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Resurgent Economy, Buyouts to Keep Health Insurers Buoyant

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Health insurance is one of the few industries that have been able to hold up their outperformance for the past several years, irrespective of economic uncertainty and regulatory changes.

With the U.S. economy on firm footing now and regulations slowly abating, the industry is on another uptrend. Rising enrollment and top-line growth, increasing contributions from complementary businesses, product modifications, improved service, demographic changes, expansion of international operations, better claims handling, medical cost management, technological investment and upgrades, growth of new business units, mergers and acquisitions and healthy balance sheets have all contributed to health insurers.

Per a McKinsey & Co. report, the private payor market in North America is expected to grow from $583 billion in 2010 to $1,421 billion in 2025.

So What Are the Industry’s Growth Catalysts?

The industry has grown 33.6% in a year’s time, more than double the increase of 15.9% clocked by the S&P 500 index, during the same time frame. Interestingly, the industry has retuned more than double the S&P 500 index in each year since 2012. Let’s look at the factors that would fuel future growth.

Massive Opportunity in Medicaid, Medicare

Medicare and Medicaid, the health plans for retirees are highly coveted by health insurers. An aging American population, with its surging population of baby boomers reaching retirement age each day, acts as a catalyst to heavy demand for these policies.

While Medicaid and Medicare are primarily provided by and are under the purview of the government, pressure on public finances is prompting many governments to impose healthcare-spending cuts or seek out private payors as intermediaries to better manage spending and outcomes. Private health insurance players have indeed been quite successful in efficient management of these programs.

Per a study by Health Affairs in 2016, Medicare and Medicaid accounted for nearly 60% of health care revenues reported by the five largest U.S. commercial health insurance companies: UnitedHealth Group Inc. (UNH - Free Report) , Anthem Inc. (ANTM - Free Report) , Aetna Inc. (AET - Free Report) , Cigna Corp. (CI - Free Report) , Humana Inc. (HUM - Free Report) . Revenues from public coverage have more than doubled since the passage of the Affordable Care Act (ACA), growing from a combined total of $92.5 billion in 2010 to $213.1 billion in 2016.  Between 2010 and 2016, Medicaid and Medicare enrollment in the five companies doubled, from 12.8 million to 25.5 million. Medicaid enrollment rose by 1 million in 2017 to nearly 55 million Americans, according to a new report from consulting firm PwC.

There seems to be no stopping this business expansion. Medicaid is the third-largest domestic program in the federal budget after Social Security and Medicare, and the share managed by private insurers is rising as states shift more of their Medicaid population to managed care plans. Per a report by PwC, the share managed by private insurers is rising as states shift more of their Medicaid population to managed care plans. This should fuel growth in this business.

Medicare is another excellent opportunity as the number of people eligible for Medicare is projected to surpass 70 million individuals by 2024, up from 60 million at present, with gross spending for Medicare expected to reach $1.2 trillion by 2024, up from $770 billion projected for 2018. Medicare Advantage continues to be a popular choice for approximately one-third of those enrolled in Medicare. Seniors have rewarded insurers with rapid growth in recent years and the same is expected to continue as the market continues to expand and evolve.

Cross Industry Collaboration to Cause Rapid Shift

Pharmacy-benefit managers teaming up with insurers is the latest in the mounting trend of health care consolidation. Healthcare companies are making concerted efforts to transform themselves into a comprehensive healthcare provider, offering a one-stop solution for their customers. To achieve this goal, pharmacy companies and health insurers are joining forces.  The coming together of two different sections of the healthcare space testifies that business boundaries are getting blurred.

Moreover, insurers are under pressure to protect margins due to high medical cost, growing consumerism and high regulations. Joining other forward- or backward-integrated companies thus seems the best survival strategy that would provide companies with additional strength and a wider business spectrum.

Some of the mega deals in this vein that are currently underway are Aetna’s takeover by CVS Health Corp. (CVS) for a staggering $69 billion and Cigna’s merger with Express Scripts, the largest pharmacy benefit management company, for a whopping $67 billion.

