Medicaid HMOs: More Growth, Less Risk

Richard

Enrollment in Medicaid HMOs will grow immediately in 2014 as some states expand Medicaid eligibility under the Affordable Care Act (ACA). Growth continues for some time thereafter as: 1) other states join the expansion; 2) an increasing percentage of Medicaid beneficiaries enter HMO-managed programs; and, 3) as dually-eligible beneficiaries (Medicare and Medicaid eligible, with 5x the spending of a non-dually-eligible beneficiary) increasingly move to HMOs

Conversely, revenues for the larger commercial HMOs will grow only gradually. Overall enrollment in employer-sponsored (ESI) plans is moving glacially in a slow employment recovery. And, the larger commercial HMOs’ share of ESI beneficiaries is likely to fall as employees (who today generally have no choice of issuer) are moved to exchanges (both public and private) where they can choose from multiple issuers. An additional consequence is that exchanges for the first time allow employees to choose from a broad range of plan values; on average employees are likely to choose considerably cheaper plans, further impairing revenue growth

Even assuming a return to 2006 / ’07 employment levels over the next five years (which reduces Medicaid eligibility, but drives employment and ESI enrollment), we estimate Medicaid HMOs will grow revenues at an average 5 year CAGR between 15 and 20 pct, as compared to total commercial premium growth (average 5 year CAGR) of 2.5 pct to 7.5 pct. Importantly, the high end of this commercial premium growth range assumes CBO’s current estimate of health insurance exchange enrollment is exactly correct (we believe it’s in fact too high). Equally important, we expect the larger ‘national account’ commercial HMOs to lose share of overall commercial beneficiaries, thus these names’ realized revenue growth rates are likely to fall below this 2.5 pct to 7.5 pct range

Current valuations imply that relative revenue and earnings growth for the commercial and Medicaid HMOs will be much more similar than we predict. According to our fundamental view CNC, MGLN, and WCG are all at least 20 pct undervalued relative to their HMO peers. Conversely, CI, UNH, HNT, and AET appear overvalued relative to their HMO peers

The analytical framework we use in this call differentiates HMOs solely on the basis of their relative exposure (pct of earnings) to each major market segment (e.g. commercial, Medicaid, Medicare). I.e., the framework assumes no difference in strategy for any particular HMO in any particular segment. Of the commercial HMOs, we’ve recently favored CI for what we believe is a better strategy versus their commercial peers – they’ve reduced small group risk exposure, and raised exposure to the services small groups will buy (ASO and stop-loss); and, they’ve been very conservative about seeking enrollment on the individual coverage health insurance exchanges (HIEs). We still think this is the right (relative) strategy for a commercial HMO; however our work on the relative growth prospects of the commercial and Medicaid HMOs convinces us the more compelling investment decision is to favor the Medicaid HMOs at the expense of the commercial HMOs

For our full research notes, please visit our published research site

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