Healthcare stocks in general, and Cigna (NYSE:CI) in particular, have displayed a surprising resiliency in the face of the turmoil stirred up by the passage of the House Republican replacement of the Affordable Care Act (ACA) and the messy demise of Cigna’s $48 billion merger with Anthem (ANTX) in the closing days of May. Adding insult to injury, after a market-clearing high in the early days of March, the S&P benchmark fell 1% - its first such decline in 110 days of trading and the longest such run since 1995, according to news reports. The market plunge sent CI crashing through its 50-day moving average as investor sentiment soured to the downside (see Figure 1, below). CI’s momentum-fueled shares continued their upward swing rather quickly. The recovery the S&P Healthcare Index has been more nuanced. Still, CI is up 25% year to date (YTD) and a full 16% since the March market plunge. If we can put the Justice Department's antitrust leanings aside for a brief moment, consider this proposition: In a new world where the Republican-controlled Congress is considering legislation that could cause 23 million Americans to lose their healthcare insurance over the next decade, is CI's current 25% market sprint remotely sustainable? CI has become a prime short play.
Figure 1: Cigna and the S&P Healthcare Index ($HCX)
It was the bill’s second attempt in as many months at passage after the Republican leadership embarrassingly rescinded an earlier iteration of the bill from a floor vote for want of support. The Trump administration had now spent 64 of its first 100 days in office chasing a ghost. Insurance companies occupied a leading role in the healthcare battles of 1993-94 and again in 2009-10. No doubt, healthcare insurance companies benefited handsomely from ACA since 2010. The Obama approach to the healthcare juggernaut was to expand the availability of insurance through any path it could find - and include insurers in the process - scrupulously avoiding the single-pay approach favored by the left-wing of his party as untenable, given the political realities of the time. By contrast, the American Healthcare Act (AHCA) was composed with little outside input from doctors, insurance, or any other healthcare provider. Unsurprisingly, much of the country’s $3 trillion healthcare industry, for a variety of reasons, oppose the initiative. After a rush of last minute deals to curry support, the bill was brought to the floor without being scored by the non-partisan Congressional Budget Office (CBO), whose job is to determine the economic impact of legislation in the real world.
As it turned out, the economic impact was huge. An estimated 14 million people would fall out of the healthcare coverage in the first year with the demise of the much-derided individual mandate. These people would largely come from the pool of the young, the indestructible, and the healthy - now relieved from the onus of tax penalties for not carrying health insurance mandated under ACA. With the absence of a credible incentive for the young and healthy to buy into healthcare insurance, the resulting risk pool can be expected to become much less healthy - and a good deal more expensive to service. Another estimated 23 million more would likely lose coverage over the next 10 years as federal aid shifted from direct subsidies to tax credits, determined by age rather than income. A last-minute deal allowed states to opt out of insurance standards, including essential benefits required by ACA, signaling that insurance plan offerings could become much less comprehensive moving forward. Less comprehensive healthcare plans could threaten the coverage of hospital care, prescription drugs, maternity care addiction abuse, and mental health services that were part of the essential health benefits under ACA. While in theory the hot-button item of pre-existing conditions access was still guaranteed, in practice, states’ ability to opt out of expensive procedures and/or drug regimes implies pre-existing conditions would likely be either left out of plan coverage or become prohibitively expensive - or both. A growing financial burden of both premiums and out-of-pocket expenses has fundamentally shifted to the medically vulnerable and an estimated 49 million people between the ages of 50 and 64 - retired ex-workers too young to qualify for Medicare but now faced with surging healthcare insurance premiums on fixed incomes. The changing economics of healthcare insurance would most likely find many in this group uninsured by 2026.
At the same time, an estimated $834 billion in federal funding for Medicaid would be cut over 10 years, a program that now covers one in five Americans - as the financial burden shifts from the federal to the state level. For the first time in its history, federal funding for Medicaid would be converted from an open-ended entitlement to a per-capita regime, complete with spending caps after 2020. Importantly, these spending caps would adjust based on the number of beneficiaries in each eligible group rather than to the changes in cost of delivering medical services - as the financial burden shifts from the federal to state level and finally to consumer. Federal reimbursement would inflate in accord with headline CPI rather than the more generous CPI-medical inflator under ACA. Block grants would become available to states after 2019 and would work in a similar fashion.
AHCA cuts off federal Medicaid payments for Planned Parenthood for one year and further bans the use of any federal tax credits to buy private healthcare insurance that covers abortions. Funding abortion procedures is the latest hot-button issue to complicate the bill as many health plans subsidized under ACA include such coverage. The AHCA provision would amount to a 41% cut the program’s $1.35 billion revenue base.
Few of these issues were newly addressed by the Senate version, euphemistically entitled Better Care Reconciliation Act (BCRA), which hit the streets last week. The difference between ACA and AHCA/BCRA boils down quickly to a stark difference in values and priorities that underline the political chasm Washington currently faces. Democrats’ focus was on maximizing insurance coverage, and they were willing to do whatever it took to accomplish the objective - irrespective of cost or political tradeoffs. Tax increases on personal and investment income funded the approach which created an outsized role for government at all levels of the delivery process. Mandates required the young and healthy to sign up for healthcare coverage to broaden and lower the cost of providing services to the resulting risk pool as a whole. Covering essential benefits mandated comprehensive coverage across the healthcare insurance spectrum. Medicaid was expanded to bring even more people into the healthcare insurance program. Government subsidies kept both premiums and out-of-pocket expenses as affordable as possible.
