UnitedHealth Group (NYSE:UNH) is scheduled to report earnings for the first quarter of 2014 on Thursday, April 17.  The health insurance giant beat market expectations for the fourth quarter of 2013 with 14% EPS growth and an 8% year-on-year increase in revenues.  This growth was helped by the launch of the new health insurance exchanges established under the Affordable Care Act (ACA) as well as expansion in the Optum division and in Brazil. However, government funding cuts to the Medicare Advantage program exerted downward pressure on the company’s margins, as its medical care ratio (medical costs to premiums) for the year increased 110 basis points to 81.5%. We expect UnitedHealth to maintain top-line growth through the first three months of the year, but margins will be key to the company’s performance.
Our $74 price estimate for UnitedHealth’s stock is in line with the current market price.
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Is Obamacare A Success?
The implementation of the ACA is expected to lead to an increase in health insurance enrollments, which will benefit UnitedHealth if the company is able to retain its market share. So far, the ACA has had mixed results; research conducted by the RAND Corporation shows that the uninsured rate has gone down from 20.5% in September 2013 to 15.8% in March 2014, with 9.4 million enrolling in health insurance services during this period.  Enrollments in Employer sponsored insurance (ESI) plans increased by 8.2 million while 3.9 million people enrolled through the insurance exchanges. Of these new enrollments, 7.2 million people who signed up for ESI were previously uninsured while 1.4 million of those who enrolled through the exchanges also fell into the same category. These statistics have raised some questions over the efficacy of the exchanges.   Outgoing Health and Human Services Secretary Kathleen Sebelius has also criticized the timing and testing procedures associated with the exchanges. 
UnitedHealth is the biggest health insurer in the U.S., with a 14% market share in the individual and employer provided insurance market space. The company’s market share has increased over the last six years, and the ACA provides both an opportunity and a challenge to the company. Customers will now have more options in terms of insurance plans to choose from; according to a report by the Department of Health & Human Services, consumers from various states will, on an 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.  We believe that UnitedHealth’s first quarter results will give us an insight on the changes in the company’s market share since the launch of the health insurance exchanges.
UnitedHealth is also one of the leading providers of Medicare, with a market share of over 20%. More than 30% of the company’s revenues and EBITDA come from this division. The Medicare program provides healthcare services to individuals aged 65 or older and younger people with disabilities. It is run by the Centers for Medicare and Medicaid Services (CMS), with companies such as UnitedHealth assuming health insurance coverage in return for a fixed monthly premium per member served from CMS. The program utilizes payroll taxes paid by employees and employers as well as other sources like income taxes paid on Social Security benefits and premiums from people who aren’t eligible for premium-free Medicare coverage. ((How is Medicare funded?, Medicare.Gov)) Total government expenditures on the Medicare program are around $550 billion per year, but the CMS is cutting down. This had a big impact on UnitedHealth last year, as its operating margin dropped from 7.6% in 2012 to 6.4%.
The CMS has announced that the base U.S. government payment rate will be reduced by 4% by next year.  We expect UnitedHealth’s margins to fall to around 6.7% by the end of the decade and will keep a close eye on the statistic in the upcoming earnings release.
Promising Signs From Optum
The Optum division, which consists of OptumHealth, OptumInsight and OptumRx, is turning into a big earner for UnitedHealth. The company reported a 26% increase in revenues from the division last year, led by a 31% growth in pharmacy services revenues. Optum accounted for more than a quarter of the company’s total revenues, with the operating margin expanding from 4.9% in 2012 to 6.2% in 2013. A large chunk (nearly 75%) of 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. Therefore, we expect a high correlation between the growth in Optum revenues and enrollments in the insurance divisions. Sustained margins will be key if this division is to have a significant long-term impact on UnitedHealth’s performance. Our estimate for UnitedHealth’s EBITDA could increase by 10%, should margins improve to over 7% through the decade. There is a 10% upside to our price estimate in the scenario.Notes:
- 2014 Earnings Release Dates, Investor Relations [↩]
- UnitedHealth Group Incorporated Management Discusses Q4 2013 Results – Earnings Call Transcript [↩]
- Changes in Health Insurance Enrollment Since 2013, Evidence from the RAND Health Reform Opinion Study [↩]
- UnitedHealth a Surprise Fixer of Flawed Obamacare Sites, Bloomberg, March 31, 2014 [↩]
- Obamacare Only Enrolled 1.4 Million Previously Uninsured Individuals [↩]
- Sebelius says timeline for ObamaCare rollout ‘flat out wrong’, April 13, 2014 [↩]
- Significant choice and lower than expected premiums available in the new Health Insurance Marketplace [↩]
- UnitedHealth, Humana Take Cut in Medicare Advantage Plans, Bloomberg, April 9, 2014 [↩]