UnitedHealth Group’s (NYSE:UNH) stock has moved to all-time high as the Centers for Medicare & Medicaid Services (CMS) has decided to retract from its original plan of reducing 2014 Medicare Advantage reimbursement rates by over 2% and will instead increase the rates by 3.3%.  The news has cleared uncertainty surrounding the stocks of healthcare insurers and triggered a rally. The outcome, coupled with the addition of millions of Americans pursuant to Obamacare Act, will certainly boost revenue growth for UnitedHealth going forward. However, an increase in the Medicare reimbursement rate should not impact its margins much as most of UNH’s network contracts are tied to reimbursement levels.
While the UNH stock has risen over 10% in the last couple of days to reach $61, we believe there is room for further appreciation. Our current price estimate for UnitedHealth stands at $70. Below we discuss the factors that will drive the stock closer to our price estimate.
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Robust Growth Ahead In Medicare & Medicaid Insurance Businesses
The Patient Protection and Affordable Care Act (PPACA), whose purpose is to reduce healthcare costs and expand healthcare coverage among Americans, will bring in another 30 million Americans to the health insurance market (either private, Medicare or Medicaid) over the next five years.  The bill includes an individual mandate which penalizes individuals who can afford health insurance but choose not to purchase it. It also expands the availability of Medicaid and restricts the ability of insurers to refuse service to customers with pre-existing conditions. Therefore, the PPACA will allow UnitedHealth to meaningfully increase its enrollments over the next four years even though its market share may come under pressure from rising competition.
The only concern was the possibility of the CMS reducing government payments for Medicare Advantage plans as that could have lowered revenue growth. However, its latest decision to increase 2014 Medicare Advantage reimbursement rates will certainly buoy revenue growth in the near term.
Economy Recovery, TRICARE To Drive Growth In Private Insurance Business
UnitedHealth may continue to witness a decline in its fully insured commercial customers in the near term as more businesses are seen covering healthcare costs themselves while they hire the insurer to manage healthcare benefits due to persistently high unemployment and weak macroeconomic conditions. High unemployment levels have had an adverse impact on the number of employer-sponsored health insurance enrollments while Medicaid enrollments have increased steadily. Additionally, many employers have cut healthcare benefits in response to market conditions. However, beginning 2014, we expect the economy to improve. This should increase employer-sponsored health coverage along with the quality of those plans (which will in turn bring higher premiums).
Beginning April 1, 2013, UnitedHealth has started managing five-year TRICARE contract for active-duty and retired military personnel in the western U.S. and their families. This adds 2.9 million beneficiaries to the company’s customer base. 
Margin Risks Are Already Incorporated
The PPACA will also introduce health insurance exchanges to encourage competition in the market and will regulate premiums and medical care ratios (medical costs/premiums) of health insurers. This will likely have a negative effect on large insurers such as UnitedHealth as it will result in pressure on pricing and mandatory caps on margins. We therefore expect margins to decline going forward. However, we believe that the benefits for UnitedHealth from the increase in enrollments will outweigh the pressures on pricing and margins.
Amil Acquisition: A Key To Growth Going Forward
As part of its strategy to focus on international expansion to maintain growth momentum, UnitedHealth had announced the acquisition of Brazil’s largest health insurer, Amil Participacoes SA, for nearly $4.9 billion. Amil serves over 5 million customers. UnitedHealth currently holds 65% share in Amil and expects to acquire an additional 25% through a tender offer by Q2 2013. 
While Brazil has witnessed one of the fastest growth rates in the world in the last few years, the market penetration is still well below that of developed markets (an estimated 25% compared to more than 75% in developed markets).  As average income and healthcare awareness continue to grow in Brazil, we expect that more people will opt for managed care plans. UnitedHealth can use its expertise, a strong balance sheet and a good network to tap this opportunity despite significant competition in the country.
Further, health insurance companies generally increase premiums regularly in order to account for increases in medical costs. With the high persistent inflation (over 5%) and rising medical costs in Brazil, we do expect regular increases in rates as witnessed historically.
Optum: Double Digit Revenue Growth
OptumHealth and OptumInsight, through which UnitedHealth provides health management, wellness, financial services as well as advisory and consulting, are expected to continue to witness mid-to-double digit growth. The health insurer continues to add network-based health programs. Further, both health care providers and payers are opting for its compliance and advisory services. However, the continued migration of consumers to cheaper generic from high cost, branded prescription drugs will continue to weigh on its OptumRx business.Notes:
- RATE ANNOUNCEMENT DETAILS PLAN PAYMENTS; OTHER PROGRAM UPDATES FOR 2014, CMS, April 01 2013 [↩]
- FACT SHEET: The Affordable Care Act: Secure Health Coverage for the Middle Class, White House, June 28 2012 [↩]
- GAO Affirms TRICARE West Contract Award to UnitedHealthcare, UnitedHealth Group, July 2 2012 [↩]
- UnitedHealth Group Reports 2012 Results, Highlighted by Strong and Consistent Growth, UnitedHealth, Jan 17 2013 [↩]
- Investors Presentation – 2Q12, Amil [↩]