in an effort to deepen their reach in the Medicare market. Some of the biggest deals in this space were the acquisition of HealthSpring by Cigna, XLHealth Corporation by UnitedHealth Group, and Health Net by Centene. Recently, Anthem announced that it will buy Florida-based Medicare Advantage insurer HealthSun.

International Markets Hold Attraction

Pressure on profit margins in the U.S. market has compelled American health insurers to look to foreign markets for sustained growth and profitability. International markets seem attractive as these are less penetrated and more competitive. Notably, Asia and Europe represent the best near-term opportunities for U.S. health insurers.

Cigna and UnitedHealth Group lead the private health insurance industry in terms of international deal activity. They’re followed by Aetna and Humana. The deals have either been mergers and acquisitions or joint ventures with local insurance companies.

Some of the deals made by players in this field echo the emerging trend of globalization.  Recently, Aetna acquired UK-based Bupa Group’s Thai business, Bupa Thailand, which will significantly increase Aetna’s presence in Asia. Earlier, it bought U.K.-based InterGlobal, which offers private medical insurance to groups and individuals in the Middle East, Asia, Africa and Europe.

Another insurer, Cigna, penetrated the Indian market through a joint venture with TTK Group.

UnitedHealth’s purchase of a stake in AmilParticipacoes of Brazil, and its recent announcement to buy Chilean company BanMedica, point toward the trend of insurers going international.

Managing Costs via ACOs

The industry is witnessing a change from volume-based care to value-based care in recent years, which has led to the emergence of Accountable Care Organizations (ACOs). These are formed when a group of health care providers (physicians, hospitals, non-physician providers, and the like) collectively take responsibility for the financial and quality outcome for a defined population.

The ACOs are appealing to insurers as these reduce medical cost and improve outcome. Insurers form an essential part of ACOs because these track and collect patient data, enabling an evaluation of patient care. Since clinical information and care processes are shared and supported by all providers, it becomes easier to manage care and effectively lower the cost. With Obamacare, health insurers have to be more than just claims payers.

Under health reform, insurers have lost flexibility in ways that they can cope with rising medical expenses. They can no longer rely on many of their traditional medical underwriting strategies, such as the exclusion of pre-existing conditions. The most effective approach for insurers now is to rely exclusively on the current cost-control mechanisms to manage members’ medical expenses. Private commercial payers -- such as Cigna, Anthem and Aetna -- are thus supporting ACO formation. CIGNA has one of the most established track records in the group for ACOs.

Developing Ancillary Businesses

Insurers are eyeing growth and expansion opportunities that accompany the critical challenges of modernizing the health care system. They are branching out to non-traditional areas.

Over the last few years, several large insurers have acquired companies that fall outside the realm of traditional health insurance, yet complement it.

Players, Humana, Aetna, UnitedHealth have all been enthusiastically developing their health services business. These players have made several acquisitions, both small and large, to achieve fast-paced growth in this space.  

Recently, UnitedHealth Group announced the acquisition of Surgical Care Affiliates. It also announced that it will take over the health care business of The Advisory Board Company ABCO. It also recently acquired Catamaran. These acquisitions and several others have been made in its health services business, Optum.

Healthy Balance Sheet

Despite incurring heavy expenditures, most of the players in the industry boast a solid capital level. This reflects their profitable operations which have outpaced expense rise, leading to balance sheet growth.

Armed with enough capital, most of the players have resorted to share buyback to aid earnings in an environment when top-line growth is a challenge. Strong cash reserves have also enabled players to make acquisitions and mergers to achieve growth, along with positioning them well to face industry issues.

Zacks Industry Rank Indicates Solid Upside Potential

This 13-company group currently carries a Zacks Industry Rank of #11, which places it in the top 4% of the 250 plus Zacks classified industries. Our back-testing shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

Stocks Worth Adding

Investors can consider the following HMO stocks that have solid fundamentals along with a favorable Zacks Rank.

Centene Corp. (CNC - Free Report) beat estimates in three of the last four quarters with an average positive surprise of 7.7%. Also, the Zacks Consensus Estimate for 2017 and 2018 moved up 2.5% and 2.1%, respectively, in the last 60 days. Centene carries a Zacks Rank #2 and sports a Value Score of A.

You can see the complete list of today’s Zacks #1 Rank(Strong Buy)stocks here.

Magellan Health, Inc. (MGLN - Free Report) has a Zacks Rank #2 and a Value Score of A. The stock beat estimates in three of the last four quarters with an average positive surprise of 23.9%. Also, the Zacks Consensus Estimate for 2018 has moved up 3.7% in the last 60 days.

WellCare HealthPlans Inc. (WCG - Free Report) carries a Zacks Rank #2 and has a Value Score of B. The stock beat estimates in each of the last four quarters with an average positive surprise of 47.4%. Also, the Zacks Consensus Estimate for both 2017 and 2018 moved up 1.7% in the last 60 days.

Aetna carries a Zacks Rank #2 and has a Value Score of B. The stock beat estimates in each of the last four quarters with an average positive surprise of 19%. Also, the Zacks Consensus Estimate for 2017 and 2018 moved up 6.1% and 2% in the last 60 days.