Duff & Phelps is pleased to present this report as part of an ongoing series of reports and white papers on the healthcare industry. This report focuses on commentary, trends and observations related to the managed care sector, with an emphasis on financial performance, merger and acquisition activity and industry highlights primarily among the publicly traded managed care companies.
Size Matters, Evolves Over Time and Can Present Antitrust Challenges
Based on a variety of factors, including revenue, market cap and share price performance over the past ten years, UnitedHealth Group Inc. (United) has not only maintained, but has also expanded its dominance over the other national publicly traded managed care companies.1 Over the 10-year period ended Dec. 31, 2017, United’s revenue grew 167%, compared to 47%–136% for the other competitors. During this period, Cigna Corporation (Cigna) and Humana Inc. (Humana) saw their pretax profits increase at higher percentages, but this is partially distorted by the fact that their pretax margins in 2007 were materially lower than United’s pretax margin. United’s shareholders have been generously rewarded for the company’s growth. During the 10-year period ended Dec. 31, 2017, United’s share price increased 279%, compared to 157%–278%, or an average of 219%, for its competitors.
Counter to what you might think, Anthem — while still the second-largest publicly traded managed care company — has lost some of its relative dominance over the past decade as all the other national publicly traded competitors have grown at faster rates. This is reflected in Anthem’s share price performance during this 10-year period, which at 157% is the lowest of the five competitors. Anthem is the only competitor to have its pretax income decline during this period. Another interesting Anthem observation is that its market capitalization (shares outstanding multiplied by share price) only grew 40% during the period, compared to 133%–255% for the other national competitors. The relatively small increase in Anthem’s market capitalization is due to a massive share buy-back program, which reduced the number of shares from 571 million in 2007 to 256 million in 2017, per data from company filings.
The size and continued growth of national managed care companies have provided increasing competitive advantages (buying power, product diversification, vertical integration with providers, IT and data analytics capabilities, access to capital and other economies of scale) relative to other managed care companies and providers. As a result, antitrust concerns (e.g., the termination of the Aetna Inc. (Aetna)/Humana and Cigna/Anthem Inc. (Anthem) transactions) and a diminishing universe of health insurance acquisition targets have limited growth opportunities through acquisitions.
The Transformation of Centene Corporation
Many people still think of Centene Corporation (Centene) as a regional Medicaid manage care company. However, Centene has gone through a complete transformation (that may be better described as a metamorphosis), and a lot of credit for this goes to Michael Neidorff, the company’s long-standing chairman and CEO, who joined Centene in 1996 as president and CEO. He has transformed Centene from a Medicaid managed care company in three states to a multi-line managed care company (Medicaid and related programs, Medicare, commercial, TRICARE, correctional and specialty services) in over 26 states and two foreign countries. Mr. Neidorff accomplished this through a combination of acquisitions and organic growth.
The stock market has rewarded Mr. Neidorff and his shareholders generously. Since the company’s initial public offering (IPO) in 2001, Centene’s stock has significantly outperformed all the other managed care companies that were publicly traded, both then and now. Centene’s share priced increased 3,734.4%, compared to 1,111.3% for a composite index comprising Aetna, Anthem, Cigna, Humana and United. Among the companies in the index, Humana was the best performer, with a share price increase of 2,247.8%.
How Important Is Investment Income for Managed Care Companies?
For many managed care companies, investment income is an important component of profitability. As a result, the managed care sector should likely benefit from rising interest rates. Similar to any insurance company, a managed care company’s balance sheet includes a significant amount of cash and cash equivalents, various types of debt investments, as well as, in some instances, equity or other non-debt investments.
For the year ended Dec. 31, 2017, for the nine publicly traded managed care companies, cash and cash equivalents and various types of debt investments accounted for 92.2% of total investments. While some amount of cash and cash equivalents may not earn any interest, the majority is in highly liquid investments, such as U.S. Treasuries with maturities of three months or less, commercial paper, money market funds and so on. For the year ended Dec. 31, 2017, investment income as a percentage of revenue for the publicly traded managed care companies ranged from 0.4%–3.5% of revenue, with an average of 1.1%. Despite being a relatively small percentage of revenue, investment income has a much bigger impact on pretax income. For the same period, investment income as a percentage of pretax income ranged from 7.2%–79.0%, with an average of 31.2%.
Over the last three years, yields for short- and long-term debt instruments were relatively low. Interest rates have been rising and are expected to increase further over the next few years. While the cost of borrowing will likely increase and offset some of the gain, managed care companies may experience an increase in investment income net of borrowing expense, which will help increase pretax income.