Profits In Health Insurance Under Obamacare

This year's Fortune 500 (covering 2013) shows that health insurers as a group continue to post rather mediocre profit results for the sixth straight year in a row. Indeed, when return on revenue is used as the measure of profits, the biggest firms among health insurers/managed care companies (e.g., UnitedHealth Group UNH, Wellpoint WLP) used to reliably outperform those in the retail pharmacy and other services industry (e.g., ExpressScripts ESRX, Quest Diagnostics DGX). But under the Obama administration, they have reversed positions. I have just updated more detailed charts for my book, The American Health Economy Illustrated[1], but wanted to give readers a quick overview of what I've learned.

Let me quickly stipulate that I am no expert stock analyst; nothing I say in this post should be used by readers to invest in any particular companies. I'm simply trying to describe some big picture trends within various health-related industries and trying to tie these back to how Obamacare has rolled out.

So let's start with a look at return on revenues since 2005. According to the official scorekeepers at NBER, the latest recession began in December 2007 and ended in June 2009, so this essentially gives us several pre-recession years to compare against several post-recession years. I generally ignore what happened in 2008 and 2009 since there's no good way to disentangle the impact of the recession itself from broader trends in health care in general or the effects of Obamacare in particular.

Profit Trends in Health Insurance and Managed Care

This group includes major players such as UnitedHealth Group, Wellpoint, Humana, Aetna, and Cigna (each of which is large enough to belong to the Fortune 100). UnitedHealth ironically appears to have benefited both from Obamacare's success as well as its failure. According to ,

UnitedHealth may have been among the medical insurers who feared the rising medical care costs and increased liability expected from implementation of the Affordable Care Act, but the nation's largest insurer cited 'sales to individuals and smaller employer groups' as a contributor to its enrollment growth at the end of 2013. The company added 4.5 million customers in total last year and its revenues increased 10.7% with help from a 26% revenue bump for Optum - UnitedHealth's technology services arm. In what might be an unintentional boost from the ACA, Optum runs the unit that was brought in to help repair HealthCare.gov in the wake of the government insurance site's disastrous rollout.

So far, Wellpoint likewise appears to have profited from Obamacare. Again, according to :

The second-largest insurer in the U.S. faced a year of challenges as the Affordable Care Act went into effect and new CEO Joseph R. Swedish took the reins. Wellpoint completed its integration of Amerigroup, which gave the company the largest Medicaid roster in the industry with nearly 4.5 million patients, and refocused its core business by selling off 1-800 CONTACTS and Glasses.com. The insurer reported sales growth of 16% in 2013, to $71.5 billion, though profits dropped over 6% year-over-year. Swedish said he expects 2014 income to be better as the company adds as many as 1.3 million net new customers, an increase driven by the public exchanges set up under the ACA.

Some will take this as a sure sign that President Obama's 'sellout' to big insurance companies has worked exactly as intended: ' to multiply the profits of five giant insurance companies.' Of course, the sometimes acid rhetoric of President Obama, Kathleen Sebelius, Nancy Pelosi and progessive bloggers notwithstanding, insurance company profits were never very large in the first place. As my chart shows, even at their 'peak' in 2005, profits as a percentage of revenues (read: premiums) were only slightly more than 7%-a respectable number to be sure, but one that was beaten by 21 other industries (of the 50 or so total industries represented on the Fortune 500). So it was always a bit bizarre to have Kathleen Sebelius denouncing health insurer profits as 'immoral' (in February 2010) when 2009 profit levels barely exceeded 3%.

Comparing Health Insurers to Other Industries

Few people understand that most profits from health insurers stem from their return on investing their pool of premium dollars while awaiting those dollars being paid out in claims months or even years after being collected. Wharton School insurance expert Scott Harrington calculates that in 2013, insurers in the individual (nongroup) insurance market overall earned negative pre-tax profits of 3.1% on the premiums they collected. That is, they actually lost 3.1 cents for every premium dollar collected, but they presumably made these losses up from their underwriting gains for group coverage as well as returns on investments.

