On Tuesday, UnitedHealth (NYSE:UNH) raised guidance by 20 cents a share, lowering 2Q 2010's medical loss ratio by 2.10% from 2Q2009 while reporting 50% more cash from operations in 1H2010 than 1H2009.
This is for three reasons:
1. Reform Rewards Size and UnitedHealth Is a Giant
Usually, in investing, large companies are the least likely to grow. However, in health insurance today, by capping medical loss ratios and restricting patient premium differentiation, Reform will most adversely impact smaller managed care companies.
Larger insurers will be better positioned to take short-term losses on underwriting both because of their absolutely larger balance sheet depth and because of their relatively lower, average expense ratios.
After Reform is implemented, many smaller, independent insurance plans, confronting higher loss ratios and less overall market share, may be acquired. This will make what is already one the most consolidated industries in America -- health insurance -- even more so.
In 2009, UNH bought HealthNet's plans for New York, New Jersey, and Connecticut.
2. Reform Stirs Price Wars Most Downmarket and UnitedHealth Is a "Luxury" Provider
Concerns about the taxes levied on so-called Cadillac plans aside, UNH's outsized presence in upmarket health insurance products means its corporate customers are more willing and able to pay higher premiums when UNH needs to raise them.
These employers are more inclined to retain their white collar employees by keeping trusted doctor networks and customer service. Health insurers focused on more downmarket products may not have employer clients who are so price-insensitive when it comes to paying for health benefits.
A related issue is the minimum benefit requirements in Reform legislation. These provisions try to standardize comparability between the benefits of competing health plans to further force explicit price competition.
Reform's minimum standards for a "Gold" plan accords much more with the benefits UNH plans already offer than the "Bronze" or "Silver" standards that might be required of more downmarket products. This implies higher future benefits expenses for UNH's competitors, health insurers for whom a greater fraction of business comes from lower-end benefits packages..
3. Reform Rewards Information and UnitedHealth Owns Ingenix
Finally, Reform makes health information a more important competitive advantage in health insurance than ever, rendering Ingenix, the leading health analytics and actuarial consulting firm owned by UNH, a hidden jewel. Consider that key provisions of Reform include
- Restricting contractual liability caps in policies (That is, putting a dollar limit on total illness claims an insurer will pay for a patient.)
- Limiting recission (That is, the practice of suing to patients to de-enroll them once they become ill)
- Mandating coverage (forcing insurers to quote a price to almost all patients, even if they have pre-existing conditions).
- State-exchanges on which insurers must quote their prices for offering nearly identical bundles of health benefits
In each case, the net economic impact of these provisions is similar. They force insurers to focus on patients and claims costs in considering the risk-reward value of an individual policy.
In any form of investing, if you can't write the contract in your favor, control incentives, or control outcomes, your main advantage is better information. In this sense, health insurance underwriting is no different.
Long-term winners under Reform's restrictions will be those companies that determine the most accurate fair-value prices for the health risks they are underwriting. That is, those companies with the best predictive health information.
Corporations like Verisk (NASDAQ:VRSK) and Reed Elsevier (NYSE:ENL) own health analytics firms that offer meaningful competition to UNH's Ingenix. But UNH is the only major American health insurer to have its own such first-class health information and analytics firm.
To be sure, near-term, Health Reform will have negative profitability consequences for all health insurers. And, until the Department of Health and Human Services and U.S. state governments more explicitly implement these laws, uncertainty as to Reform's exact consequences remains.
But even after Tuesday's upbeat guidance announcement, UNH is still selling at 7x last year's free cash flow. Despite the economic downturn, it returned over 16% free cash on its non-goodwill assets in FY2009. If American health insurance is being transformed as I describe, this is a stock worth watching.
Disclosure: No positions