Big healthcare right now looks rocky and it could get worse
Just a few years ago, investors were absolutely enthralled with big healthcare – the massive companies that led vertical integration and seemed to be delivering strong margins and robust outlooks. But today, the investment community is concerned about a number of high-profile missteps from these big companies as well as external pressures that may force change.
The big healthcare companies
So, what companies are we talking about? Of course, I focus in on the big companies that have insurers as a major piece of their business – this includes UnitedHealth Group, Elevance Health, The Cigna Group, CVS Health, Centene Corp., Humana, and Molina Healthcare. Most of these entities have either large, concentrated insurance lines or are combination insurers and service providers.
Let’s take them one at a time and discuss some of their missteps of late.
UnitedHealth Group (UHG) – United has made fewer missteps, except for the massive Change Healthcare cyberattack that crippled the nation for months this year and still has impacts. Change is part of Optum, UHG’s mega services entity. The cyberattack will cost United billions over time to sort out and likely mean huge fines for the company. What we know so far about the cyberattack is that United concentrated solely on acquisition to add to margin. It did little to nothing to modernize and integrate the technology it acquired into the broader enterprise. It also appears to have invested little in security. Its OptumRx pharmacy benefits manager (PBM) is also facing an antitrust lawsuit from the Federal Trade Commission (FTC). United’s stock is off about 6% from its yearly high right now.
Elevance Health – While it is busy building its Carelon services entity, Elevance is having a hard year financially. Its stock has dropped from over $560 per share to about $430 per share. Elevance is being hit by higher medical expense, lower Medicaid enrollment, lower Medicare Advantage (MA) and Medicaid managed care rates, and lower MA Star scores.
The Cigna Group – Like UHG, Cigna is doing better overall as it too builds out its growing Evernorth services unit. CEO David Cordani is selling his poorly performing MA line to Health Care Service Corporation (a Midwest and South Big Blue) in favor of the Evernorth growth push. But rumors are that talks could be back on to acquire MA-concentrated Humana. Cordani recently threw cold water on the rumors, without totally shutting the door closed. Its PBM, Express Scripts, faces the same FTC lawsuit as OptumRx. Cigna’s stock is off about 8% from its yearly high right now.
CVS Health – CVS is perhaps in the worst financial shape. It just ousted both its Aetna insurer president as well as the overall company’s CEO. Its stock has slipped this year from over $80 per share to about $60 per share. Aetna is bleeding financially, with a medical loss ratio (MLR) that could be about 95%. Its pharmacies are performing poorly after a huge boost during COVID. Its Caremark PBM is also part of the FTC lawsuit.
Humana – MA-dominant Humana’s stock has slipped this year from over $520 per share to below $270. The decline is tied to a perfect storm of low rates, dropping Star scores, surging medical expense, and new restrictive regulations from the Centers for Medicare and Medicaid Services (CMS). Earlier Humana and Cigna were on the verge of merging. The deal fell through. The thought is that with Humana’s stock drop, it might create the needed short-term investor value for both companies and the deal could be consummated. Again, Cordani is not enamored with MA from an insurer standpoint, but could see great potential in leveraging Evernorth services for Humana’s over 6 million lives. That’s why he did not totally close the door recently. I still say the marriage is a long shot given Cordani’s MA concerns and his obsession with Evernorth growth in general.
Centene Corp. – Centene’s stock has slipped from over $80 per share to just above $60. Centene has the most Medicaid membership of any large plan as well as strong MA investments. Like the other major Medicaid plans (United, Elevance, Aetna, and Molina) it has been battered by lower Medicaid enrollments due to the return of redeterminations as well as a mismatch between rates and medical expense in the program. Its MA business has been contracted due to margin issues. It has had very low Star ratings, impacting revenue and its ability to compete in the market. Centene may report a decent Q3, but will still have some negatives to deal with.
Molina Healthcare – Like Centene, Molina is very Medicaid-dominant. It, too, is seeing lost enrollment and rate issues. Its stock this year has gone from a high of just below $420 to just below $290. Molina went through a big financial meltdown a number of years ago. However, it appears Molina may be weathering the Medicaid storm a bit better than others and may rebound some in Q3.
Will big healthcare stay or go?
