Healthcare stocks got a bit of good news when the Supreme Court gave the green light to Obamacare’s individual mandate nearly two years ago, clearing the way for them to rake in the profits from insuring millions of young, healthy individuals who by law must now carry health insurance.
Unfortunately for healthcare stocks and their investors, new regulations threaten to turn that dream into a nightmare — at least in the short term.
As managed care giants have cut back on providers to save money, consumers have cried foul. Federal regulators appear poised to answer by forcing insurance companies to broaden their provider networks — a move that could erode their earnings in the short term and send healthcare stocks like Aetna (AET), WellPoint (WLP) and UnitedHealth Group (UNH) lower.
A recent report by McKinsey & Co. found that 70% of the new Obamacare plans offer narrow networks that could come under fire by the new regulations.
Here is the outlook for the top three healthcare stocks if the changes take effect:
Healthcare Stocks: UnitedHealth Group (UNH)
UnitedHealth Group (UNH) has the largest health plan among U.S. healthcare stocks. It’s a major player in the Medicare and Medicaid space — and that’s where it may face the greatest headwinds this year and into 2015 if the draft rules take effect. UNH also competes for business health plans and corporate self-insurance.
UNH stock reported strong fourth-quarter earnings last month — profit of $1.41 per share up from $1.20 per share a year earlier. But CEO Stephen Hemsley still warned that the costs of implementing Obamacare and cuts in the Medicare Advantage program would negatively impact earnings for UNH stock this year.
However, UNH stock is already finding ways to combat those costs. Plans include reducing its provider networks — UNH’s Medicare Advantage network, for example, will shrink by 10% to 15% this year, according to published reports. UnitedHealth’s Obamacare strategy is aimed at using lower than average premiums to attract high volumes of insurance exchange customers.
To offset those lower premiums — and a new health insurance tax — UNH has cut costs by shrinking those networks. But the new regulatory review could undo that strategy, putting significant pressure on UNH stock and other healthcare stocks.
Healthcare Stocks: WellPoint (WLP)
In the heat of 2010’s health reform debate, former WellPoint (WLP) CEO Angela Braly became Obamacare’s Public Enemy No. 1 after the President himself railed on the company’s decision to raise some premiums in California by 39%.
The ensuing firestorm turned out to be the life preserver Obama’s signature healthcare law needed to survive — and the beginning of the end of Braly’s tenure at WellPoint. Braly’s successor, Joseph Swedish, has embraced both government business and insurance exchanges — some 45% of its business now is driven by government programs.
The company participates with Medicare and Medicaid and expanded its focus on the latter with the $4.9 billion purchase of Amerigroup in 2012. Although the strategic shift will deliver a strong market position in the future, WLP stock does face significant near-term headwinds.
WLP’s fourth quarter earnings fell by 68%, as policyholders scrambled to use their health coverage before policies were cancelled, and the company divested its 1-800-CONTACTS business. On Jan. 29, WLP stock reported earnings of 49 cents per share, down from $1.51 a share for the same quarter in 2012.
WellPoint, which has signed up some 500,000 Obamacare enrollees so far, has trimmed back its networks — in some cases dramatically — to deliver lower premium prices. In New Hampshire, for example, WLP is the only carrier participating in the exchange, and its plans include only 14 of the 26 hospitals and 65% of the primary care physicians.
That scenario is precisely the one HHS aims to make healthcare stocks reverse with the draft rules. It’s a significant headwind that could impact 2014 earnings for WLP stock.
Healthcare Stocks: Aetna (AET)
The smallest of these three healthcare stocks, Aetna (AET) announced record revenues on Thursday, in large part because of its $8.7 billion deal to acquire Coventry Health Care. But AET stock missed Wall Street expectations by 2 cents on the bottom line, reporting EPS of $1.34 — an improvement over the 94 cents per share in the year ago quarter.
Aetna’s earnings miss — and its disclosure that it will lose money in its Obamacare exchange this year — caused AET stock to drop nearly 2%.
Those results illustrate the twin challenges healthcare stocks are facing from Obamacare: a larger pool of older, sicker and poorer people enrolling first, and the coming “doc shock” (subscribers losing their doctor as insurance companies like Aetna tighten up their networks).
The company’s acquisition of Coventry gives it an additional 110,000 Medicare Advantage members in the first quarter of 2014. While this growth will be valuable to AET stock down the road, the company has gained exposure to a plan that faces considerable federal cuts.
With HHS’ draft rules on network access casting a shadow of uncertainty over Obamacare, Bertolini recently suggested that AET might need to double its rates or opt out of the exchanges. Because of this, Aetna will not release its 2015 rates until May 15.
Bottom Line: Although all three of these healthcare stocks — UNH, WLP and AET — look like good bets over the long term, shares are likely to take a near-term hit of 10%. So if you want to play these healthcare stocks, buy on the dip.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.