UnitedHealth: Medicare Advantage Uncertainty Weighing On Valuation – Wait For Dips
Contributor since 2018 / 9818 Followers
Summary:
- UnitedHealth, a healthcare giant, faces a dilemma as the US population ages and the “baby-boomer” generation begins to retire.
- The aging population will create more demand for UnitedHealth’s healthcare products and services – most notably Medicare Advantage.
- However, UnitedHealth’s insurance business benefits when members are younger and healthier, with fewer frequent healthcare visits.
- The CMS is already pushing back against MA plan rate increases and unexpectedly high costs have begun to impact relatively thin margins.
- UnitedHealth remains an extremely strong company, but its share price may become volatile as the shift to Value Based Care is negotiated. United will be a very different company is a few years time. Long term shareholders may consider cashing in while new buyers should wait for short term dips.
Wolterk
Investment Overview
Here is an interesting dilemma to consider – does an ageing population, such as there is in the U.S., make a bull or a bear case for a healthcare giant such as UnitedHealth Group Incorporated (NYSE:UNH)?
America’s “baby-boomer” generation refers generally to adults between the ages of ~55 – ~75, and it is estimated they are >76m in number. This population is now beginning to retire in larger numbers – ~3.2m “boomers” retired in 2020, and, according to the United States Census Bureau, “by 2030, all baby boomers will be older than age 65,” meaning that, “within just a couple decades, older people are projected to outnumber children for the first time in U.S. history.”
This phenomenon is often referred to as the “silver tsunami,” and you can make the argument that it is good news for a company like UnitedHealth – which combines 2 main business: Optum Health, which “brings together clinical expertise, technology and data to make health care simpler, more effective and more affordable, at scale,” according to a 2022 Investor Conference company deep dive; and UnitedHealthcare, which provides healthcare insurance plans across Employer and Individual, Medicare and Retirement, and Community and State.
As a population ages, it will inevitably require more healthcare products and services, which will create more demand for UnitedHealth’s specific range products and services. The corollary to that argument, however, is that UnitedHealthcare’s insurance business benefits when members are accessing products and services less frequently.
In other words, health insurance is arguably a better business model when members are younger, healthier, and costs are more of the one-off kind, i.e., a broken leg, viral infection requiring hospitalization, etc.
UnitedHealth – Briefly By The Numbers
UnitedHealth is a ~380k employee company serving ~149m on a regular basis. For a company this size to be projecting a long-term growth rate of 13 – 16%, as United did at its 2022 investor conference, is truly impressive.
If you are a mainly passive investor who prefers to buy de-risked blue chips, UnitedHealth ought to be close to the top of your watchlist – although no company’s business is ever 100% de-risked, and there will bumps along the path to achieving that target, which, armed with the right knowledge, short-term investors can take advantage of.
When I discussed UnitedHealth’s Q2 2023 earnings results in a post for Seeking Alpha in mid-July, I began by noting that the company’s “share price has increased in every year since 2010, gaining by an astonishing 1,350% over the period,” and I added that:
Revenues have increased in every year since at least 2013 – from $122.5bn, to $324bn in 2022 – up >160%, and so has operating income – from $9.6bn, to $28.4bn in 2022 – up 195%. Its quarterly dividend has risen from 3 cents in 2010, to $1.88 announced in June this year – a gain of >6,000%. Current yield is ~1.7%.
My conclusion was that “It doesn’t get much better than that for investors, across any sector of the stock market,” but I also reflected on the fact 2023 could be the year in which United’s incredible share price bull run ends.
Ultimately my conclusion was bullish – that 1H23 revenue growth has been so strong – up $24bn, or ~15% year-on-year – it was easily off-setting pressure on margins caused by an increase in medical costs across the year to date (operating expenses were also up 15% year-on-year) and increasing bottom line profits – EPS grew 11%, to $11.77 per share across 1H23.
UnitedHealth blamed the increase in medical costs primarily on patients undergoing a higher than expected number of treatments and surgeries, although not necessarily due to age, but more due to the end of the pandemic, when non-elective surgeries were discouraged.
With that said, it does seem inevitable that as the U.S. population ages, UnitedHealth’s costs are going to keep increasing – and that has necessitated a new approach to administering healthcare – the very fast-growing Medicare Advantage industry.
The Importance of Medicare Advantage To UnitedHealth’s Business Model
It’s likely no coincidence that Medicare Advantage (“MA”) has become the fastest-growing sector of the health insurance industry. United has larger divisions – for example, its Employer and Individual healthcare segment serves ~26.6m members in the US, and 7.5m ex-U.S., whilst Medicare Advantage members number ~7m – although UnitedHealth says it will add another 900k members in 2023. Here is a definition of MA I have used in previous posts on this company:
Medicare Advantage is a mechanism whereby private health insurers provide health benefits coverage in exchange for a fixed monthly premium per member from the Centers for Medicaid and Medicare (“CMS”), plus a monthly consumer premium. Medicare Advantage plans can offer seniors lower premiums, plus additional advantages such as basic vision and dental coverage, and gym memberships.