Moreover, everything is relative. Compared to retail pharmacies and other services, the largest players in the insurance industry have seen their return on revenue beaten down between 2010-2013 compared to the levels they enjoyed prior to the recession. The opposite has been true of retail pharmacies and other services, which now enjoy profit levels nearly double their counterparts in health insurance and managed care. Is Laboratory Corporation of America (9.9% return on revenues in 2013) engaged in immoral profit-making? And if it's so insanely profitable, why did its stock price grow only half as quickly as the Standard and Poor's 500 since July 2009? What does that say about profits in the rest of corporate America?

Where Are Things Headed?

Admittedly, UnitedHealth Group's stock price has gone up nearly twice as fast as the Standard and Poor's 500 over the past 5 years, but that's only because it had been beaten down so much by mid-2009 (when UNH's stock price was nearly 50% lower than it had been 5 years earlier while the S&P 500 average stock price was about 50% higher than 5 years earlier). If we use a 10-year frame of reference, the UNH stock price has risen at the identical rate as the S&P 500.

According to the Chicago Tribune, '12 analysts raised their profit expectations over the past 90 days for Aetna's earnings, with a mean change of 2.2 percent higher, and just one revised them lower. For Cigna , 15 analysts increased their profit estimates in the period, with a mean of 1.8 percent higher, compared with one revising them down, according to the StarMine data.' Yet it's unclear how long this will persist. ' You have more people using healthcare at these higher rates, and that's going to get you earnings, but my question is for how long,' said Kim Forrest, senior equity research analyst, Fort Pitt Capital Group in Pittsburgh. 'It's really unclear at this point how much money this is and how long it can be sustained.'

What could go wrong? A report this week in the Wall Street Journal has highlighted an unintended consequence of President Obama's decision to allow people to keep their old (non-compliant) health plans through 2016:

'The people in pre-health-law plans are overall 'a lot healthier,' and the effect is 'going to be a major issue for some states and some health plans,' says Ross Winkelman, an actuary at Wakely Consulting Group, which is using data from 51 insurers in 33 states to analyze the health status of enrollees. Keeping these healthier people out of the new plans could increase average per-member medical costs for some health-law plans by 'double digits' in percentage terms, he said.'

One factor that will affect health insurer profitability will be the so-called 'bailout' funds for health insurers. Those who have paid attention to this issue know that the ' risk corridors' were originally supposed to be budget neutral ('excess profits' by some insurers would be clawed back to pay to insurers who experienced losses on the Exchanges). But now it has been estimated that the risk corridors will cost taxpayers about $900 million in 2014. This bailout amounts to 6.7% of the total profits of Fortune 500 managed care and health insurance companies in 2013, so it will not exactly cripple the industry if policymakers find a way to deny them these funds.

Footnotes

Of more critical importance will be whether regulators deny insurers the rate increases needed to forestall losses on the Exchanges in 2015. In some states, double-digit rate increases are in the offing, both because fewer young people signed up than had been hoped, but also because the young people who did sign up were far unhealthier than average. These increases come on top of massive increases already endured in some states (49% on average in the nongroup market, according to a Manhattan Institute analysis that breaks these increases down to the county level). Since Obamacare provides for annual review of 'unreasonable' health insurance rate increases and since 10% has been established by DHHS as the threshold for 'unreasonable', there will be huge political pressures to hold down rate increases (especially in an election year in which health care is shaping up to be a critical issue). But an insurer that sees a 20% requested rate increase slashed in half by regulators might find itself 13% in the hole in the nongroup market instead of only 3%. This might be sufficient for such insurers to walk away from Exchange participation entirely. But that in turn could trigger a cascade of undesirable effects (cancelled plans, disrupted relationships with providers etc.) with unpredictable political consequences (do regulators back down? crack down? illegally bend the rules further?). The dynamics of how all this plays out in the months ahead will be interesting to see.

[1] I have 6 separate charts showing return on revenues, return on assets and return on equity for both industry groupings shown in the post. The figures for medical facilities, retail pharmacies and other services, health insurance and managed care, and health care wholesalers are at this module. Note that you have to go to the Download section at the bottom of the page to see the updated versions through the year 2013. Figures for pharmaceuticals and medical devices are at this module. The Excel spreadsheet used to produce them all is here.