In the United States, "Medicare-for-all" proposals are igniting debate over the future of the health insurance industry -- and that could create a wealth of investing opportunities. If you're interested in investing in this important market, it's important to understand what health insurance is and isn't, how companies target different niches within this industry, and how to analyze their financials.
What is health insurance?
Health insurance is insurance that provides payment for medical services, such as emergency room and doctor visits, drug prescriptions, medical equipment and devices, and medical procedures. Health insurance doesn't typically provide coverage for vision or dental care, although some plans may do so.
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Health insurance is offered by private companies -- such as UnitedHealth Group (NYSE: UNH), the nation's largest private health insurer -- or through the government. Most Americans receive health insurance from private insurers via their employer. The cost of this health insurance is usually subsidized by the employer as an employee benefit. That said, some employers contribute more than others, so an employee's share of the monthly cost of employer-sponsored health insurance varies. The amount that's paid by consumers every month to health insurers is called the premium.
On the government side, the two best-known health insurance programs are Medicare and Medicaid. Those programs fall under the purview of the U.S. Government's Department of Health and Human Services (HHS). Specifically, the Centers for Medicare and Medicaid Services (CMS), an agency within HHS, is responsible for them.
Part A provides coverage for hospital care, and most people don't pay a premium for it. Part B provides coverage for non-hospital health care, such as primary- or specialty-care doctor visits. People pay a monthly premium for Part B health insurance, but it's relatively low compared with private health insurance because the government significantly subsidizes the cost.
Part D plans provide prescription drug coverage. They're offered by private insurers, and they generally come with a premium. And finally, Part C -- health insurance -- is more widely known as Medicare Advantage. Medicare Advantage plans are offered by private insurers, and they usually combine Part A, Part B, and Part D coverage into one plan. Most people pay a monthly premium for Medicare Advantage, but here, too, the cost is government-subsidized, so it's relatively inexpensive compared with employer-sponsored health insurance.
Additionally, private companies also offer Medigap health insurance plans that provide coverage for health-care costs (such as out-of-pocket expenses) that aren't covered by Part A or Part B.
As a government-funded health insurance program, Medicaid is administered by the individual states. Enrollment is limited to Americans who are disabled or who have a household income that's below preset maximums. Some states choose to manage their Medicaid health insurance programs directly, but many states outsource the management to private health insurance companies, such as UnitedHealth or Centene Group (NYSE: CNC).
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How the industry works
Investors can't invest directly in government health insurance. But they can invest in private companies that offer health insurance, whether that's through employers or directly through health insurance exchanges (including the Affordable Care Act's marketplace). Investors can also invest in private companies that sell Medicaid Advantage plans or Part D prescription drug plans, or those that manage state Medicaid programs.
Private health insurance companies choose the markets they will do business in based on their analysis of each market's pool of patients. If they choose to operate within a state, they're regulated by that state's health insurance laws. But they don't have to participate everywhere within a state. If they desire, they can offer insurance in some communities and not in others.
To determine whether to participate in a market, health insurers employ actuaries. Actuaries compile and analyze data regarding the health of a population, then use this information to determine the premiums insurers must charge and the coverage restrictions they must put in place in order to be profitable.
As a refresher, a deductible is the amount a patient must pay for their care before insurance coverage begins. A co-pay is a fixed amount paid by a patient in addition to the amount paid by their insurer. Co-insurance is a the percentage of the cost of health care paid by a patient. And an out-of-pocket maximum is the most a patient will pay toward their health care in a specific period. Actuaries help insurers decide how to balance the pricing of their monthly premiums, deductibles, co-pays, co-insurance, and out-of-pocket maximums in any given market.
If a health insurer's actuarial analysis supports doing business in a market, then the health insurer will charge premiums to employers, employees, or individuals. Or, in the case of Medicaid or similar programs, such as the Children's Health Insurance Program (CHIP), it will charge a per-person fee to manage a state's program.
If the insurer's actuarial analysis proves incorrect, that insurer must wait until the plan is up for renewal. Then, the insurer can either withdraw from the market or increase their premiums and fees. In the case of government programs, a health insurer can opt not to rebid for the contract or can file a higher bid.
Ultimately, health insurers are profitable when the premiums and fees they collect exceed the cost of the health care they provide to their members, plus their operating and non-operating expenses. Patient health care is the largest expense facing health insurers, so they negotiate with health-care providers and companies on pricing to save money. Health insurers may create "limited networks" consisting of providers and companies that have agreed to lower prices in exchange for less competition. And they may use different coverage "tiers" to encourage patients to choose lower-priced treatment options. For instance, they may offer members a lower co-pay if they choose a health-care provider from a favorable "tier."
The top health insurance companies
The private health insurance market is dominated by large companies, but UnitedHealth and Anthem Inc. (NYSE: ANTM) are the largest publicly traded health insurers. Both companies offer health insurance through employers and directly to individuals. Additionally, each also markets Medicare Advantage plans, Medicare Part D plans, and Medigap plans, and they manage state programs, including Medicaid, too.
UnitedHealth is the larger of the two. It served a combined 49 million members as of December 2018, and it generates more than $225 billion in annual revenue from premiums, fees, and services. Anthem served 40 million members in 2018, and its revenue from premiums, fees, and services exceeds $90 billion per year.
