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Industry Outlook

In a volatile global economic environment, the U.S. health insurance industry provides investors a micro defense thanks to high degree of its domestic business exposure. Players like Cigna Corp. (CI - Analyst Report) , UnitedHealth Group Inc. (UNH - Analyst Report) , Centene Corp. (CNC - Snapshot Report) and Aetna Inc. (AET - Analyst Report) with business in international markets also have limited exposure (accounting for 3%, 4%, 1% and 0.5% of revenues respectively). More importantly, the sector is largely insulated from headwinds – low oil prices, interest rate hikes, strengthening dollar, China’s economic slowdown – which have been plaguing other sectors of the economy.

The sole factor that has shaken the healthcare industry and changed it wholly is the Health Care Reform or Obamacare, enacted in Mar 2010. Though initially intensively lobbied against by the players, health care reform has turned out beneficial. Courtesy of Obamacare, insurers have witnessed meaningful gains in their membership enrollment, which has beefed up their revenues.

Total revenues of the top eight players, UnitedHealth , Aetna, Cigna, Molina Healthcare (MOH - Analyst Report) , Centene, WellCare Health Plans, Inc. (WCG - Snapshot Report) , Anthem Inc. (ANTM - Analyst Report) and Humana, Inc. (HUM - Analyst Report) increased to $437 billion in 2015 from $383 billion in 2014, with medical enrollment rising to 150 million in 2015 from 145 million in the prior year. Along with posting strong operating numbers, most of the players guided strong earnings for 2016, pointing to the fact that despite hurdles, the industry presents enough growth opportunities.  

Now, after sharing the space with Obamacare for almost six years, insurers have embraced the law. Most of the players are now looking for newer avenues to expand their business. They are reassessing their business model from the perspective of product, pricing, risk management, distribution and claims to fraud management for a realistic pace of growth.

Let’s discuss some of the opportunities provided by the changing industry landscape:

Extensive Consolidation

The Affordable Care Act (ACA) has heightened the drive toward market consolidation. The influx of the previously huge uninsured population into the space has increased overall membership. Now, the players are scrambling to maintain and grow their member enrollment further, and the best way to achieve this is by growing in size. With the health care law emphasizing value-based care, it becomes imperative for health insurers to have a large number of patients to dilute risk, and of course ensure premium dollars to cover the expenses of their sick enrollees, thereby improving overall health outcomes.

Moreover, a bigger size would help in leveraging fixed cost and reducing overall administrative cost (increase cost of compliance with the new health care law). A bigger market share will also equip them better to negotiate harder with hospitals. ‘Get big or get out’ has therefore become the trend in the industry.

The merger frenzy hit a fever pitch with Anthem agreeing to acquire Cigna, Aetna seeking the Humana buyout and Centene’s recent acquisition of Health Net. The market is speculating that consolidation will lead to the “big five” insurers transforming into the “big three,” likely comprising Aetna, Anthem and UnitedHealth.

Higher Insured Population = Top Line Growth

Thanks to ObamaCare, the nation’s uninsured rate has gone down to single digits. Before ACA, around 47 million lacked health coverage. Current data shows that the uninsured rate is around 9%. According to an ongoing NHIS/CDC study, the current uninsured rate of 9% for 2015 is the lowest in over 50 years.

The data shows that Obamacare has to a large extent accomplished its purpose which also points to the increased coverage provided by health insurers that would in turn add to their top line. Most health insurers have reported a secular rise in their revenues from membership gains because of the law.

Baby Boomers Present Medicare Growth

According to the U.S. Census data, the population of Medicare beneficiaries will grow by 36% by the end of this decade led by a vast aging baby boomer population. In fact, in the next 25 years, the compounded annual growth rate of the Medicare population is expected to increase to 2.7% from 1.5% at present.

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. Until now, only two public providers -- UnitedHealth and Humana -- control more than 10% of the market. Carriers in the health insurance sector are in a race to win Medicare Advantage market share and the fastest way of achieving the target is by acquiring a company in the same business.

Shift to International Markets

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 competitive than the U.S. Asia and Europe represent the best near-term opportunities for the 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 toward globalization. In Apr 2014, Aetna bought U.K.-based InterGlobal, which offers private medical insurance to groups and individuals in the Middle East, Asia, Africa and Europe. Prior to that in Feb 2014, Cigna announced its debut in India's underpenetrated health insurance sector, in a joint venture with an Indian conglomerate TTK Group. In 2013, UnitedHealth bought a stake in AmilParticipacoes of Brazil for a nearly $5 billion. It already had a presence in Australia, the Middle East and the U.K.

ACOs Gaining Prominence

Health insurers are trying to clinch accountable care payment contracts following the healthcare reform law's inclusion of Accountable Care Organization (ACO) tests under Medicare. The law’s emphasis on providing accurate and efficient health care service rather than volume of service has led to the emergence of ACOs. These are formed when a group of health care providers (physicians, hospitals, non-physician providers, and the likes) 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 ACO 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 exclusion of pre-existing conditions. The most effective approach for insurers now is to rely exclusively on 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 the 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. Humana acquired Antiva in 2011 to provide analytics services, Aetna invested in Health IT by acquiring Medicity and UnitedHealth has the broadest approach to and the greatest potential in cross-selling synergies via its health benefits business via Optum. The Optum division is the poster child of UnitedHealth boasting successful diversification.

Healthy Balance Sheet

Health insurers are also well poised with respect to their balance sheet. The risk-based capital ratio of Anthem, Cigna, Aetna and UnitedHealth stands north of 500%, substantially higher than the statutory level of 200%. A low utilization rate, which has reduced claim payments, has helped to strengthen the balance sheet of these players.

Bottom Line

In a changing industry, which is witnessing the shift of power from insurance players to consumers, the need of the hour is to understand what consumers want and need, and provide quality service at the right time. Only those health players that modify their business strategy in tandem with the changing market will prevail and flourish in a consumer-centric health insurance industry.