Health Insurance Stock Outlook - Oct. 2015

The health insurance industry, an integral part of the U.S. economy, has caught the attention of presidential candidates who are vowing to major changes to the 2010 legislation that gave a complete makeover to the industry. The insurers who strived hard to adapt to the numerous changes brought in by the reform might have to readjust if the new president brings in his/her desired changes.

The Affordable Care Act of 2010 (aka Obamacare) has been at the left, right and center of the industry since its passage, making any discussion of the industry without analyzing its effects almost impossible. It brought such a marked change that now the health insurance industry can be divided into two periods: pre-Obamacare and post-Obamacare. So what necessitated this sweeping regulation?

Pre-Obamacare Era

Industry operators had a lot of autonomy in running their businesses during this period. Health insurers were free to choose their customers, entertain claims and determine their premiums. Yet while spending huge sums of money on health care, a big portion of the population remained uninsured. On top of this, rising cost of care not only made the system unaffordable for many but threatened to become an even bigger problem down the road.

The stated objective of the Affordable Care Act (ACA) was to make health care affordable. The law brought along with it a number of provisions which put a lid on the indulgences of insurers.

Post-Obamacare

The ACA law has been in place for over five years now and has mostly been absorbed by the industry. Most of the provisions of the law, which were implemented in tranches, have been well received by the players, with its effects turning out a net positive, since the reform increased sales thanks to the mandate that every individual carry insurance (the so-called "individual mandate").

The players have also started to refocus on long-term growth opportunities since they are now faced with price- and service-consciousness among consumers, fierce competition and a shift in customer mix.

Although previously feared by insurers, the changes and challenges put forth by the health care reform act haven't really caused any damage. On the contrary, health insurers have benefited from the enrollment of millions of new members that has in turn increased their sales. Big players like CIGNA Corp. CI, Anthem Inc. (ANTM), Humana Inc. HUM, Health Net, Inc. HNT, UnitedHealth Group Inc. UNH, Molina Healthcare, Inc. MOH and Centene Corp. CNC have reported unfaltering growth in premiums, fees and other income since health care reform was put into effect.

From the period 2010 to 2014, the revenues of these insurers, which control a major market share of the private health insurance industry, increased 45% to approximately $375 billion while operating profit increased 65% to $21 billion.

New Inroads Made by the Industry

Amid this transition, health insurance plans face both challenges and opportunities, many of which require a shift in business mix. The formation of online exchanges (operational in Oct 2013) and Medicaid expansion have widened the customer base. Then again, the players in the industry face heightened competition from these online exchanges as these provide customers with comparable shopping options and easy access to information.

Alternative forms of care such as Accountable Care Organizations (ACOs) are also gaining prominence in the industry. These ACOs pay health care providers on the basis of the quality of service rendered rather than the volume of service provided, as was practiced earlier. Health insurers are busy forming ACOs which eliminate duplicity of service provided and therefore help in reducing claims. This in turn lowers their medical cost ratio and helps in driving up their bottom line.

Moreover, the industry has opened up to the international market which offers significant growth potential in untapped areas. Plus, the industry is reaping diversification benefits as it is branching out to analytics and health services which are complementary to its core business. The industry is also witnessing increased use of information technology in the form of electronic records through which "big data" can be used to take informed decisions.

A welter of mergers and acquisitions is also kept the industry on its toes. The companies are trying to get bigger in size in order to reap economies of scale. The buyers are mainly seeking companies with a large government business (Medicaid and Medicare), which is expected to lead to growth.

Greater scale should lower the IT and other overhead costs of new customers and claims' management. Greater heft would also strengthen an insurer's bargaining power with hospitals and physician groups, which are gaining power through consolidation.

Industry Ranking: Overall Positive

Within the Zacks Industry classification, Health Insurance is grouped under the Finance sector (one of the 16 Zacks sectors).

We rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook for 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 260+ companies is by considering the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) as positive, the middle one-third (Zacks Industry Rank between #89 and #176) as neutral and the bottom one-third (Zacks Industry Rank #174 and higher) as negative.

The health insurance industry features on the top that is in the 1/3rd range with a Zacks Industry Rank #33. 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

Health insurance is a part of the broader Finance sector. So far 15 of the 85 Finance sector companies in the S&P 500 have reported earnings, but these 15 companies account for 39.3% of the sector's total market cap in the index. Total earnings for these 15 Finance sector companies are up +18% on -2.6% lower revenues, with 66.7% beating EPS estimates and 33.3% coming ahead of revenue estimates.

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