While traditional health insurance services like Private Health Insurance and Medicare And Retirement businesses have been UnitedHealth Group’s (NYSE:UNH) main source of income accounting for nearly 77% of 2012 revenues, it is the Optum division which has shown the most promising signs of growth this year. The division, which consists of OptumHealth, OptumInsight and OptumRx, accounted for 23% of the company’s operating earnings through the first six months of 2013 with the figure surging 80% over the prior year. OptumHealth reported a 110% increase in EBIT for the first half of 2013, accounting for more than 40% of the Optum division’s earnings while OptumInsight and Optum RX reported a 66% and 58% increase respectively. The contribution to EBIT from these divisions was roughly 30% each.
Growth in the division will be driven by expansion in the insurance market, but margin expansion from the business alignment could provide an upside.
Our $76 price estimate for UnitedHealth’s stock is in line with the current market price.
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What Is Optum?
Optum provides health services to individuals, employers, government as well as life sciences companies.
The division can be further subdivided into three subdivisions:
OptumHealth which primarily provides health and wellness services such as behavioral solutions, care solutions, financial services, collaborative care and logistics health. The division covers over 61 million individuals across the U.S.
Behavioral solutions include disability solutions, mental health and substance abuse solutions which include risk identification, targeted programs and therapy. Care solutions include providing personalized health management services such as benefit and claims support education for employees, cost estimates and analysis for health plans, specialized programs for conditions such as asthma and diabetes, women’s health services, and wellness programs such as fitness reimbursements and health discount programs. The behavioral solutions and care solutions divisions serve around 50 million and 40 million individuals each.
The company also allows employees and employers to deposit part of pre-tax income and get tax advantages and health savings in the future through the financial services subdivision. Collaborative care allows physicians to connect to each other and logistics health provides mobile care delivery.
OptumHealth’s products are offered on a risk basis, wherein the company assumes responsibility for health care costs and in turn earns fixed monthly premiums from policyholders. For financial services, the company also earns investment income on managed funds.
OptumInsight which provides software and information products and services as well as advisory and outsourcing services to clients. The division primarily caters to hospitals and physicians as Medicaid and Medicare administrators. State and Federal government bodies as well as biotechnology, pharmaceutical and medical device companies also avail OptumInsight services.
OptumRx is responsible for processing and paying prescription drug claims of its clients. It offers pharmacy benefits management (PBM) services serving more than 14 million people nationwide by processing over 300 million retail, mail and specialty drug prescriptions annually. The division reported 8 million new customers through the first six months of 2013, driving the aforementioned growth in earnings. The company primarily provides pharmacies a good number of customers and negotiates prescription costs and processes these prescriptions for its customers.
A large chunk of the Optum’s revenues come from intersegment transactions, through sales of pharmacy benefit products and services to customers enrolled in private health insurance or Medicare plans. Three-fourths of the Optum division’s revenues through the first six months of the current year were through intersegment transactions. Therefore, we expect a high correlation between the growth in Optum revenues and enrollments in the insurance divisions. As highlighted in our article, A Look At UnitedHealth’s Private Health Insurance Business, we expect employment and individual policyholders to grow from 27 million at the end of 2012 to around 30 million by the end of the decade. This increase will be driven by the Patient Protection and Affordable Care Act (PPACA) as well as the organic population growth in the U.S. and will also allow UnitedHealth to expand its Optum division.
However, the main upside to the Optum division comes from margin expansion. After eliminating intersegment transactions, the pre-tax (EBIT) margin for Optum went up from 16% in the first six months of 2012 to 25% in the same period in 2013. Margins for OptumHealth went from 16% in 2012 to 27% in 2013, while those for OptumInsight and OptumRx went up from 22% and 13%, to 31% and 18% respectively. The company attributed this margin expansion to productivity gain from disciplined focus on 10 product families. Our current forecast accounts for a marginal near term decline in margins due to increased competition arising from the implementation of the PPACA, as well as increasing medical costs. However, our estimate for UnitedHealth’s EBITDA could increase by 10%, should the company maintain the current year margins through the decade. There is a 10% upside to our price estimate in the scenario.