The completion of these deals will further leave the industry, which is already highly consolidated, with very few players.

Services Beyond Insurance Acts a Complement

In an effort to diversify their business operations, most health insurers have developed a portfolio of products and services aimed at creating a holistic and integrated approach to individual health and wellness. These products and services, which include care delivery, population health management and engagement, health financial services, health IT, benefit operations, care operations and pharmacy care services complement their core business lines — Commercial, Medicare and Medicaid products — and enable enhanced service delivery and experience to their customers.

One of the leading health insurers, UnitedHealth, has been proactive in developing its health services business, which accounts for nearly 20% of its 2017 total revenues. We expect this trend to continue as the traditional business becomes more competitive and burdened with regulations.

Investment in Technology

Use of cutting edge technology is a necessity in the healthcare industry to reduce inefficiency and wastage, which have caused the U.S. healthcare to be the costliest in the world. Healthcare inefficiencies in the form of improper medical record maintenance and duplication of services have been known to be third-most common factor causing deaths in the United States after cancer and heart diseases.

The need therefore is to streamline operations with the latest technologies. Electronic health records, use of analytics and data management, are some of the uses of technology which have greatly helped health insurers. Going forward, technologies such as blockchain, augmented reality, artificial intelligence and the Internet of Things will be the game changers.

Business Opportunities Outside the U.S.

More than one-half of global health care spending occurs outside the United States, and domestic health insurers serve nearly 1-2% of that market. Continued worldwide expansion, both on an organic basis and through strategic acquisitions, is a therefore a tremendous growth priority.

Moreover, excessive competition and pressure on profit margins in the U.S. market has compelled the country’s health insurers to look beyond their local dominion to foreign markets for business diversification and sustained growth and profitability.

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.

Recently, UnitedHealth acquired a Chilean company, Empresas Banmédica, which will enhance its footprint in South America. The international business remains unexploited and we expect players to divert attention to this area.

Healthy Balance Sheet

Capital level across the industry is solid, which has enabled investments in strategic growth areas with mergers and acquisitions, technological investments and innovations. Also, disciplined capital management has led to share buybacks and dividend increases, thereby increasing shareholders’ returns.

Zacks Industry Rank Indicates Solid Upside Potential

This 12-company group currently carries a Zacks Industry Rank of #34, which places it in the top 13% of the 256 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.

Valuation

While the industry has outperformed the broader market, valuations remain at the same level as that of the industry.

The Zacks HMO industry is currently trading at a forward 12-month price-to-earnings ratio of 16.95 which is near 17 for the S&P 500 index as a whole. Over the last five years, the industry has traded in a range of 10.6 to 20.1, with a median of 15.3.

We therefore go a bit further and look at the PEG ratio, which bakes in the growth rate of the industry. The industry’s PEG ratio is 1.3, which compares favorably with the industry’s PEG ratio of 1.8. This shows that the industry is undervalued and has room for upside. 

How to Play Life Insurance Stocks

With an estimated 85 million people representing $1 trillion in annual health care spending still not served through managed care in the United States alone, health insurers are well positioned for continued growth. New markets also continue to emerge around areas like social, home care and caregiver services; personalized wellness; as well as global opportunities, which place health insurers on an upward trajectory. 

Health insurers’ prospects are looking up on a number of positive factors. So, it would be prudent to pick a few stocks based on a favorable Zacks Rank.

Here are a few top-ranked stocks that you may want to consider:

WellCare Health Plans, Inc. (WCG - Free Report) : This Zacks Rank #1 (Strong Buy) has seen the Zacks Consensus Estimate for current-year earnings being revised 3.3% upward over the last 30 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Anthem, Inc. (ANTM - Free Report) : This Zacks Rank #2 (Buy) has seen the Zacks Consensus Estimate for current-year earnings being revised 1.7% upward over the last 30 days.

Humana Inc. (HUM - Free Report) : This Zacks Rank #2 has seen the Zacks Consensus Estimate for current-year earnings being revised 0.8% upward over the last 30 days.

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