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Investment Overview
UnitedHealth (NYSE:UNH) is the 10th largest NYSE-listed company by market cap – $476bn at the time of writing – and the fifth largest by revenue – $324bn in FY22. The company operates two “distinct, yet complementary business platforms” which between them cover the full spectrum of healthcare services, from health analytics, pharmacy benefit manager, healthcare operations, health insurance for employers, individuals, and Medicare and Medicaid beneficiaries – and everything in between.
UnitedHealth shareholders have every reason to be delighted with the company’s performance over the long term – the company’s share price is up >115% across the past five years, which is more than double the performance of the S&P 500 over the same period: +54%.
With that said, the market’s initial reaction to United’s Q123 earnings release earlier today has not been positive – the stock price has fallen ~3%, from $528, to $511. To understand why, we need to look beyond the headline figures at the ongoing dispute with CMS over Medicare Advantage health insurance.
The Headline Figures
At first glance, it’s hard to understand the market’s negative reaction to earnings, since they appear to be broadly positive.
Overall, United’s revenues were up 15% year-on-year to $91.9bn, while earnings from operations increased 16%, to $8.1bn, implying a net margin of 6.1% – slightly down on the 6.3% margin reported last year. Cash flows from operations were $16.3bn, whilst adjusted cash flows from operations were $5.1bn.
Diluted earnings per share were $5.95 – up 13% year-on-year – while adjusted earnings per share were $6.26 – up 14% year-on-year. For good measure, United has upped its net earnings forecast for FY23 to $23.25 – $23.75 per share, and adjusted earnings forecast to $24.5 – $25 per share (formerly $23.15 – $23.65 per share, $24.40 – $24.90 on an adjusted basis).
Optum Excels (Although Margin Dips)
UnitedHealth’s Optum division – comprised of Optum Health, Optum Insight and Optum Rx – grew revenues by an impressive 25% year-on-year to $54.1bn, while earnings from operations improved to $3.7bn, although operating margin once again decreased slightly – to 6.9%, from 7.3% in Q122, and 8.3% in Q422.
According to a UnitedHealth press release, Optum Health increased revenue per consumer by 34% year-on-year, Optum Insight’s revenue backlog increased by 35% to $30.7bn, and Optum RX’s revenue grew 15%,whilst adjusted scripts grew to 378m, from 352m in Q122.
In reality, however, the scrutiny of today’s earnings, and discussion on the Q123 earnings call, was directed much more towards the health insurance business.
The Medicare Question – Medicare Advantage Overview
UnitedHealth is the largest provider of health insurance in the US. According to the company’s 2022 10-K submission (annual report), UnitedHealthcare Employer & Individual provides access to medical services for 26.7 million people, plus another 7.7m outside of the US.
Despite the huge membership numbers, however, Employer & Individual drove only $72.3bn of the health insurance division’s $249.7bn overall revenues in 2022. The Community and State segment drove $63.8bn of revenues, but the largest contributor was Medicare & Retirement, which drove $114bn of revenues.
This division caters to individuals aged 50 and above and one of its major products is Medicare Advantage – a mechanism whereby private health insurers provide health benefits coverage in exchange for a fixed monthly premium per member from the Centers for Medicaid and Medicare (“CMS”), plus a monthly consumer premium. Medicare Advantage plans can offer seniors lower premiums, plus additional advantages such as basic vision and dental coverage, and gym memberships.
In 2022, total US Medicare Advantage enrollment was ~28.4m, 66% of which were individual members, according to research conducted by Kaiser Family Foundation (“KFF”). With 7.1m members as of YE22, UnitedHealth is the most dominant player in this market, its share being >25%. Humana, with an ~18% share, is the next largest, whilst CVS (CVS) has an ~11% share.
Not only is Medicare Advantage a huge market today, it has the potential to grow and grow, given that it is estimated ~10,000 members of the “baby-boomer” generation become eligible for Medicare plans every day. Humana has predicted that the market will reach 35m members by 2025, but it could end at double that figure, or more.
The US government appears to be becoming aware that Medicare Advantage is becoming a cash cow for health insurers however – as per a recent statement in the Federal Register:
Medicare Advantage enrollees’ medical records do not always support the diagnoses reported by Medicare Advantage organizations, which leads to billions of dollars in overpayments to plans and increased costs to the Medicare program as well as taxpayers.
According to NorthCarolinahealthNews, the CMS also suggested that taxpayers are funding as much as $15bn in additional charges related to Medicare Advantage for the same level of service as is provided by fee-for-service Medicare.
As such, when the CMS announced its Medicare Advantage rate changes on Feb. 2, it advised that rates will increase by just over 2% in 2024, and factoring in star ratings (higher rated plans receive additional bonus payments) and risk adjustments the CMS advised the change in revenues would be ~1.03%
The legislation around Medicare Advantage is – as you might expect – infinitely detailed and highly complex – the initial ruling released in February runs to tens of thousands of words – but if CMS has not exactly declared war on health insurers margins, changes included in the most recent legislation are apparently designed to claw back $4.7bn in overpayments over the next 10 years.
The Medicare Question – UnitedHealth Reacts
After the CMS announced its rate change plans for 2024 in February, the share prices of health insurers with Medicare Advantage exposure fell significantly, with UnitedHealth’s share price slipping from ~$500, to ~$470, although when the final rules and changes were announced in early April, analysts at Raymond James upgraded both UnitedHealth and Cigna (CI) to a Strong Buy, given the final proposal from CMS suggested a 3.3% rise in payments in 2024, as opposed to the >2.5% cut that health insurers had feared.
After the upgrade – with Raymond James analysts setting a price target of $630 for UnitedHealth stock – and CMS more modest announcement in early April, UnitedHealth shares began to rise again, reaching their highest value in 2023 before today’s earnings call. So what did UnitedHealth say that spooked the market?
