Humana (NYSE: HUM) is a health insurance company. Historically, about half of Humana's beneficiaries have participated in government sponsored programs, including the state- and federally- funded Medicare, the federally funded Medicaid Advantage, and TRICARE, a program for armed services personnel. Humana's longstanding relationship with the government is beginning to pay high dividends, as it has capitalized on Medicare Part D's prescription drug coverage by enrolling over 3 million seniors in new benefits programs. Enrollment in government programs now accounts for 70% of all of Humana's membership. The company earned $31 billion in revenue and $1 billion in net income in 2009.
In addition to standard health insurance, Humana sells dental products, and has recently acquired a company selling vision and other dental insurance products. Still, the product line is not terribly diversified; it is largely concentrated in the government programs. This ignores the trend towards diversification that other insurance companies like Aetna have been quick to exploit.
As an insurer, Humana is in the business of risk and cannot avoid it. Key risk areas include the possibilities of government regulation of insurance and expanding national insurance. While Humana does benefit from government expenditure on health insurance, that relationship will last only as long as the government continues working with the private sector. Insurers also face risk from interest rate fluctuations, because their income is in part derived from investment.
Humana’s business is based on managing health risk for beneficiaries. As a health insurer, Humana agrees to pay for a percentage of its customers' medical expenses in exchange for a fee, called the premium. These medical expenses include hospitalizations in case of emergency as well as more routine costs like prescription drugs. The vast majority of Humana’s income comes from the premiums it charges customers; the remainder comes from investments made on this income (more on this below) and from a handful of other services, such as call-in pharmacies.
Most insurers offer clients a premium based on the expected cost of caring for them, plus a markup for administrative costs and profit. An insurance company can actually turn a profit even if the cost of administration and insurance claims exceeds the premiums it collects. It does so by investing income on the float: between the time when a client pays a premium and the time when the client needs payment for his or her medical expenses, Humana invests the premium in stocks and bonds.
There are two key statistics that measure an insurer's performance:
Over the last several years, the majority of Humana's enrollees have been in state- or federal-government-sponsored programs. Historically, members of these programs have constituted some 50-55% of Humana's membership; however, that number has recently jumped to 70%. Humana currently offers four government-sponsored programs:
The bottom figure demonstrates that the majority of Humana's revenue from government programs originates with Medicare. It also suggests that the growth in government sponsored membership came from the introduction of Medicare Part D and growth in Medicare Advantage. Revenues in these divisions both grew strongly while the other programs experienced no growth at all.
As more businesses plan to obtain dental, vision, and health insurance from a single provider, consolidation has been growing in the health insurance industry. In 2002, the four largest health insurance providers held only a combined 13% share of the U.S. market; by 2005, those same companies now controlled 22% of the market. This increased concentration of revenues at the top of the ladder comes from the bundling of various insurance products--bundling increases a company's revenue without driving up sales costs.
Humana has not capitalized on this consolidation trend. While the company provides dental insurance to 1.1 million beneficiaries and has some 0.5 million other enrollees in non-health programs, Humana has not historically had significant operations in vision or behavioral health programs, making effective health-related bundling nearly impossible.
National health insurance has become a hot topic on the legislative agenda. While the national insurance plan is currently quite limited, restricting participation to lower-income residents (Medicaid) and senior citizens (Medicare), a national insurance program for children is now under congressional consideration. If passed, it would greatly expand the coverage offered by S-chip, the insurance program sponsored by both the state and federal governments. States have also begun to offer their own universal health care plans, with Massachusetts and California leading the way. If these plans become more widely implemented, they could increase competition for Humana and for other insurance companies. But the federal subsidies also present another possible risk; because of the looming budget deficit, funding may not always exist for Medicare. If the government were to cut the program, Humana would lose a huge share of its enrollment and its revenue. Medicare funding seems safe for the moment, though, since the Democrats, who have historically been more keen to promote programs like Medicare, currently control both houses of Congress.
Nonetheless, Medicare spending is expensive-- one of the federal government's greatest expenses. This is because the elderly require substantially more medical care than younger people, often at a higher cost, and the U.S. population is aging at a considerable rate. This has two potential effects for Aetna. A population with greater health care needs requires additional insurance: age drives demand. But to the extent that people already insured face rising health care costs, medical losses rise in response to population aging.
Prescription drugs expenses are one of the largest outlays that Humana makes on its clients' behalf, and prescription drug costs have been rising rapidly. Between 1995 and 2005, prescription drug costs increased by an average of 12%, while other medical costs increased by just 5-6%. UNH saves money when its clients purchase generic drugs instead of brand name drugs. The differences between generic and brand name drugs can be staggering: Costco Wholesale (COST) sells Prozac and Zocor for over $140, while their generic equivalents cost only $5 each.
In terms of a larger debate about the availability of quality health care in the U.S., there has been growing pressure on pharmaceutical companies to lower prescription drug prices by either cutting prices or granting generic licenses. This issue is often brought up in political discourse, with many politicians pushing for prescription drug reforms. Humana stands to benefit from these activists' success in achieving their goal of lower drug prices; whether through pharmaceutical companies' cost cutting or an increase in the availability of generics, Humana would see its outlays for patients' medications decrease, boosting profits.
The following table compares Aetna to three other leading health insurers across various measures of performance and profitability. In addition to MLR and ACR, it presents two other important statistics:
In reality other factors also influence profitability, especially legal fees. The investment ratio is equal to net investment income divided by revenue from premiums and fees.In reality other factors also influence profitability, especially legal fees. The primary companies in this industry are:
By implied operating margin, Humana ranks near the bottom of the pack: it is even with UnitedHealth Group, and well behind Cigna and Aetna. But whereas UnitedHealth Group is an industry leader with relatively high revenues, Humana is a smaller company. Looking a bit more closely, we see that, while Humana has the lowest ACR of the group, it has by far the highest MLR, and this is the source of its low operating margin. A high MLR is usually a sign of lax pricing discipline, as enrollees are taken on and charged too little for their health expenses. A low ACR, on the other hand, can indicate efficiency in administration or sales.