For Health Insurers Investors, Uncertainty Equals Opportunity

Sometime in the second quarter of 2012, David Einhorn’s Greenlight Capital Re (NASDAQ:GLRE) invested $1 billion in six of the nation’s largest providers of healthcare plans.

Clearly, he believed these stocks would benefit from Obama’s reelection. And most experts agreed the Affordable Care Act would be a boon for companies like UnitedHealth Group (NYSE:UNH) and WellPoint (NYSE:WLP), thanks to new customers in 2014.

Not so fast, though.

UnitedHealth announced first quarter earnings Thursday that were reasonably good. Unfortunately, its outlook for 2014 provided investors will all kinds of uncertainty. CEO Stephen Hemsley indicated that the funding cuts to Medicare Advantage plans along with other federal funding reductions and rising medical costs could put a serious crimp in next year’s profitability.

UnitedHealth’s Medicare Advantage plans insure more than 3 million people — around 21% of existing plan-holders — and account for 20% of the company’s revenue.

The difference between original Medicare and Medicare Advantage is that the government pays for your Medicare benefits as you receive them in the former, while the government pays companies like UnitedHealth to cover your benefits in the latter. Interestingly, Medicare Advantage plans do not cover hospice care while original Medicare plan holders who also have a Medicare Advantage plan are covered.

Quirks aside, the Center for Medicare and Medicaid Services threw health insurers a bone April 1, reversing its February decision to cut the reimbursement rate for running Medicare Advantage plans by 2.2% in 2014. It chose instead to increase the payout by 3.3%. The supposed cuts were in addition to those being implemented as part of the ACA.

Prior to the CMS’s reversal, health insurers were facing an 8% cut in Medicare payments. Now it looks as if reimbursements will be 2% to 4% lower in 2014. Hemsley and the rest of his CEO peers can be thankful for the 5% turnaround.

In fact, even as the insurers protest these cuts, the reality is that they wouldn’t be offering the plans if they weren’t profitable. And that’s just one reason investors shouldn’t be worried, despite the uncertainty.

UnitedHealth Group, for example, tends to be conservative in its guidance. According to, the company has a 74% positive surprise history over the past 27 quarters. When you consider that UnitedHealth grew its Medicare Advantage membership by over 14% in 2012 (February through February) — 460 basis points higher than the increase nationwide — it’s hard to feel sorry for it.

UNH’s total revenue in 2012 was $110.6 billion. Medicare Advantage accounted for 20%, or $22.1 billion of its revenue. That works out to $7,270 per member.

Based on a 2012 increase of 374,375, it brought in an extra $2.7 billion in revenue. So while it might receive lower payments for each senior enrolled in the plan, the ACA provides quality of care bonuses to make up for the lost revenue. According to Forbes, there were 3,518 Medicare Advantage plans available in the U.S. in 2012 with 200 additional plans to come on stream in 2013.

Humana (NYSE:HUM) is another exmample; it generates two-thirds of its revenue and 58% of its profits from Medicare Advantage. Really, the cuts simply mean insurers have to do a better job providing quality care for less. Sure, they might not make quite as much profit per MA plan member, but they’ll more than make up for it in volume.

To top it off, Aetna (NYSE:AET) announced last August that it was buying Coventry Health Care (NYSE:CVH) for $7.3 billion in cash, stock and the assumption of debt. The deal is expected to close in the second quarter. When originally agreed upon, Aetna’s stock was trading around $38. Eight months later, it’s at around $55, providing Coventry shareholders with an additional 16% return.

The merger brings together the nation’s fourth and eighth largest companies in terms of Medicare Advantage enrollment. In 2012, Aetna and Coventry increased their MA membership by 45% and 24% respectively. The combination solidifies Aetna’s fourth place in Medicare Advantage market share as well as increasing its government business to 30% of overall revenue.

While there’s uncertainty in 2014 and beyond, the Aetna/Coventry deal and others before it are a good indication that the world’s not about to end because of the ACA.

Heck, just consider this: The first baby boomers started hitting 65 in 2011. The last (including myself) will hit 65 in 2029. Plus, those first boomers will be 83 by then … meaning a huge number of seniors will be relying on Medicare.

Over the next 16 years what happens to Medicare Advantage will largely depend on the federal government’s ability to control spending. If it can’t, it will become far more difficult for insurers to make money off these plans.

However, as it stands now, the margins are still reasonably decent. I would use this uncertainty to buy more of your favorite healthcare stock or ETF whenever it makes a 10% to 15% retreat. As long as the federal government supports the idea of private insurance, I find it hard to believe that it would cut Medicare Advantage payments arbitrarily to force seniors back into the original Medicare.

In the end, competition is a healthy thing.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities. 

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