United has a ~25% share of the MA market, which is the largest of any company. Humana (HUM) has an ~18% share, and CVS Health (CVS) an ~11% share. The per-member, per region payment per plan is set by the Centers for Medicaid and Medicare (“CMS”), based on historical data.
The CMS effectively pays private health insurers to take on the risk of the policyholders, and then it is up to the health insurers to earn a profit by administering the required care for less than from the CMS. The payors earn a percentage of any money saved, and also receive additional bonuses if their plans are rated 4 out of 5 stars or higher. 99% of UnitedHealth’s MA members are in a plan rated 4 stars or higher, the company says.
UnitedHealth estimates 70m people in the US will be eligible for MA by 2025 – ~10k Americans become eligible for these plans every single day – and thanks to their flexibility, ability to offer premiums as low as $0, and additional services offered such as dental care and wellness programs, they are a popular choice for seniors.
Medicare Advantage plans were introduced in 2008, and over the years, healthcare payors’ enthusiasm for the plans has begun to worry the CMS, which now believes the rates it has been offering are too favorable to payors, with billions of tax-payers money being diverted to health insurer’s bottom lines, as opposed to being spent on taking care of patients.
While there is an element of truth to that statement – research suggests gross margins per member across MA are double that of Medicaid, employer-funded, or individual – if we look at a company like Humana, almost a “pure-play” MA business, revenues generated in 2022 were $92.9bn, and net profit was $2.8bn – a margin of ~3%.
United Health’s was somewhat higher, at 8% last year, while if we look at another sector of healthcare – pharmaceuticals – the average net profit margin amongst the U.S.’ 8 largest Pharma’s in 2022, was >20%. Compared to that, MA plan operators margins hardly look obscene, and yet the CMS says it intends to claw back billions from health insurers who it suspects it may have overpaid.
Why Medicare Advantage Could Become A Thorn In UnitedHealth’s Side
Reviewing the above, we can identify 2 fundamental mistakes that may have been made – one by the CMS, and one by the health insurers. The mistake made by the CMS was to miscalculate how much it should be paying healthcare payors to take on the risk of administering MA plans, and the mistake made by health insurers – and perhaps by the stock market and shareholders also – was to believe that this error on the CMS’ part would never be corrected.
Looking ahead, we can also potentially identify another mistake made on the part of the health insurers – which was to underestimate the long-term cost of administering the plans.
The market watches health insurer’s medical care cost ratios – essentially how much is received in the form of premiums, versus how much is paid out on administering care – very carefully, and usually reacts to any sign that it is narrowing with a selloff, as happened in June this year, when UnitedHealth cautioned the ratio would increase to ~83%, due to a higher number of patients accessing in-person care post-pandemic.
In response, United’s share price dipped from ~$480, to $445, before climbing again sharply as management produced its Q222 earnings, showing high rates of revenues growth, which it promised would soon translate to growing profit margins.
What if we consider a scenario, however, where the growth in medical costs comes not from patients catching up on treatments sidelined during the COVID era, but from an ageing population requiring more care than UnitedHealth and other healthcare payors bargained for. After all, the “silver tsunami” is a new demographic shift that has never been experienced before, and the costs of administering care to this population are going to be astronomical.
UnitedHealth says that annual U.S. spending on employer and individual health benefits is currently around ~$1 trillion, whilst $1.2 trillion is spent on Medicare. That figure is likely to keep widening, which is not necessarily good news for health insurers who are all-in on Medicare Advantage.
In fact, by my reckoning there are several clear and present dangers associated with Medicare Advantage – once perceived as a golden ticket and a cash cow. Firstly, taxpayers, represented by the CMS, already think they are paying health insurers too much to administer MA plans – in 2024, for the first time, the rates set by CMS for administering MA plans will fall.
Secondly, despite its promise and popularity, MA has not yet proven to be nearly as profitable a business model as many seemed to think – witness the narrow profit margins of nearly pure-play MA provider Humana, or to a lesser extent, how UnitedHealth profit margins haven’t been growing as fast as revenues.
Thirdly, the cost of administering MA plans is more likely to go up than down, as more and more people sign onto $0 premium plans (health insurers have no option other than to offer these to ward off new market entrants happy to sacrifice profits for growth), live longer, and require more regular healthcare products and services.
In summary, a business model that seemed infallible and highly attractive to private health insurers across the past decade, presents unexpected challenges and obstacles to profitability today. As a recent report on the sector by McKinsey and company concludes:
The MA market has been on an upward trajectory for years, with a continual stream of investor dollars chasing double-digit growth rates annually, enabling a thriving ecosystem of payers, care delivery partners, and services and technology companies. The variety of disruptions emerging, however, means that the winning strategies of the past five years are unlikely to be sufficient to meet members’ evolving needs and preferences. Success in the future will be determined by bold moves made now.
