Health Care Review & Outlook - Sept. 2010 - Industry Outlook

The health care industry is currently undergoing a period of tremendous uncertainty due to the implications of the recent Health Care Reform Act -- named the PPACA -- after it becomes fully effective.

Why was the reform enacted?

The legislation, passed after a heated year-long debate, was signed into law on March 30, 2010.

The legislation includes numerous health-related provisions that take effect over the next four years, including

The costs of these provisions are offset by a variety of taxes, fees, and expense-saving measures, such as new Medicare taxes for high-income brackets, taxes on indoor tanning, cuts to the Medicare Advantage program in favor of traditional Medicare, and fees on medical devices and pharmaceutical companies. Besides, there is also a tax penalty for citizens who do not obtain health insurance (unless they are exempt due to low income or other reasons).

Though there are multiple pilot programs in the bill, most of its provisions do not come into effect until 2014; dramatic changes should not be expected right away.

Medicare Advantage will see significant cuts under the new program, and reimbursement rates are expected to be set for the 2011 budget year. The plans affected the most are the ones that have a higher exposure to Medicare Advantage revenue; the higher the exposure, the greater the decline. Health insurers such as

(

) and

(

) have the highest exposure to the Medicare Advantage program compared to others in the field.

(

) and

(

) also have a substantial exposure.

However, the Act expands the Medicaid program to additional lower income bracket. Thus, Medicaid managed care plans will likely benefit from this expansion.

The legislation is expected to have a mixed impact on the industry. The benefits of covering more than 30 million uninsured will likely be offset by the negative impact of Medicare Advantage payment cuts, industry taxes and stringent new regulations on underwriting practices, leading to an overall loss for the industry.

On the other hand, as the insurance and managed care sector responds to these reforms, insurers will likely seek to increase their footprint in an effort to become more desirable to the state insurance exchanges. This may drive consolidation in the sector.

As the economy recovers, unemployment will decrease and discretionary spending will rise, leading to industry growth as individuals, families and self-employed business owners are better able to afford health care coverage. Moreover, as employment increases, the demand for employer-sponsored plans, which generates the majority of industry premium, will improve.

The U.S. population is aging, which is an important indicator of the demand for health insurance coverage. Older individuals are generally more likely to utilize medical coverage than their younger -- and healthier -- counterparts. Consequently, the aging population is expected to support industry growth as individuals look to lower their exposure to health-related costs.

Though there remains a cloud of uncertainty over the companies in the sector, there are two names in particular --

(

) and

(

) -- that we would recommend investors to take a closer look at. CIGNA is relatively safe as the non-risk segments drive most of the health care earnings and the company has minimal (albeit growing) Medicare exposure.

Also, it is more or less compliant with the forthcoming minimum medical cost ratio (

) regulations. Its balance sheet continues to strengthen. CIGNA is also witnessing a rebound in the employer marketplace, particularly in the ‘select' (50–250 employees) and ‘middle market' segments (250-5,000 employees), as it leverages the Great West acquisition and distribution network. Moreover, CIGNA has an increasing profile for the international segment which is a key to its future growth.

Though the other safe stock, UnitedHealth Group, is more exposed to Medicare Advantage cuts than its peers, its diversified product offering will allow it to adapt to the regulations that will likely follow the health care reform legislation. Driven by improved customer focus with better systems, completed acquisition network integrations, and more regional management, UnitedHealth's performance should continue to improve. Its strong balance sheet will allow it to annex weaker firms that cannot adapt as well to the reformed health insurance system.

Other names which carry a Zacks #3 Rank are

(

),

(

) and

(

).

Though the companies will likely suffer share price volatility in the near future, all the businesses are expected to perform well in the long term. With good fundamentals and an expected boost from the Reform Act later, none of the companies have any significant weaknesses, resulting in an absence of any carrying a Zacks #4 Rank (Sell) or even a Zacks #5 Rank (Strong Sell).

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