UnitedHealth Group (NYSE:UNH) reported an 8% year-on-year increase in revenues for the fourth quarter of 2013 with a 14% EPS growth, beating market expectations.  However, the stock slid 3% as the health insurance company’s operating margin for the full year dropped from 7.6% in 2012 to 6.4%. Government funding cuts to the Medicare Advantage program and the implementation of the Patient Protection and Affordable Care Act (PPACA) have been exerting downward pressure on UnitedHealth’s margins; the 2013 medical care ratio (medical costs to premiums) increased 110 basis points to 81.5%.
The company has been looking to offset this downward pressure through revenue growth and international expansion, particularly in Brazil. UnitedHealth is the biggest health insurer in the U.S., with a market share of 14%. This market position will be crucial in the coming months as the Obamacare act gets into full swing. Through 2013, the company reported 900,000 enrollments in the U.S. and 400,000 enrollments in its international operations. Our $74 price estimate for UnitedHealth’s stock is in line with the current market price.
Will UnitedHealth Be Able To Retain Its Position?
The website www.healthcare.gov was launched during the December quarter, offering individual health insurance plans in 36 states in the U.S. The remaining states also launched their own websites. Although there were some technical issues leading to a slow initial response, the exchanges picked up momentum in December with 2.2 million people enrolling in insurance plans through December 28. 
Around 7 million Americans are expected to enroll in health insurance plans and 8 million additional people are expected to enroll in Medicaid plans by March 2014.  According to the last U.S. census, around 17% of the U.S. population is uninsured, indicating that more enrollments can be expected in the coming months.  UnitedHealth is currently in a strong position to capitalize, with a market share of 14% in the private heath insurance market and 20% in the Medicare market.
On the downside, the myriad choices offered by the health insurance exchanges might lead to a loss of share for UnitedHealth. According to a report by the Department of Health & Human Services, consumers from various states will, on average, be able to choose from 53 health plans through the exchanges. More than 95% of customers will have a choice between at least two health insurers, with more than 1,300 health insurance companies in the market.  As a result of the competition, we expect a slight decline in market share for UnitedHealth over the coming months.
The Big Downside
Medical costs account for more than 80% of UnitedHealth’s operating expenses (excluding Depreciation and Amortization) and the company has maintained a medical care ratio of 80% for the last few years. However, the PPACA mandates a minimum medical care ratio (medical costs divided by premiums) of 80% for individual and small group plans, and 85% for large group plans. To make matters worse, the government has decided to cut Medicare payments to insurance companies by nearly 30% in the next 10 years.  Although the company has undertaken several cost cutting measures to reduce operating costs, we expect the margins to drop from 9% to 7% in the coming years.
A big concern for health insurance companies is the demographic opting for enrollment through the PPACA. Obamacare is designed to distribute costs evenly through the U.S. population; the act requires policies to be issued regardless of community rating or medical condition, with insurers offering the same premium to all insured parties of the same age and location, regardless of gender or pre-existing condition. The act also offers subsidies to low income individuals and families with income below the federal poverty level. This means that the cost of health insurance will increase for young and healthy citizens who might be disinclined to opt for the plans.
So far, this trend appears to be true; 33% of the citizens who enrolled in the plans were in the 55-60 age bracket. This age group is more likely to incur medical costs; 44% of the people in the 45-64 age group visit medical providers 3 or more times in a year, with over 50% regularly using prescription medicine. For the lower age groups, the percentage of people visiting medical providers 3 or more times in a year is just around 25% with 30% of the population not utilizing medical services at all. 
Industry experts have termed this trend an “adverse selection death spiral”. In the worst case, if enrollment in the 18-34 age bracket falls to 25%, health insurance companies can even run on losses, with costs exceeding premium income.  We will keep an eye on this sector in the coming months and update our model as the situation develops.Notes:
- UnitedHealth Group Incorporated Management Discusses Q4 2013 Results – Earnings Call Transcript [↩]
- Nearly 2.2 million Americans selected plans in the Health Insurance Marketplace from October through December, Department of Health and Human Services Press Release, January 13, 2014 [↩]
- Obamacare launch poised to reach millions despite shutdown drama, Reuters, October 1, 2013 [↩]
- Health Status by Selected Characteristics and Health Insurance Status: 2010 [↩] [↩]
- Significant choice and lower than expected premiums available in the new Health Insurance Marketplace [↩]
- UnitedHealth Culls Doctors From Medicare Advantage Plans [↩]
- Adverse Selection: Obamacare Exchange Enrollment Skews Much Older Than U.S. Population; Cost Increases Likely, Forbes, January 13, 2014 [↩]