The Republican approach has gone decidedly in the opposite direction. The web of funding mechanisms underpinning ACA, from mandates to have insurance to payroll taxes to surcharges on dividend income to government subsidies to insurance companies minimize deductible expenses, were systematically curtailed and/or eliminated. Both BCRA and AHCA do away with the federal funding for the expansion of Medicaid. The aim is to minimize the role of the federal government in the delivery of healthcare by cutting its reimbursement costs to states via spending caps and block grants while reducing its outlays by lowering inflation calculations on future benefits. That BCRA ignored the CBO estimate of 23 million people losing access to insurance benefits over a 10-year period under AHCA signals quite clearly that these benefit losses were deemed acceptable.
Cigna fits rather precariously into this toxic political mix. If and when a House/Senate conference committee convenes, a bitter contest in rectifying the myriad conflicting interests of both House and Senate members that played out in the design of their respective bills awaits. The headline loss of 23 million from insurance rolls over the next decade, about 2.3 million per year, is unprecedented. The loss of resulting revenue from such a cataclysmic drop in the insurance rolls will ripple through the industry like a pandemic disease. Premiums account for 77.5% of Cigna’s total revenue and amounted to $39.7 billion through the end of the company’s fiscal year ending in December. Premium growth was up 3% YOY. Total expenses hit $36.7 billion, up 6% for the same period YOY, which means expenses are running double current growth. The deficit caused net income to fall for the year by 11%. Expenses were down 3 percentage points from 2015 which rose 9% YOY, causing net income to fall just over 17% YOY. The company’s client base now stands at 15.2 million through the end of 2016, up 1.3% YOY. That base increased by 3.58% through the end of 2015 YOY due in part to the acquisition of QualCare Alliance Network in the 2015 fiscal year. Since 2014, the client base has increased 5.12% overall. Expenses have increased 16.1% over the same period.
Cigna fell just over 5% in the March market swoon as investor sentiment turned against both the industry and the stock. Forward uncertainty in healthcare stocks and insurance providers in particular proved just too hot to handle as both issues sunk below their 50-day moving average. The market slide began mid-March and stretched into the first days of April (see Figure 1, above). AHCA had passed the House a week prior on a strictly party-line vote. This left just enough time for investors to digest the bill’s intent and market impact before another selloff sent both the stock and index to the downside by just over 3% on the heels of the demise of the Anthem merger. Once again, the downdraft was contained shortly thereafter as the stock continued on its upside ways with a 6% gain through Friday’s market close (23 June). Cigna’s market growth remained throughout the period well above that of the S&P (see Figure 1, above).
Total revenues increased 5% through March ending the company’s first quarter to $10.4 billion year over year (YOY) with global healthcare contributing 79.2% of total revenues. Income before taxes climbed 9% for the period while earnings per share were up just over 15% to $2.30/share over the period. Dividend growth has remained flat at $0.25/share since 2014. Revenue growth was up 5% through the end of the company’s fiscal year in 2016 in December YOY at $39.7 billion. That annual growth was 8% in 2015 YOY. Operating income was up 4% in 2016 at $39.5 billion YOY and was up 9% in 2015 at $34.8 billion, also YOY. Earnings per share in 2016 fell 11% to $7.19/share YOY from $8.04/share in 2015. Earnings per share grew at an annualized rate of 3% through the end of 2015 YOY from $7.83/share through the end of 2014.
This brings us to Figure 2, where the S&P Healthcare Index is divided by Cigna’s presence in the Index. After free-falling through its 50-day moving average, the S&P Healthcare Index has languished below that demarcation line since early April. Only in the last week has the Index broken out of its sideways trading profile of the past two months, posting its highest share price in the better part of a month on strong investor sentiment. This upward surge by the Index means CI growth has cooled markedly relative to the index. The growth space in the Index has been cycled to high-beta biotech stocks which have jumped 9.6% during the month. While the Index retains strong investor support, CI continues to slip. Further evidence of an investor pullback is evident from CI’s performance relative to that of the S&P 500 and the S&P Healthcare Index which is trending to the downside (see Figure 2, below).
Figure 2: S&P Healthcare Index as a Ratio of Cigna
Cigna faces a highly uncertain growth future as its healthcare insurance premium lifeline goes under the knife in a windowless Capitol Hill operating room. Given the overall mindset of both AHCA and BCRA, premium growth is likely to reverse course over the intermediate term and beyond if any rendition of these proposals actually become law. The increase in the uninsured will be disproportionately larger for those with income less than 200% of the federal poverty level, or about $30,300/year. Those between the ages of 19 and 29 on the one hand and between the ages of 50 to 64 on the other will be particularly singled out by the proposed changes. Access to medical care at the lower rungs of the income scale will also slide as cuts in Medicaid funding from both the federal and state levels of government take hold, especially after 2019 when federal funding for the 31 states that expanded Medicaid programs is withdrawn.
As the company continues to make plans to pull out of ACA-based market exchanges in 2018, Cigna looks to expand into the presumably safer venue of Medicare Advantage for seniors and selling plans to mid-sized employers in the group healthcare space. It has over $14 billion in retained earnings through the end of its first quarter which could possibly fund an acquisition, such as the purchase of the Medicare Advantage powerhouse Humana (HUM) and jump-start its own push into the senior market. Humana has a market value of about $34.21 billion. Yet, with its failed merger with Anthem and Aetna (AET)'s January flame-out attempt at purchasing Humana both being squelched by the Justice Department over similar antitrust concerns, growth through acquisition in the healthcare insurance sector is problematic at best.
The company has plans to repurchase about $1.6 billion in its own stock through the end of the year and has averaged $1.64 billion in stock repurchases since 2014. Still, stock repurchase programs are no substitute for organic growth, and paths to such growth in the industry are quickly narrowing. Cigna has dropped the better part of 2% in the last five trading days as its momentum-fueled rise of the past month appears long in the tooth. Expect another 15% market drop to $145/share in the next 12 months.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.