Will Election 2016 Mean New Challenges for Health Insurers?

Health insurers raised the ire of regulators with Anthem Inc. (ANTM) proposal to acquire Cigna Corp. CI and Aetna Inc.'s AET buyout deal with Humana Inc. HUM. Moreover, presidential candidates are looking at ways to fine tune the provisions of the healthcare legislation, which, if implemented, will see insurers reworking their business strategies.  

Democratic presidential candidate Hillary Clinton recently said that her priority would be to "crackdown on insurers to limit out-of-pocket costs." These costs are expenses like deductibles, coinsurance and copayments for covered services among others that aren't reimbursed by insurance.

Also on Hillary Clinton's agenda is giving more power to lawmakers to reject undue rate hikes by health insurers. Under the current heathcare reform, this authority is in the hands of certain select states only.

But that's not where Hillary Clinton has drawn her line. She is pitching for three sick visits per year in insurance plans before deductibles kick in. In her campaign, Clinton pointed to a recent Kaiser Family Foundation study that the average deductible for an individual has increased seven times faster than a worker's average wage since 2010.

According to the Presidential hopeful, high deductible is barring some people to visit a doctor because they cannot pay the first few thousand dollars of the bill before insurance kicks in. Having a deductible so high that one cannot afford to go to a physician is akin to not having insurance.

Deductible is part of the medical bill which must be cleared before patients can use their insurance coverage. But thanks to a high deductible, doctor visits are being barred by some thousands of dollars that must be shelled out before patients can avail of insurance.

It is ironic that health plans with high deductibles are being sold widely on health insurance exchanges. High-deductible plans have proliferated among employers, and, in 2014, they made up 85% of all plans sold on the Affordable Care Act's (ACA) health insurance exchanges. Employers and insurers have turned to the plans to lower premiums and shift the more out-of-pocket costs to consumers. These plans also cost less than a plan with low deductible.

Coming back, the legislation has undoubtedly altered the regulatory landscape in ways that are not always beneficial to a private health insurer's bottom line. But calling it a permanent drag would be an overstatement.

U.S. health plans are expected to operate in a lowered margin environment in 2015 and beyond. Some health plans — especially the smaller ones — may not survive. Pricing pressure, higher taxes and fees, rising medical costs, regulatory compliance costs, increased competition (from smaller players/start-ups non-traditional players), and general marketplace uncertainty are some of the headwinds faced by the players in the industry.

While the aim of this write-up is to put the spotlight on the headwinds facing the industry; an earlier write-up in this space had the opposite focus.

Some of the challenges faced by the industry are briefed below:

Growing Consumer Power

Until the passing of the ACA, the insurance companies had an upper hand in choosing who to provide coverage and consumers (people receiving health care) had no active role in the decision-making process. But now the trend has changed. Consumers' increased purchasing power and access to information to take health care decisions are the major threats to insurers.

Prior to reform, big insurers dominating large markets hardly ever bothered to provide consumers with even basic information, such as the performance of health insurance policies, procedures to claim, the size of the provider network and cancellation processes. Now customers demand transparency, value and convenience, leaving insurers grappling for innovative ways to satisfy these unmet needs. The new mission, however, will not be easy to execute.

Global Economic Woes and Regulatory Challenges

A fragile global economy presents a headwind for insurers looking to expand their international operations. One of the largest insurers, UnitedHealth Group Inc. UNH recently made an acquisition to reap benefits from the Brazil market but is now facing slowing growth rates in that country.

In the case of India, which remains one of the most profitable opportunities for insurers, the regulatory environment has proved challenging. China -- which merits the highest risk-adjusted opportunity ranking, largely because of its immense scale -- poses significant investment restrictions to foreign insurers entering and operating there.

Margins to Shrink

The industry has witnessed a shift in insurers' business mix from Commercial insurance to Government (Medicare, Medicaid and State-subsidized marketplace or exchange). This shift in business has impacted profitability of the players to some extent. Premiums for Medicare, Medicaid and State-subsidized policies tend to be higher due to serious health issues for many enrollees; however, they carry smaller profitability margins compared to commercial insurance.  

Addressing the health needs of the previously uninsured or underinsured non-group populations also has typical startup and educational costs. These people can push up health plan administrative costs and medical expenses, once enrollees begin to receive coverage, leading to lower profitability as health plans expand into these new segments. As more industry revenue is derived from lower margin Government sources, it is projected that aggregate industry margins will modestly decline.

ACA Fees and Taxes

ACA fees and taxes remain a big issue for insurers in 2015. They face an annual health insurance industry fee, exchange user fee or "Cadillac fee," which are all likely to eat into their bottom lines. The biggest health insurer UnitedHealth expects its share of the managed care industry's non-deductible ACA insurer tax to reach $1.8 billion in 2015 from $1.3 billion in 2014. This is on top of an estimated $320 million of reinsurance fee in 2015.

The company expects these two headwinds to cost $0.15 per share in 2015. In 2014, UnitedHealth's margins fell 50 basis points at United Healthcare (benefits) due to Medicare Advantage cuts, ACA costs, mix (more government business) and less favorable development of medical costs. These trends are likely to continue through 2015.

While the above discussed factors might deeply affect the players in the industry, we do not recommend selling any stock under our coverage, namely UnitedHealth Group Inc., Anthem, Aetna, Molina Healthcare, Inc. MOH, Humana and Health Net, Inc. HNT. None of these hold a Zacks Rank #5 (Strong Sell) or even a Zacks Rank #4 (Sell).

Bottom Line

The changed regulatory landscape has undoubtedly created hurdles that would weigh on profits and margins of industry operators going forward. But it is hardly the unmitigated disaster that some industry players make it out to be. But beyond the ACA, the investment appeal of the space also reflects its perceived defensive and counter-cyclical orientation, which is crucial in the current uncertain backdrop.
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