Health Insurers Suffer On High Costs, Unprofitable Exchanges

Health insurers called upon themselves the close scrutiny of regulators, with Anthem Inc.’s (ANTM) proposal to acquire Cigna Corp (NYSE:CI). (CI) and Aetna Inc (NYSE:AET).’s (AET) buyout deal with Humana Inc (NYSE:HUM). (HUM).

Recently, the viability of the proposed merger between Anthem and Cigna was challenged by Insurance Commissioner Dave Jones, who contends that the mega deal worth $48 billion would curb competition and hurt consumers in the state of California.

Moreover, the presidential candidates are looking at ways to fine-tune the provisions of healthcare legislation, which, if implemented, will see insurers reworking their business strategies.

Democratic presidential candidate Hillary Clinton’s priority includes a crackdown on insurers to limit out-of-pocket costs. These costs are expenses like deductibles, coinsurance and copayments for covered services among others that aren't reimbursed by insurance.

Also on Clinton’s agenda is giving more power to lawmakers to reject undue rate hikes by health insurers. Under the current healthcare reform, this authority is in the hands of certain select states only.

Donald Trump said that he would end Obamacare and replace it with something that would require a lot less money.

Coming back, the legislation has undoubtedly altered the regulatory landscape in ways that are not always beneficial to a private health insurer’s bottom line. But calling it a permanent drag would be an overstatement.

U.S. health plans are expected to operate in a lowered margin environment. Some health plans — especially the smaller ones — may not survive. Pricing pressure, higher taxes and fees, rising medical costs, regulatory compliance costs, increased competition and general marketplace uncertainty are some of the headwinds faced by the players in the industry.

While the aim of this write-up is to put the spotlight on the headwinds facing the industry; an earlier write-up in this space had the opposite focus.

Public Exchanges Losses

Public Exchanges made their debut in Oct 2013, and were considered one of the signature achievements of Obamacare aimed at providing subsidized insurance to millions. The insurers were also sanguine about the exchanges, hoping to make big business out of them. But health insurers are now struggling to make profits from the public exchange business.

These insurers are saddling high medical expenses of individuals who are buying the subsidized policies under the health care law. The public exchanges attracted a disproportionate number of unhealthy individuals compared to healthy ones. A higher percentage of unhealthy patients led to higher claims for the insurers, thus leading to losses from the policies sold to these groups of people.

In Nov 2015, UnitedHealth Group (NYSE:UNH) (UNH) disclosed concerns about losses incurred on its individual business from the public exchange.Compelled by the loss suffered from the individual insurance policies sold on the exchanges, the health insurer announced that it will not entertain such losses and may exit this unprofitable market completely by 2017. The company has already scaled back its marketing efforts for individual insurance policies sold on exchanges.

Another insurer, Aetna, also suffered losses in its public exchange business in 2015 and reduced its operations to 15 states this year from 17 states last year. It is, however, taking measures such as re-pricing and product modification to generate profits in 2016.

Another player Humana is also contemplating to drop individual insurance coverage through exchanges in the states of Alabama, Kansas, Wisconsin and Virginia. The company is considering to exit this business which brought in meager profits in this years’ first quarter and would likely result in a loss for the full year.

If the players realize that the exchanges are not seeing profitable business opportunities, a mass exodus may happen which may hamper the functionality of the exchanges and cause a failure of the ObamaCare exchanges, thus defeating the basic aim of providing coverage to millions of uninsured Americans.

Some of the other challenges faced by the industry are briefed below:

Margins to Shrink

The health insurers are expected to witness lowered margin environment onward. A host of factors including compliance costs related to health care reform regulation, increased fees and taxes, pricing pressure, stiff competition and rising medical costs will squeeze the bottom line. A general shift in patient mix from Commercial insurance to Government (Medicare, Medicaid and State-subsidized marketplace or exchange) will also affect profitability to a large extent. Premiums for Medicare, Medicaid and State-subsidized policies tend to be higher due to serious health issues for many enrollees; however, they carry smaller profitability margins compared to commercial insurance.

High Compliance Costs

Regulatory reform sweeping through the sector has hit insurers with high compliance costs. The expenditure involved in redoing the internal systems can pinch the players hard. There has been huge spending on health information technology (“HIT”), following the implementation of The American Recovery and Reinvestment Act of 2009 (“ARRA”), or "Recovery Act," which contains the Health Information Technology for Economic and Clinical Health Act, or the "HITECH Act." Notably, HIT includes electronic health records (EHRs), health information exchanges (HIEs) and other initiatives.

The federal government's emphasis on the use of health IT, which helps providers communicate better with each other about patient care, reduces medical errors, paperwork and needless duplicate screenings and tests, leading to better coordinated patient care and lower health care costs. These have increased current health care information technology spending. Financial incentives offered by regulators to providers and hospitals for the implementation of the meaningful use of health care IT products are primarily driving IT spending.

Growing Consumerism

Rising consumerism has now become the reality of the health insurance industry. Until the implementation of the ACA, the insurance companies had an upper hand in choosing who to provide coverage to and consumers (people receiving health care) had no active role in the decision-making process. But now the trend has changed. Health insurance reform has put consumer power and choice in the hands of the Americans, and ensure that all Americans receive the health care services that they need and deserve. Consumers’ increased purchasing power and access to information to take health care decisions are the major threats to insurers.

Prior to reform, big insurers dominating large markets hardly ever bothered to provide consumers with even basic information, such as the performance of health insurance policies, procedures to claim, the size of the provider network and cancellation processes. Now, customers demand transparency, value and convenience, leaving insurers grappling for innovative ways to satisfy these unmet needs. The new mission, however, will not be easy to execute.

Global Economic Woes and Regulatory Challenges

A fragile global economy presents a headwind for insurers looking to expand their international operations. One of the largest insurers, UnitedHealth Groupmade an acquisition to reap benefits from the Brazil market but is now facing slowing growth rates in that country.

In case of India, which remains one of the most profitable opportunities for insurers, the regulatory environment still remains somewhat challenging. China -- which merits the highest risk-adjusted opportunity ranking, largely because of its immense scale -- poses significant investment restrictions to foreign insurers entering and operating there.

Bottom Line

The changed regulatory landscape has undoubtedly created hurdles that would weigh on profits and margins of industry operators going forward. But it is hardly the unmitigated disaster that some industry players make it out to be. Beyond the ACA, the investment appeal of the space also reflects its perceived defensive and counter-cyclical orientation, which is crucial amid the current uncertainty.