It certainly didn’t take UnitedHealth CEO Andrew Witty long to address the Medicare Advantage rates issue. He began by stating:
While we remain concerned about some of the potential unintended consequences of the changes of the risk adjustment model, particularly around adequate diagnosis and support for people with diabetes, complex behavioral needs and more, we do appreciate CMS’ decision to phase-in the changes. This phase-in will allow for more time to minimize impacts on beneficiaries as we lean on the multiple levers available to us, including our ability to manage costs and our relentless focus on member and patient needs.
Witty’s discussion of the “unintended consequences” of the CMS rates and other changes seems somewhat disingenuous, since the CEO must surely believe – like everybody else – that the changes were intended to stop the likes of UnitedHealth earning what many regard as obscene profits from its plans. Nevertheless, the CEO continued to mount a robust defense:
Seniors know that with MA versus fee-for-service, they can access a more integrated and comprehensive suite of critical health benefits, including prescription medicines, vision, dental and hearing care.
They can seek care in more convenient settings. They experience better health outcomes, such as an over 40% lower rate of avoidable hospitalizations and consistently derive much greater value.
In fact, the typical Medicare Advantage senior spent about $2,000 a year less out of pocket compared to seniors in traditional Medicare. And well over 90% of seniors in Medicare Advantage report they are highly satisfied with their coverage and care. That’s why more than 30 million Americans, fully half of all seniors, choose Medicare Advantage today.
Health insurers have powerful lobbies – such as the Better Medicare Alliance, which has launched television campaigns against the proposed rate changes – which it can use to fight back against the CMS. Another “weapon” that most insurers tend to use in relation to Medicare Advantage is the concept of “Value Based Care” – as CEO Witty explained during the earnings call:
We think value-based care as a piece of this program is a crucial and best way of managing members to give them the best quality outcome, best experience and best cost outcome. Given our established capabilities and our ability to focus on cost management as well as the broad portfolio of value-based services, clinics, in-house activities provided by Optum, we feel super confident in our ability to manage the evolving funding landscape.
Value-based care is, according to the New England Journal of Medicine (“NEJM”) “a healthcare delivery model in which providers, including hospitals and physicians, are paid based on patient health outcomes.”
This is an ideal model for a company as large as UnitedHealth, which can leverage its Optum services division to make sure patients are well cared for, and potentially keep them out of hospital, and increase its plan star ratings, leading to higher payouts from the CMS. It also may explain why CVS has recently spent close to $20bn acquiring two value-based care specialist companies.
The Market’s Response – The Rates Battle Is Not Won Yet
Whether the market overreacted to April’s release of less punitive rate changes, or whether CEO Witty was a little too quick to discuss them – potentially putting analysts on the alert – the response to today’s earnings and earnings call has been somewhat negative or UnitedHealth, although not overly so – shares still trade at a near 10% premium to February lows (when the original rate changes were announced).
As much as UnitedHealth CEO Witty may have attempted to explain away rate changes – and other measures, such as the removal of certain reimbursement codes in attempt to prevent health insurers “game the system,” United – as the largest provider of Medicare Advantage plans in the market – will doubtless feel some heat.
CEO Witty insisted that the rate changes would not affect UnitedHealth’s 13%-16% EPS growth targets over the next several years, and expressed gratitude that the CMS is introducing its changes over a period of three years as opposed to all at once.
Even so, Medicare Advantage is UnitedHealth’s single largest business, and it’s clear that CMS is determined to hold the company’s feet to the fire – UnitedHealth may deny it, but the market is not buying that denial.
Conclusion – Should Investors Be Worried That Medicare Advantage Rate and Rule Changes Will Create Long Term Issues?
UnitedHealth is a behemoth of a company, and as much as Medicare Advantage could become a thorn in its side if the CMS continues to wage a campaign against supposed profiteering by health insurers, if UnitedHealth comes out on top at the negotiating table, as it arguably has done this time around, it could prove to more of a boost to the share price than a drag.
There’s clearly a lot of gamesmanship being employed by both the CMS and the health insurance industry, the CMS claiming it is acting to protect the tax-paying public, and UnitedHealth and other insurers claiming that a new era of “value-based care” is upon us and that they’re best equipped to keep the baby-boomer generation healthy and well long term.
It’s not too difficult to see both sides of the argument, and since none of the issues at stake are remotely close to being resolved, and there are 30m Medicare Advantage members across the US, every skirmish will be analyzed in detail and UnitedHealth’s share price will be adjusted accordingly.
My advice to UnitedHealth shareholders would be not to ignore the fact that the company operates divisions outside of Medicare Advantage that drive the bulk of its revenues, and that it is entirely natural for a company like UnitedHealth to be involved in high level discussions around the future of healthcare insurance.
Nevertheless, it’s becoming increasingly obvious that the battle between the CMS and health insurers around Medicare Advantage could be the dominant theme in health insurance for a generation at least. UnitedHealth is very clearly all-in on Medicare Advantage – it’s no exaggeration to say this is the most important business segment and may be chiefly responsible for UnitedHealth’s stellar gains over the past five years.
There’s a very real chance that the CMS’ determination to claw back billions in unnecessary payouts to Medicare Advantage plan operators will have a seriously detrimental effect on UnitedHealth’s share price, and there’s a long way to fall – its stock traded <$325 as recently as two years’ ago – but my gut feeling is that UnitedHealth stock will end 2023 – and most likely 2024 and 2025 – trading >$500.
Longer term, I believe UnitedHealth’s MA revenues could climb past the $150bn mark before the end of the decade, pushing overall revenues close to the $400bn mark, and that’s simply too high to contemplate stock price downside of any real significance.