UnitedHealth Group’s (NYSE:UNH) first quarter earnings were about in line with market expectations, but the health insurer’s stock tumbled after management acknowledged the headwinds associated with implementation of the Affordable Care Act (ACA).  Revenues grew 5% over the prior year, driven by a 2.7 million increase in enrollments, but sequestration cuts to the Medicare Advantage funding and newly effective ACA taxes reduced the net margin from 4.1% in the first quarter of 2013 to 3.5%. The medical care ratio (medical costs to premiums) improved 20 basis points to 82.5%, helped by billing ACA fees. However, as the fees were not tax deductible, the effective first quarter tax rate increased 5 percentage points to 42%, directly affecting the bottom line.
The health services division, Optum, continued to perform strongly, with a 29% year-on-year increase in revenues and 20% operating income growth. The division accounted for 35% of the company’s revenues, compared to 28% in 2013. We expect a greater contribution from this division going forward.
Our $74 price estimate for UnitedHealth’s stock is in line with the current market price.
TRICARE Helps Employer And Individual Division
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 division accounts for nearly 35% of the company’s revenues but reported a 10% decline in revenues for the first quarter, as UnitedHealth’s pricing strategy led to a 345,000-person decrease in enrollments in risk-based products. The strategy, which was implemented in order to maintain profitability, resulted in a decrease in market share during the quarter. UnitedHealth also reported the loss of a large state employer account, which resulted in a decrease of 705,000 in fee-based accounts.
However, the TRICARE program, which was launched last year to provide insurance to U.S. active and retired military and their families, provided some good news for the company and resulted in a 1.8 million year-on-year increase in employer and individual enrollments. UnitedHealth also reported a 7% year-on-year increase in consumer-directed health care products driven by increased market demand. The implementation of the ACA is expected to lead to an increase in health insurance enrollments which can benefit UnitedHealth if the company is able to retain its market share.
Medicare Cuts Will Affect Results
The Medicare program provides healthcare services to individuals aged 65 or older as well as younger people with disabilities. It is run by the Centers for Medicare and Medicaid Services (CMS), with companies like UnitedHealth assuming health care 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)) However, cuts to provider payments for the Medicare program were a part of the Budget Control Act of 2011 and began to take effect in April 2013.  The Congressional Budget Office (CBO) expects budget cuts to total $123 billion up to 2021.
For the first quarter, UnitedHealth reported a 4% increase in enrollments in the Medicare Advantage program. However, the company has been taking actions to counter the aforementioned budget cuts, including reducing product offerings, reducing benefits and even exiting some markets. UnitedHealth is one of the leading providers of the Medicare program, with a market share of over 20%. However, we expect a decline in market share in the coming years.
Optum Gives Hope
The Optum division provides health services to individuals, employers, government as well as life sciences companies. The division can be further subdivided into three subdivisions:
OptumHealth provides health and wellness services such as behavioral solutions, care solutions, financial services, collaborative care and logistics health. This subdivision reported a 6% year-on-year increase in revenues for the first quarter, driven by an expansion in customer services.
OptumInsight 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, biotechnology, pharmaceutical and medical device companies also use OptumInsight services. For the first quarter, the division reported an 85 increase in revenues, driven by Optum360 revenue management 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 subdivision reported a 38% increase in volumes, which led to 44% revenue growth. We expect all three subdivisions to continue to deliver in the coming years.Notes: