Medicaid HMOs: Growth Prospects Undervalued

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Richard Evans / Scott Hinds / Ryan Baum


203.901.1631 /.1632 / .1627 richard@ / hinds@ /


April 16, 2014

Medicaid HMOs: Growth Prospects Undervalued

  • Please see the SSR Health YouTube Channel for a podcast of this research note
  • The outlook for commercial premium growth is sluggish; modest enrollment gains from the Affordable Care Act (ACA) and rising employment are offset by the rising tendency of beneficiaries to either buy cheaper policies, or forego coverage altogether
  • On top of this, the large ‘national account oriented’ commercial HMOs (e.g. CI, AET, WLP, UNH) stand to lose share of commercial beneficiaries, as employer sponsored beneficiaries move to the ACA’s exchanges or (more frequently) to private exchanges
  • Conversely, Medicaid is expanding; enrollment losses from rising employment are more than offset by more generous eligibility standards under the ACA; and by rising enrollment as states that have not participated in the expansion eventually choose to participate. Medicaid HMOs are gaining share of this growing population; and, average contract values stand to rise as dually eligible Medicare / Medicaid beneficiaries eventually enter HMOs
  • Importantly, we believe many of the Medicaid hold-out states would have expanded their programs to 100 percent of the federal poverty level (100 FPL) if Health and Human Services had agreed to pay the enhanced federal match on enrollees in these smaller expansions
  • Former Secretary Sebelius’ decision not to provide enhanced matching to partial expansions presumably was meant to encourage full expansions in most states, but this has not worked; more than 9 million Medicaid beneficiaries at or below 100 FPL remain on the sidelines in states that have not expanded. Former Secretary Sebelius’ policy was set to expire at the end of 2016, however we see some chance that the new Secretary nominee may choose to retire the policy sooner, bringing these additional 9 million beneficiaries into the program more quickly
  • We believe the relatively narrow difference between commercial and Medicaid HMOs’ valuations fails to reflect the broad differences in these subsectors’ growth prospects, and we conclude that the Medicaid HMOs are undervalued

We believe that growth prospects for the commercial HMOs (e.g. CI, AET, WLP, UNH) are substantially weaker than growth prospects for the Medicaid HMOs (e.g. MGLN, WCG, CNC, MOH), but that valuations fail to fully reflect these disparate fundamentals – making the Medicaid HMOs undervalued by comparison

Relative Fundamentals: Commercial v. Medicaid HMOs

Fundamentally, demand for the commercial HMOs’ services is the combination of enrollment gains from expansion of coverage under the Affordable Care Act (ACA) and from rising employment, net of enrollment losses as employer sponsors move beneficiaries to private health exchanges[1], and also net of falling average contract values as beneficiaries choose cheaper plans. In the most generous possible case (ACA enrollment meets CBO expectations, and beneficiaries do not choose cheaper forms of insurance), we would expect commercial premium growth (5 year CAGR) of 7.5%. In the least generous case (ACA enrollment is 1/3rd the CBO estimate, and average contract values fall by 20 percent[2]), we would expect 5 year commercial premium growth of 1.8% (Exhibit 1). N.B.: these estimates reflect anticipated commercial premium growth across the entire commercial market, regardless of where the commercial beneficiaries go for coverage (employers v. ACA exchanges, or employers v. private exchanges). To the extent that the large ‘national account oriented’ commercial HMOs lose share (beneficiaries shift from employers to either ACA or (more likely) private exchanges), their realized rates of premium growth will be lower

Conversely, growth fundamentals for the Medicaid HMOs are almost the exact opposite case – overall growth in potential beneficiaries is rapid, the Medicaid HMOs are gaining share of the growing number of Medicaid beneficiaries; and, average contract values for Medicaid beneficiaries stand to rise as dually eligible (Medicare and Medicaid) beneficiaries increasingly find their way into the Medicaid HMOs

Central to our Medicaid HMO thesis is the belief that all states ultimately will expand their Medicaid programs – either to an upper income eligibility limit of 100 percent of the federal poverty level (100 FPL, most likely scenario), or to 138 FPL. At present, some states have expanded to 138 FPL, and other states have not expanded at all. Former HHS Secretary Sebelius established a policy restricting the availability of enhanced federal matching for expansion enrollees only to states that had expanded ‘fully’ to 138 FPL. The purpose was to create an incentive for states to expand fully; and, to block states’ otherwise optimal strategy of expanding Medicaid only to 100 FPL[3]. We presume her strategy was intended to maximize states’ participation in the Medicaid expansion; however because hold-out states with the majority of potential expansion enrollees remained on the sidelines, it’s now apparent that refusing the enhanced federal match to states that might be willing to expand only partially (to 100 FPL) is leaving more than 9 million potential Medicaid beneficiaries without coverage. Former Secretary Sebelius’ policy was set to expire at the end of 2016. Because the policy arguably has not worked – states with most of the potential expansion enrollees refused to expand coverage – we see at least some chance that the Secretary nominee will revisit the policy. Whether she changes the policy or not, we still hold a mid- to long-term expectation of an ‘equilibrium’ wherein most states expand to 100 FPL; however with the change in HHS leadership we see at least some odds of the hold-out states expanding to 100 FPL even sooner

Assuming an eventual expansion across all states to 100 FPL, we would expect 5 year Medicaid spending growth of 11 percent; if all states expanded to 138 FPL (less likely) we would expect 5 year Medicaid spending growth of 17 percent (Exhibit 2)

Valuations in the Context of Growth Expectations

Relative longer-term growth expectations arguably are best reflected in forward price-earnings ratios; ignoring risks, higher fPE’s reflect higher growth expectations and vice versa. In Exhibit 3, the y-axis represents relative fPE’s on FY+3 consensus for the ten HMOs. The x-axis represents relative growth prospects as calculated by us … all we’ve done here is to multiply the percent of each HMO’s current revenues coming from any given segment (commercial, Medicare, or Medicaid) by our 5 year expectation for premium growth in each of these segments. In Exhibit 3, we assume none of the HMOs gain or lose share in any segment – so the commercial HMOs don’t lose share of employer sponsored beneficiaries as these beneficiaries shift to private exchanges, and the Medicaid HMOs don’t gain any further share of Medicaid beneficiaries. Exhibit 4 is the same as Exhibit 3, except that in this case we assume Medicaid HMOs continue to gain share of Medicaid beneficiaries – effectively what this represents is an assumption that states with lagging shares of Medicaid beneficiaries in HMOs reach the point of having an average share of Medicaid beneficiaries in HMOs. In both exhibits the 45 degree line is ‘par’, i.e. the point at which relative fPE (x-axis) accurately reflects relative growth prospects (y-axis). Stocks below the par line appear undervalued, and vice versa. Whether we assume the Medicaid HMOs continue gaining share of Medicaid (Exhibit 4) or not (Exhibit 3), it’s clear the Medicaid HMOs generally appear undervalued, both relative to ‘par’ and in particular relative to the commercial HMOs

  1. Where local issuers can compete for these beneficiaries
  2. From a current average employer sponsored actuarial value (AV) of 82, to an average of 65
  3. Persons from 101 to 138 FPL are eligible for federally subsidized coverage on the ACA exchanges; having persons in these income ranges on ACA exchange coverage results in substantially more federal inflows to the state
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