Healthcare Reform 2.0 is here – this time without as much pork.
Good thing, too. Pork is loaded with cholesterol, which increases heart disease, healthcare costs and… well, you get the idea.
The President released his revised plan for healthcare reform earlier this week. And while the new proposal is similar to the Senate’s on Christmas Eve, it eliminates some of the pork to Nebraska and other special interests.
I’m not going to politicize, though. I’ll leave that to the wackos on talk radio and cable “news” programs. I’ll just focus on what the plan means to health insurers – and investors.
Stemming the Tide of Health Insurance Premium Hikes
Obama has stated that his proposal is an opening bid to get negotiations rolling again. But despite expected GOP opposition, one part that will likely stay is regulatory oversight of health insurance premium hikes.
Republicans will have a hard time removing this populist section – particularly after Anthem Blue Cross said it will raise its premiums by up to 39%. This from a firm that earned $525 million in 2009.
According to the Los Angeles Times, since WellPoint (WLP) acquired Anthem in 2004, Anthem has contributed $4.5 billion in profits.
Rapidly rising insurance premiums are crippling individuals and small businesses alike. I expect that whatever beast emerges from healthcare reform, some form of caps or heavy regulation on premiums will be part of it.
Gauging the Impact of Regulation On Health Insurers
Back in December, I wrote that healthcare reform would hurt health insurers and that companies’ bottom lines will almost surely take a hit. But what about their stocks?
The bad news may already be priced in.
Let’s put it in the context of another heavily regulated industry – utilities.
When utilities want to raise rates, they have to file their request with state regulators. Often, utility companies must keep their return on equity (ROE) below certain levels. If regulators determine a price increase will boost ROE above the legal threshold, the request will be rejected.
Case in point: St. Louis-based Ameren Corporation (NYSE:AEE) recently requested permission to boost its ROE to 11.5%. However, Missouri regulators are capping ROE at 9.7%.
Elsewhere, San Francisco’s PG&E (NYSE:PCG) is allowed a ROE up to 11.35%, while New Jersey-based Public Service Enterprise Group’s (PEG) is slightly lower at 11.25%.
However, while regulation certainly curbs profits, it doesn’t necessarily mean under-performance in the stock market.
Over the past 10 years, utility stocks have returned an average of 54%, as measured by the Philadelphia Utility Index. That compares with a loss of 26% for the S&P 500 over the same period.
In addition, utilities have an average price-to-earnings (P/E) ratio of 15, versus health insurers’ P/E of 11. Utilities are also trading at more than twice their average 7% projected earnings growth rate, compared to just one times growth for health insurance companies.
Granted, the overhang of healthcare reform could put a cap on health insurance stocks for the time being. But as you can see from the utilities sector, regulation doesn’t have to mean sub-par performance.
It’s too early to tell what kind of parameters will be placed on health insurers. But let’s look at the potential winners and losers…
Overhauling the Healthcare Insurance Industry
If regulators treat health insurers anything like utilities, they’re likely to look at two main numbers when it comes to overhauling the healthcare insurance industry…
~ ROE: The average ROE for the healthcare insurance industry is 13.1.
If health insurers have caps placed on their ROE, companies like Cigna (CI) and WellPoint, would likely have to lower theirs, given that they both sport ROEs in the 20s.
On the other hand, those with room for ROE expansion include Coventry Health Care (NYSE:CVH) andUniversal American (NYSE:UAM).
~ Profit Margin: The industry average here is 3.4%.
So if profit margins go under the microscope, look for WellPoint to come under heavy scrutiny again. Its 18% net margin soars above that 3.4% number.
The Climate Is Uncertain… These Cheap Healthcare Stocks Could Prosper
Given that health insurance stocks are trading at nearly half their five-year average P/E of 18, there could be upside once the uncertainty of reform is lifted. And that’s even if regulations are implemented that limit price increases.
So if you’re a fan of cheap healthcare stocks in uncertain environments, take a look at these two firms…
- Humana (NYSE:HUM): The company sports a P/E of just 8 and a projected annual earnings growth rate of 10%.
- HealthSpring, Inc. (HS): This is a lesser-known firm, but one also trading at 8 times its earnings and 10% its expected growth. In addition, it’s trading at less than 7 times cash flow from operations and has a healthy balance sheet that boasts $462.2 million in cash.
But considering that utility companies have operated this way for years and returned plenty of value to shareholders, it might be tough to argue that health insurers shouldn’t be regulated, too. Particularly if it makes insurance more affordable for more people.