Other large, publicly traded health insurers include Humana (NYSE: HUM), Centene, and WellCare Health Plans (NYSE: WCG). Humana specializes in Medicare Advantage and part D plans. Centene and WellCare specialize in managing state health insurance programs, including Medicaid. The following table highlights the member populations most important to each of these companies' revenue.
|Top Health Insurance Companies|
|Company||Symbol||Employer market||Individual market||Medicare||Medicaid|
How to analyze a health insurance stock
Investors can analyze health insurers similar to the way they look at companies in other industries, but there are some important metrics that deserve particular attention.
Revenue growth is an important consideration in every industry, but the insurance marketplace is mature, so changes in revenue here typically occur because of alterations to premium prices or decisions to enter or exit specific markets. That means it's important to understand why revenue is changing before drawing conclusions.
For example, UnitedHealth's revenue growth decelerated after it determined its participation in the Affordable Care Act marketplace wasn't profitable enough. Alternatively, Centene's revenue increased because it decided to enter the Affordable Care Act marketplace, despite the marketplace's lower profit margins. In this example, UnitedHealth's higher operating expenses made ACA participation unprofitable, but Centene's lower operating expenses made entering the ACA market worthwhile. If an investor didn't fully understand the reasoning behind these conflicting decisions, they might draw the wrong conclusion regarding the respective changes to revenue.
The medical care ratio, or MCR, may be the most important metric that health insurers report for investors to track. (It's also sometimes called the health benefits ratio.) The MCR tells investors, in percentage terms, how much of the premiums the insurer collects are being used to pay for members' health care. Generally, a lower MCR is better than a higher one, but there are some caveats. Insurers such as UnitedHealth and Anthem make most of their money in the employer-based health insurance market, and that market tends to have a lower MCR because members are generally healthier than Medicare or Medicaid participants. Meanwhile, Medicaid insurers including Centene tend to report a higher MCR because members in that market tend to require more health care. Generally, a MCR between 80% and 85% is desirable for employer-focused health insurers, while a sub-90% MCR is OK for a Medicaid insurer.
If MCR changes dramatically, it's important to understand why. Management will usually address the cause for changes in its MCR in its quarterly earnings conference call or in its quarterly or annual filings with the Securities and Exchange Commission. MCR changes are often temporary, so investors shouldn't necessarily extrapolate one quarter into the future. Instead, it's better to evaluate the trend in MCR over time.
Investors should also pay attention to operating margin. Insurers spend a significant amount on member health care and selling, general, and administrative expenses. As a result, operating margin is typically in the mid-single-digit percentages for insurers serving the employer-sponsored insurance market and the low-single-digit percentages for Medicaid insurers. Medicare insurers, including Humana, usually produce operating margins in between those of commercial and Medicaid insurers.
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How top health insurers compare
The health insurance industry faces political risk associated with health-care reform that could be more problematic for smaller players than for larger ones. Also, health insurance companies that are less diversified in membership could be more negatively affected by legislation that imperils their negotiating power with health-care providers and drug developers. For these reasons, it's helpful to understand how exposed the top health insurance companies are to political risk.
UnitedHealth and Anthem got 24% and 39% of their revenue from employer and individual health insurance markets in 2018. Government health insurance solutions contributed 52% of UnitedHealth's revenue and 61% of Anthem's revenue in the period. UnitedHealth's Optum health services business, including its pharmacy benefit manager and data analytics solution, accounted for about 19% of revenue in 2018. Anthem is in the process of launching its own pharmacy benefit manager, so it could generate more revenue from services beginning in 2020.
Humana is the purest play in Medicare. Medicare products account for more than 80% of its sales, and it offers at least one Medicare product in each of the 50 U.S. states. Florida is its biggest state, contributing 15% of revenue.
Centene and WellCare are both big Medicaid insurers, but Centene does derive revenue from other markets, including the ACA marketplace. About 60% of Centene's 14 million members are Medicaid members, and Medicaid accounts for about 65% of revenue. Commercial health insurance membership represents roughly 14% of total membership and accounts for about 21% of revenue. The rest of Centene's revenue comes from Medicare (approximately 8.5%) and other solutions.
Over at WellCare, Medicaid represents 64% of revenue and Medicare accounts for the bulk of the rest. WellCare serves 3.9 million Medicaid members as of the end of 2018.
The following table shows revenue, MCR, and operating margin for each of these insurers:
|Top Health Insurance Companies|
|Company||Revenue (TTM)||Year-Over-Year % Change||MCR||Operating Margin|
|UnitedHealth Group||$226 billion||12%||81.6%||7.7%|
Data: SEC filings. YoY = Year over year. MCR = Medical Cost Ratio.
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What to watch in 2019
An attempt to repeal the Affordable Care Act failed in 2017; however, that doesn't mean that Congress won't act in ways that negatively impact membership, revenue, or profitability at health insurance companies in 2019. The 2020 presidential race will also heat up as the year progresses, and health-care costs are likely to be in focus. Health-care spending is expected to grow at an average annual rate of 5.5% between 2018 and 2027, reaching nearly $6 trillion, according to a Centers for Medicare and Medicaid Services (CMS) National Health Expenditures report. If that happens, then health-care spending will grow to 19.4% of gross domestic product in 2027 from 17.8% in 2019.
The anticipated increase in health-care costs suggests that changes could be coming to affect insurers. President Trump has already outlined strategies to rein in spending on medicine, but drug industry lobbyists are angling to have intermediaries -- and, perhaps, health insurers -- bear some of the brunt of legislation to crimp drug pricing. If changes include lowering members' level of cost-sharing, this could increase insurers' MCR and weigh down their operating margin. For this reason, investors will want to keep a close eye on Washington, D.C., in 2019.
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Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned.The Motley Fool recommends UnitedHealth Group. The Motley Fool has a disclosure policy.