For the past few years, health-insurance providers’ shares have been ailing. No surprise, really: Insurers in general – life, auto, home, you name it — have all been hurt by lousy investment returns and soft prices. But health insurers, in addition to those standard concerns, have also been weighed down Wall Street fears that pending healthcare policy changes would threaten future profitability.
Now, after a long period of underperformance, the sector seems to be pulling out of its slump.
Insurers are benefiting from a growing sense that the policy overhaul won’t dent margins as badly as many people had been expecting.
YCharts Pro says two of the sector’s biggest players – Wellpoint (WLP) and Aetna (NYSE:AET) – are significantly underpriced, and a third, UnitedHealth Group, (NYSE:UNH) is trading moderately below fair value. Only Aetna, however, appears on the short list of "attractive" selections listed on YCharts’ Large Cap Value screen.
Aetna shares were even cheaper before they jumped 12 percent this month on the day officials unveiled stronger-than-expected year-end results, offered a surprisingly upbeat 2011 forecast, and announced a fifteen-fold increase in what had previously been an anemic dividend payout.
Amidst all this good news, we shouldn’t forget that Aetna’s got a bit of history to overcome: in 2008 and early 2009 it underpriced the premiums it sold, either because it had misread the extent to which healthcare costs were trending higher, or because it wanted to grab business from rivals even if its margins suffered. Or both.
Margins took a serious hit, obliging CEO Ronald Williams to conversationally confess in the company’s 2009 annual report that earnings "were not as robust as we originally projected." The company moved to fix the damage, he continued, by cutting costs and "recalibrating our pricing." In the insurance biz, that’s known as practicing underwriting discipline – resisting the impulse to grab business by offering unrealistic, lowball premiums – and Aetna’s recent profit performance suggests it’s back on track after its little adventure on the wild side.
Williams, who is slated to step down in April after a five-year tenure as CEO, was able to brag to analysts this month, accurately, that Aetna had "strong operating fundamentals" across all its lines in the final quarter of 2010.
The bad economy, of all things, helped pull Aetna’s chestnuts out of the fire following the pricing fiasco: many financially cautious consumers opted to cut back on medical visits and defer elective surgery, and the resulting unusually low utilization rate meant Aetna faced fewer margin-squeezing claims in 2010 from its earlier, underpriced policies than it might have.
Still, like its two bigger rivals, Aetna’s future profits face an unknown amount of pressure from a provision of the new federal healthcare law that requires health insurers to spend a specific percentage of the premiums they collect on care-related costs, as opposed to things like administrative outlays or insurance-broker fees. These days, previously-worried investors appear to have decided that the impact of that "medical loss ratio" requirement, which kicks in this year, will be manageable.
Aetna’s multiple is firming but remains low by long-term standards, while ROE is improving:
Aetna’s earnings yield, a handy comparison to a bond yield, looks like that of a junk bond.
Whether spending on the new dividend eventually crimps Aetna’s substantial share-buyback effort remains to be seen.