Why Health Insurance Stocks Are Poor Bets

by: Donald Johnson

On Monday, liberals sneered when insurers' stocks rose, indicating that speculators thought ObamaCare (HR 3590) would be good for the big regional companies. But on Wednesday several of the stocks were sinking, probably in response to University of Chicago Professor Richard A. Epstein's op-ed piece in The Wall Street Journal, Harry Reid turns insurance into a public utility; the health bill creates a massive cash crunch and then bankruptcies for many insurers. His original and more detailed argument is here.

Here are comparison charts for Aetna (NYSE:AET), Cigna (NYSE:CI), Coventry Health Care (CVH), Healthspring (NYSE:HS), Humana (NYSE:HUM), UnitedHealth Group (NYSE:UNH) and Wellpoint (WLP). Click on a chart for more information. The stocks that are sinking serve the individual and small group markets. Those that are rising are less invested in those markets, I think.

Now, the big companies might benefit from having smaller insurers that serve individuals and small employers bankrupted. But they would be crushed by new regulations and price controls that would not allow them to make profits. Nothing in the bill says insurers should be allowed to earn market returns. That means they're as likely to go bankrupt as the smaller insurers. Epstein's impact graph:

The perils of the Reid bill are made evident in a recent Congressional Budget Office (CBO) report that focused on the bill's rebate program, which holds that once an insurance company spends more than 10% of its revenues on administrative expenses, its customers are entitled to an indefinite statutory rebate determined by state regulatory authorities subject to oversight by the Secretary of Health and Human Services. Defining these administrative costs is a royal headache, but everyone agrees that they are heaviest in the small group and individual markets, where they typically range between 25% and 30%, without the new regulatory hassles.

Equally important, Epstein writes, the bill would turn insurers into heavily regulated utilities without giving them the right to make market rate returns on investments, which is unconstitutional.

That the bill appears unconstitutional may be good news for insurers, but think of the uncertainty that investors in insurers will face for years as the courts take their time deciding the case.

Who would want to invest in companies that face being put out of business unless the Supreme Court saves them? Who wants to invest in companies that would face cash crunches under the health bill? Who wants to invest in companies that in future years would be forced to comply with even more expensive coverage mandates than those already in the bill?

The bill not only would turn insurers into de facto utilities, it also would make it almost impossible for them to change their business models so they could make money. The government would tell them what to sell, when to sell it and both indirectly and directly at what unprofitable price they should sell their policies.

Some speculators and insurance CEOs may be thinking that they would have plenty of time to fix these problems before major sections of the bill became effective in 2013 or 2014, depending on what comes out of conference. But President Obama will be president for three more years. Even if Republicans improbably regained control of Congress in next year's elections, Obama would veto a lot of the fixes the industry sought. He thinks profits are bad for everyone but the billionaires who contribute to his campaigns.

For speculators playing the health insurance stocks market, Epstein's article is worth a studied read and the price of today's paper.

While the insurers' stock charts still look bullish, look for them to start showing weakness as investors come to their senses. There is no way the politicians will.

Disclosure: I don't own these stocks.