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Health Insurance Stock Outlook - January 2018

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The year gone by was a tumultuous one for health insurers as the industry reeled under constant uncertainty stemming from President Trump and the Republican Congress’ efforts to repeal and replace Obamacare. Toward the end of the year, the individual mandate (which required most Americans to obtain health insurance or pay a fine) of Obamacare was stripped from the GOP tax bill.

Apart from political tumult, tough regulatory oversight led to the blockage of two mega-mergers: Aetna Inc. (AET - Free Report) with Humana Inc. (HUM - Free Report) and Cigna Corp. (CI - Free Report) with Anthem Inc. (ANTM - Free Report) .

On an operational level, rising medical costs, public exchanges woes, increased investments in technology, higher operating costs and stiff competition were some of the headwinds that prevailed. Nevertheless, the players emerged as winners with most of them reporting a rise in revenues, membership and margins. Factors such as low medical utilization, greater emphasis on value-based care, diversification of operations, product and service development, cost control efforts and strong capital levels worked in their favor.

Rapid evolution is being witnessed in the health insurance industry as the players are taking concerted efforts to transform themselves into comprehensive health care providers from their earlier role of traditional payers. This metamorphosis is being driven by growing consumerism, changes brought about by healthcare reform, more focus on value-based care, the need to control rising medical costs and being more competitive.

Another wind blowing across the industry is cross-sector collaboration, wherein health insurers are foraying into another realm of the health care industry such as pharmacy benefit management, ambulatory care and physician services.

These combinations that qualify as lateral integrations are catching the eye of insurers since such deals enable them to broaden their service and product portfolio, and become a comprehensive healthcare company. Some of the mega deals in this vein are UnitedHealth Group’s (UNH - Free Report) acquisition of Catamaran and the pending merger of Aetna with CVS Health Corp. (CVS - Free Report) .

Despite all the ambiguity, the industry remained an outperformer by growing 54% in a year’s time compared with the S&P 500 index’s 24% gain.

What’s in the Cards in 2018?

The year 2018 will be fraught with risk and uncertainty as the repeal and replace conundrum continues. Though the individual mandate has been stripped off, legislators will have to come up with some replacement policy for the individual mandate.

Nevertheless, since insurers have been paying high tax, the tax reform pursuant to The Tax Cuts and Jobs Act of 2017 should come as a breather. Recently, UnitedHealth reported that it has gained $1.22 per share non-cash benefit for 2017 from the revaluation of its net deferred tax liability due to the tax reform.

The savings from a lower tax rate will most likely be utilized in accelerating investments in data analytics, technology and innovations to better serve consumers and care systems and to advance new and existing business platforms.

The year 2018 should see more of vertical integration via mergers and acquisitions as players will look for suitable targets to a) strengthen an existing business or platform; b) provide a new platform for future growth; c) bring tools, technologies or skills that cannot be otherwise obtained or developed more efficiently.

We also see the potential for sustained growth particularly in expanding government programs, Medicare and Medicaid. Increasing demand for Medicare plans from baby boomers and migration by more states to manage Medicaid have created huge growth opportunities in this line of business.

Is Further Upside Potential Left?

While the industry has outperformed the broader market, valuations remain a bit stretched and leave limited or no room for further upside.

The Zacks HMO industry is currently trading at a forward 12-month price-to-earnings ratio of 19.4 which compares unfavorably with 19.3 for the S&P 500 index as a whole. Over the last 5 years, the industry has traded in a range of 9.3 to 21.8, with a median of 15.9

What this shows is that while HMO stocks are somewhat pricey.

Zacks Industry Rank

Within the Zacks Industry classification, health insurers are broadly grouped in the Medical sector (one of the 16 Zacks sectors).

We rank 265 industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by more than twice as much. The Zacks Industry Rank is #23 (top 108%). The ranking is available on the Zacks Industry Rank page.

Please note that the Zacks Rank for stocks, which is the core of our Industry Outlook, has an impressive track record -- verified by outside auditors -- of foretelling 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.

Stocks Worth Considering

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

UnitedHealth Group Inc. is a diversified health and well-being company in the United States. The company offers consumer-oriented health benefit plans and services, health care coverage, and health and well-being services to individuals aged 50 and older.

The stock currently has a Zacks Rank #2 (Buy) and surpassed earnings estimates in each of  the trailing four quarters, with an average beat of 4.78%. Also, the stock has seen the Zacks Consensus Estimate for 2018 being revised upward over the past seven days. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Nobilis Health Corp. ((HLTH - Free Report) ) own and manage ambulatory and acute care facilities for healthcare services. In addition, it owns and manages ambulatory surgery centers, acute care hospitals, imaging centers and urgent care clinics. The stock currently has a Zacks Rank #2 and has a Value Score of A. It surpassed earnings estimates two of the last four reported quarters, with an average beat of 9.6%. Also, the stock has seen the Zacks Consensus Estimate for 2018 being revised upward over the past 60 days.

Anthem Inc. ((ANTM - Free Report) ) provides medical products through its subsidiaries. It operates through Commercial, Consumer and Other segments. The company offers managed care plans to the large and small employer, individual, Medicaid and senior markets.

The stock currently has a Zacks Rank #2 and has a Value Score of A. It surpassed earnings estimates in each of the last four reported quarters, with an average beat of 11.5%.  Also, the stock has seen the Zacks Consensus Estimate for 2018 being revised upward over the past 30 days.

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