Trends in the Valuation of Health Insurers: 2015

Socioeconomic Trends

Demographers estimate that the American population will age meaningfully over the next several decades, with the share of the total population over 65 years old rising from approximately 15.0 percent in 2015 to over 20.0 percent by 2030. ³ As the American population steadily ages, more individuals will likely qualify for financial subsidies for health care, strengthening the demand for both government healthcare programs (e.g., Medicare) and private insurance programs, which complement or supplement existing government healthcare programs.

In addition to the aging population, Americans' overall health levels continue to suffer from high levels of obesity, heart disease, diabetes ,and other chronic conditions. The Centers for Disease Control estimated that 67.6 million Americans were obese, and 65.2 million Americans were overweight as of 2012, marking the first time that obese individuals have outnumbered overweight individuals. ⁴ According to Congressional Budget Office projections, if current laws remain in place, the rising number of recipients of exchange subsidies and higher healthcare costs per person will boost spending on the major federal healthcare programs from 6.5 percent of GDP in 2015 to almost 14.2 percent in 2040. ⁵

Patient Protection and Affordable Care Act

As mentioned in an earlier article, expanding revenue growth from more individuals qualifying for financial subsidies has generally been offset by benefits cost increases and high, legislatively mandated minimum loss ratios, placing downward pressure on industry profit margins.

Another outcome of PPACA is that health insurance providers were required to pay the Health Insurance Providers Fee for the first time in 2014, but it is still not clear how the Internal Revenue Service will approach refund requests by companies that have overpaid their share of the fee. Health insurers are also considering the appropriate tax accounting for amounts that are payable or receivable under ACA's "3 Rs" (Transitional Reinsurance Fee, Risk Adjustment, and Risk Corridor) for the first time in 2015. ⁶

The largest risk in the health insurance industry, however, stems from political uncertainties due to the wide range of healthcare plans presented by presidential candidates for 2016, many of whom have proposed significant overhauls to the current healthcare system. Healthcare plans proposed by several frontrunner presidential candidates include repealing the PPACA, curbing Medicaid, adopting a single-payer system, or letting states lead healthcare legislation efforts. ⁷ Thus, potentially significant changes in the political and legislative environment may impact the industry over the next several years.

Continued Growth through Consolidation

Higher regulatory costs associated with complying with the PPACA, combined with increased benefits costs, have encouraged more private insurers to consolidate and gain efficiencies from greater economies of scale. The trend toward industry consolidation is already benefiting the largest firms, with the top five largest publicly traded domestic health insurers substantially improving their profitability in 2015. The general increase in net income was driven primarily by private insurers' conservative approaches to pricing, better utilization management strategies, and slower-than-expected medical expense growth rates. ⁸

Even the largest industry participants are targeting higher levels of consolidation. The Centene Corp.—Health Net, Inc., proposed merger, with a transaction value of $6.8 billion, is anticipated to close in early 2016, which will likely spur growth for Centene by expanding both its product offerings and geographic presence. Several very large proposed mergers, including the Anthem—Cigna merger with a proposed transaction value of $54.0 billion, and the Aetna—Humana merger with a proposed transaction value of $34.1 billion, both of which have been approved by shareholders, still must be approved by antitrust agencies. An American Medical Association study estimates that the Aetna—Humana merger could reduce competition in 58 metropolitan areas across 14 states, while the Anthem—Cigna merger could reduce competition in 111 metropolitan areas across 14 states. ⁹ UnitedHealth Group Incorporated has recently focused on expanding Optum, Inc., its pharmacy benefits, technology, and health services arm, to help diversify the additional risks that industry consolidation has created.

Growth in Healthcare Startups and Venture Capital Funding

Inefficiencies of large insurance companies and the rise in big data over the past decade have created opportunities for startups looking to take advantage of the PPACA's mandated use on health insurers of machine readable data. In 2014 alone, health insurance startup companies raised $308 million across 32 venture rounds, a 250 percent increase from the $88 million raised in 2013, and a 556 percent increase compared to the total raised in 2012. ¹⁰

Oscar, one of New York's top-funded startups, is an example of one of these "new age" health insurance providers. Oscar aims to personalize and simplify coverage using big data, and the company was valued at $1.5 billion earlier this year. Currently servicing over 40,000 customers, Oscar is expected to grow rapidly as it participates in the third round of open enrollment and expands to Texas and California in 2016. ¹¹

Price-to-Earnings Valuation Analysis

To provide insight into how industry trends are impacting valuations within the health insurance industry, I analyzed the following publicly traded companies (the "Industry Group").

• Aetna Inc. (AET)
• Anthem, Inc. (ANTM)
• Centene Corp. (CNC)
• Cigna Corp. (CI)
• Health Net, Inc. (HNT)
• Humana Inc. (HUM)
• Molina Healthcare, Inc. (MOH)
• Triple-S Management Corporation (GTS)
• UnitedHealth Group Incorporated (UNH)
• WellCare Health Plans, Inc. (WCG)

As demonstrated in the "Price-to-NTM Earnings" graph, forward price-to-earnings (P/E) multiples have experienced high levels of volatility over the past 4 years. There has also been an upward trend in recent years, reflecting not only improved general economic conditions, but also strong growth expectations particularly for the Medicare/Medicaid segments. Industry participants recognized this growth and capitalized on it through mergers and acquisitions of managed care focused companies. I note that several companies in the Industry Group are involved in pending mergers, including CNC, HNT, ANTM, and CI, and that these companies' multiples may be impacted by these pending merger agreements. I observed that the median forward P/E multiple for the third quarter of 2015 for the entire Industry Group was 17.7x, while the median forward P/E multiple for the companies currently involved in pending mergers was 16.5x.

Higher growth expectations are also reflected in long-term earnings-per-share (EPS) growth that has been trending steadily upward toward prerecession levels. As the PPACA generated greater demand for health insurance, earnings expectations rose accordingly. Additionally, higher healthcare costs contributed to revenue growth for the health insurance industry. However, as the industry shifts more toward publicly funded insurance, operating margins are likely to deteriorate, causing a slight decline in EPS growth in the near term.

Health Insurance Industry Outlook

The expanding impact of healthcare legislation, increasing benefits costs, consumerism, and the rise of big data will continue to affect the entire risk, growth, and profitability profile of the healthcare industry. In addition, the presidential election in 2016 may bring yet another substantial effort to change the existing legislative environment for the industry. If a candidate with a platform that is significantly different from the existing current structure is elected, the industry could face considerable new regulatory costs associated with meeting new regulations. Finally, declining health outcomes, combined with the meaningful aging of the overall American population, will likely lead to higher levels of spending on healthcare from individuals, private corporations, and the government for the next several decades. All of these dynamics can have a dramatic impact on the value of health insurers and call for the latest real-time regulatory and market information in order to perform an accurate valuation.