UnitedHealth Group's (UNH) stock had done well after the health insurance company released its Q4 earnings in January. The company exhibited strong growth across the board except for its risk-based commercial business. However, the stock lost most of the gains this week after the U.S. government proposed to reduce government payments by as much as 2% for Medicare Advantage insurance plans beginning in 2014.
Despite the concern, we think there are other positive factors that will help drive the business and support our price estimate for UnitedHealth, which currently stands at $70. That is about a 25% premium to the current market price.
Economic Recovery, Obamacare to Bolster Insurance Business
In the near term, UnitedHealth could continue to witness a decline in its fully insured commercial customers as more businesses are seen covering healthcare costs themselves while they hire the insurer to manage healthcare benefits due to persistently high unemployment and weak macroeconomic conditions. High unemployment levels have had an adverse impact on the number of employer-sponsored health insurance enrollments, while Medicaid enrollments have increased steadily. Additionally, many employers have cut healthcare benefits in response to market conditions. However, beginning in 2014, we expect the economy to improve. This should increase employer-sponsored health coverage along with the quality of those plans (which will in turn bring higher premiums).
The move, as part of healthcare reforms, to reduce government payments for Medicare Advantage plans will certainly weigh on revenue growth to some extent. However, the Patient Protection and Affordable Care Act (PPACA), whose purpose is to reduce healthcare costs and expand healthcare coverage among Americans, will bring another 30 million Americans to the health insurance market (either private, Medicare or Medicaid) over the next five years. The bill includes an individual mandate that penalizes individuals who can afford health insurance but choose not to purchase it. It also expands the availability of Medicaid and restricts the ability of insurers to refuse service to customers with pre-existing conditions. As a result, the government estimates that an the PPACA will allow the company to meaningfully increase its enrollments over the next four years.
In addition, UnitedHealth won a five-year TRICARE contract to manage active-duty and retired military personnel in the Western U.S. and their families. The contract, starting from April 1, 2013, will add 2.9 million beneficiaries.
Margin Risks Are Already Incorporated
The PPACA will also introduce health insurance exchanges in order to encourage competition in the market and will regulate premiums and medical care ratios (medical costs/premiums) of health insurers. This will likely have a negative effect on large insurers such as UnitedHealth as it will result in pressure on pricing and mandatory caps on margins. Therefore, we expect margins to decline going forward. However, we believe that the benefits for UnitedHealth from the increase in enrollments will outweigh the pressures on pricing and margins. Furthermore, a cut in Medicare reimbursement may not impact much as most of UNH's network contracts are tied to reimbursement levels.
Amil Acquisition: A Key to Growth Going Forward
As part of its strategy to focus on international expansion to maintain growth momentum, UnitedHealth had announced the acquisition of Brazil's largest health insurer, Amil Participacoes SA, for nearly $4.9 billion. Amil serves over 5 million customers. UnitedHealth currently holds 65% share in Amil and expects to acquire an additional 25% through a tender offer by Q2 2013.
While Brazil has witnessed one of the fastest growth rates in the world in the last few years, market penetration is still well below that of developed markets (an estimated 25% compared to more than 75% in developed markets). As average income and healthcare awareness continue to grow in Brazil, we expect that more people will opt for managed care plans. UnitedHealth can use its expertise, a strong balance sheet, and good network to tap this opportunity despite significant competition in the country.
Furthermore, health insurance companies generally increase premiums regularly in order to account for increases in medical costs. With the high persistent inflation (over 5%) and rising medical costs in Brazil, we do expect regular increases in rates as has been witnessed historically.
OptumHealth: Double-Digit Revenue Growth
OptumHealth and OptumInsight, through which UnitedHealth provides health management, wellness, financial services as well as advisory and consulting, are expected to continue to witness mid- to double-digit growth. The health insurer continues to add network-based health programs. Furthermore, both health care providers and payers are opting for its compliance and advisory services. However, the continued migration of consumers to cheaper generic from high cost, branded prescription drugs will weigh on its OptumRx business.
Disclosure: No positions.