The Bold Move UnitedHealth Can Make – The Shift to “Value Based Care”
If the premise of MA has begun to turn slightly sour for the health insurance sector, then why do major players continue to direct their efforts more towards MA than any other insurance sector?
The answer is that the likes of UnitedHealth, CVS and Humana believe they can slash the costs of administering healthcare by switching from the traditional “fee-for-service” model, to a “value based care” model.
Fee-for-service involves hospitals and physicians charging patients for services and sending the bills to the health insurers to pay. But what if a health insurer creates its own network of physicians, private surgeries, and nursing staff whose first focus is to prevent the patient requiring the surgery or hospital visit in the first place, and whose second is to administer any necessary care more cheaply than a hospital or physician outside of its network would do?
This is the Value Based Care “value proposition.” The health insurers become more involved in taking care of their plan members and administering care, as opposed to simply signing cheques and hoping it writes less cheques than it receives premiums.
Thanks to the other half of its business – Optum Health – focused on using data analytics to help patients’ manage their health conditions more optimally, or even prevent them in the first place, deciding the prices of drugs being administered, and using AI powered analytics to identify inefficiencies in how care is being administered – UnitedHealth is arguably in the best position to become a successful value based care (“VBC”) operator – although it should be noted CVS recently spent ~$20bn on two companies – Signify Health, a home health specialist, and Oak Street Health, a network of physicians, with a view to establishing early supremacy in the VBC market.
UnitedHealth says that in 2022, MA plans involved 40% lower out-of-pocket costs versus original Medicare, and 43% lower rate of “avoidable hospitalizations.” The company added that:
Members with complex diabetes have a 52% lower rate of avoidable hospitalizations. Members with complex diabetes have a 52% lower rate of all related complications and a 73% lower rate of serious complications compared to those in original Medicare.
In short, health insurers like UnitedHealth still believe they can win with the MA plan model, thanks to the shift away from fee-for-service (“FFS”), and into VBC, but the size of the gamble these companies are taking should not be underestimated, given that profit margins in this industry are thinner that the public and even the market seems to think they are.
Concluding Thoughts – Different Ways To Play The Medicare Advantage Paradigm Shift
Because of their thinner margins, perhaps, health insurers are often unusually sensitive to news about potential rises in costs of administering healthcare. If the market believes there is a reason why medical costs and the medical costs ratio is going to climb, it tends to aggressively sell them.
Witness June’s sell-off, and rapid recovery – a relatively straightforward way for a speculative investor to make a few bucks is to “be greedy when others are fearful,” and acquire some stock after a panic-driven selloff – health insurers are typically resilient to short-term setbacks.
Longer term, however, there are doubts emerging about the MA business model that investors may find more concerning. As the population ages, medical costs will inevitably increase, but the tax-payer and the CMS think they are already paying too much to MA plan providers – something has to give.
Ultimately, that something may be the plan members themselves – premiums may increase slightly to reflect the fact that rates offered by CMS are expected to be less favorable going forward. Health insurers still believe they can make the VBC model work, but these savings are arguably already priced into valuations. Achieving significant cost reduction goals in that respect is what the market expects, rather than something it will reward going forward with a rising valuation and share price.
As such, if I were considering investing in UnitedHealth, I would be a little wary about opening a position today, as there is a genuine threat that margins are being squeezed, although I would take significant comfort from management’s promise of double-digit annual earnings per share growth.
I would instead look to pursue a strategy of buying dips – which are likely to occur regularly as the market, CMS, healthcare payors, plan members and tax-payers make up their minds about how to play the “silver tsunami.”
If I were a long-term holder of UnitedHealth stock who had seen the value of my shares increase by >80% over the past 5 years – substantially more than the 55% increase of the SPX index over the same period (if I had UnitedHealth stock for a decade or more held for a decade or more my gains exceed >400%), I would be considering if now was a good time to sell, given the uncertainty and price volatility likely to come United’s way over the next few years as the MA model is tested more severely than it ever has been before.
In many ways, MA is now beginning to trigger the actions that it was arguably designed to trigger – a “virtuous circle” whose motto is – find a way to administer healthcare cheaper, to a larger elderly population, and be rewarded for it. In the early days of the program, the scheme may have looked like a cash cow for health insurers, but longer term, it is a much more challenging outlook that requires buy-in from multiple stakeholders, and that may signal an end to UnitedHealth’s excellent long-term bull run.
Investors in UnitedHealth do not need to panic – this is still a great company with good growth potential, and a dividend yielding 1.6%, with compelling growth projections from management, but every time the market doubts these targets are achievable, it is going to punish the stock price.
This can be exploited to build a large position in UnitedHealth with judicial buys on perceived setbacks, but beware – we are in uncharted territory now with MA and VBC – nobody can say for sure this scheme will work out.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
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