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In the first nine months of the year 2016, the U.S. health insurance industry was largely dominated by issues related to the underperforming public exchange business and stringent regulatory intervention relating to the two proposed mega mergers. Notwithstanding these, the companies performed favorably, with most of the players reporting an increase in the top line along with membership growth.

The Department of Justice filed lawsuits against the proposed mergers of Anthem Inc. (ANTM - Free Report) with Cigna Corp. (CI - Free Report) , and Aetna Inc. (AET - Free Report) with Humana Inc. (HUM - Free Report) . The mergers, which were scheduled to be completed this year, have now been delayed. In fact, the closure of these deals is now uncertain.

This apart, concerns related to the public exchanges business have been adding to the woes. Most insurers incurred losses from this business in the first half of the year, and the trend is unlikely to reverse anytime soon. Although insurance companies expected improved profitability in 2016 after making meager profits in 2015, the individual exchange business disappointed the firms.

Major players incurred losses in this business and are now reducing their participation on the exchanges by exiting unprofitable markets. For 2017, the players have very little exposure on the public exchanges.

Nevertheless, the companies have managed to record higher revenues on the back of an increase in premium from the government businesses – Medicare, Medicare Advantage and Medicaid. A surge in baby boomer retirees has led to higher demand for these policies. In 2015, about 55 million people were enrolled in Medicare. The number is expected to climb to 75 million by 2026, courtesy aging baby boomers. Humana, Cigna, Aetna, UnitedHealth Group Inc. (UNH - Free Report) have expanded their government businesses and are very optimistic about it.

In addition, a higher number of enrollees in the Medicare, Medicaid and Medicare Advantage businesses drove membership growth across the board. However, this upside was partly offset by a decline in membership on the public exchange business.

The insurers are likely to see earnings growth on the back of their international operations. Players like Aetna, Cigna and UnitedHealth Group have extended their business worldwide in the wake of stringent regulations on the home turf. However, a stronger U.S. dollar will be a drag on earnings from international operations.

Strong balance sheets with low leverage and attractive organic cash flow generation, along with excess capital in the form of statutory reserves and parent cash continue to make this sector attractive.

Factors that might impact the industry significantly in the coming months are the Presidential election, the Public Exchange Business, and mergers and acquisitions.

The industry has caught the attention of the presidential candidates who are vowing to make major changes to the legislation that gave the industry a complete makeover. Insurers who have strived hard to adapt to the numerous changes brought about by the reforms may have to readjust their businesses if the new president brings in his/her desired changes.

Industry Flashback

The industry witnessed a massive overhaul following the Health Care Reform Act which came into effect in Mar 2010. The reform changed the face of the industry, so much so that the once-successful strategies and business practices of the players were no longer sustainable.

The players enjoyed no interference from government entities from the early 1980s til 2010. The health insurers were fully autonomous in conducting their business, many a times refusing to grant coverage to people with pre-existing diseases and also rejecting genuine claims. But with the implementation of Obamacare, things have changed substantially.

The reform, via its numerous provisions, put a bridle on insurers. Some of the clauses of the law related to the provision of insurance coverage for people with preexisting diseases, a bar on rejecting claims, restrictions on increases in premium and many more have changed the operating environment of the industry. These players are now faced with increased competition, regulatory compliance costs, changing patient mix, pricing pressure, rising consumerism, higher taxes and fees, rising medical costs and a general marketplace uncertainty.

Amid the sea change in the industry, the players are busy remodeling their businesses with innovative, consumer-centric products and services. They are also aggressively hunting for new avenues of growth both at home and abroad.

Industry Ranking Overall Positive

Within the Zacks Industry classification, Health Maintenance Organization is grouped under the Medical sector (one of the 16 Zacks sectors).

We rank all the 257 industries in the 16 Zacks sectors based on the earnings outlook of the constituent companies in each industry. The ranking is available on the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257 companies is by considering the outlook for the top one-third of the list (Zacks Industry Rank of #86 and lower) as positive, the middle one-third (Zacks Industry Rank between #86 and #172) as neutral and the bottom one-third (Zacks Industry Rank #173 and higher) as negative.

The HMO industry features in the top 1/3rd range with a Zacks Industry Rank #70. This indicates that the overall outlook is ‘Positive.'

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, to foretell 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.

Earnings Trends

With the impending Q3 earnings season, it’s time to look at the estimate revision trends. The broader Medical Sector, of which HMOs are part, is currently expected to be up 2.7% from the same period last year on 7.4% higher revenues. This, however, compares unfavorably to 2016 Q2 earnings growth of 4.8% and 9% revenue growth.

For more information about earnings for this sector and others, please read our ‘Earnings Trends’ report.

Stocks Worth Adding

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

WellCare Health Plans, Inc. (WCG - Free Report) provides managed care services for government-sponsored health care programs. It operates through three segments: Medicaid Health Plans, Medicare Health Plans, and Medicare PDPs. The stock currently has a Zacks Rank #1 (Strong Buy) and experienced positive estimate revisions over the past three months. It company has a long-term expected growth rate of 18%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Aetna Inc. operates as a health care benefits company in the United States. It operates through three segments: Health Care, Group Insurance, and Large Case Pensions. The stock currently has a Zacks Rank #2 (Strong Buy) and experienced positive estimate revisions over the past three months. It company has a long-term expected growth rate of 10%.

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 (Strong Buy) and experienced positive estimate revisions over the past three months. It company has a long-term expected growth rate of 13.4%.

Humana Inc. together with its subsidiaries, operates as a health and well-being company. The company operates through three segments: Retail, Group, and Healthcare Services. The stock currently has a Zacks Rank #2 (Strong Buy) and experienced positive estimate revisions over the past three months. It company has a long-term expected growth rate of 13.5%.

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