For the first time in a long time, the question of whether big healthcare stays or goes is an open question. There are really two arguments here. From a pro-big healthcare standpoint, some would argue that bigger means you are insulated from the vagaries of forces on various parts of the business. As an example, health plans may have major impacts at some points, whereas other healthcare investments (services, pharmacies, PBMs, etc.) may not. In addition, vertically integrated companies have the ability to “cross-contract” to derive incremental margin. As an example, a PBM, provider group, or services entity earns from an insurer.
From the anti-big healthcare standpoint, some argue that these companies have just gotten too big to plan strategy and execute on growth, revenue, and margin. Further, regulators and Capitol Hill may be coming after big vertically integrated organizations for controlling too much of the healthcare market and intercompany agreements that could get around regulatory requirements, violate antitrust rules, and raise consumer prices.
Breaking down each argument with examples
Regulators and Capitol Hill may come after United and others for vertical integration and antitrust issues, but United seems to prove the rule that bigger can be better. United is a growth machine and overall delivers for its investors consistently. While United does have some insurer challenges, its diverse offerings do seem to insulate it from risk. Its “cross-pollination” from the insurer to Optum entities seems to point to the investor benefits of vertical integration.
Others are seeking to emulate what United has done. Cigna has invested tremendously in its Evernorth enterprise and it is growing dramatically. If it does steal Humana, The Cigna Group would look even more like UnitedHealth Group.
While Elevance Health is far behind, I noted it is doing something similar with service entity Carelon.
All three of the companies cited above seem the best insulated in the current environment.
In terms of the anti-big healthcare argument, it would appear that at least CVS Health is rethinking whether bigger is always better. Rumors out of CVS and in the investor community are that CVS is thinking about splitting up. While its main problem is Aetna, some also argue that CVS got so big too fast and that caused the underlying problems. “Big” created a frenzy to grow with too little focus on financial discipline. Some argue that repairing CVS will require a break-up of its insurer, pharmacy, and other assets.
As for the other companies, they may make arguments on both sides of the debate:
- Humana – It bet big on the lucrative nature of MA. While it has developed some other healthcare entities, its main focus remains just MA and to some degree Medicaid. MA is still a good bet over the long term, but the Cigna-Humana merger talks again point to the need to diversify and insulate investors. On the flip side, some argue that Humana’s big MA growth strategy the last few years may have caused its financial issues.
- Centene – Its recent less-than-disciplined growth in Medicaid and MA may have led to its current financial struggles. On the other hand, without major investments in non-insurance ventures, it may be subject to increased risk.
- Molina – It is heavily dependent on Medicaid, with some MA. Medicaid is a low-margin business and is subject to economic trends and the vagaries of politics and policy.
How could the government influence what happens with big healthcare?
As I alluded to, regulators, from CMS to the FTC, as well as Congress could heavily influence whether big healthcare gets bigger or eventually downsizes or even splits up. Here are some major issues in the policy arena:
- The antitrust agenda and whether big healthcare is too big: The Biden administration has been especially keen on the issue. A Harris administration would continue it. Whoever is president, it stands to reason that Congress will be focused on the cost and access impacts of both insurer and provider consolidations. As noted, the FTC is already suing the Big 3 PBMs on insulin pricing. These suits are likely to be expanded.
- Vertical integration and inter-company transfers: Inter-company transfers are agreements between sister companies within big healthcare enterprises. They have the effect of keeping revenue within the overall company and driving margin. These inter-company agreements are growing at the major diversified healthcare entities. Three big areas include agreements between insurance entities and owned provider groups, service entities that provide services to control medical expense, and PBMs. There is growing concern that such agreements are not arms-length, are written to be more expensive than external agreements, and get around the minimum medical loss ratio (MLR) that is in force in most insurance segments. Regulators and Congress are looking at these agreements and whether vertical integration must be stopped and rolled back.
- PBM reform: While PBM reform has eluded Congress for some time, betting odds are that it will pass in the next year or two. This could ban many current practices (e.g., spread pricing) and increase transparency. This could lead to a slow but sure growth of the so-called transparent PBMs and models out there.
- Drug negotiations: If drug negotiations are expanded in Medicare or even to commercial, it could also fundamentally change how PBMs and other drug channel entities operate.
- Change Healthcare cyberattack: Congress is sure to continue to look at the huge hold United has over vast parts of the healthcare system – pharmacies, providers, hospitals, and health plans. The inquiries could go beyond United to other healthcare entities.
- MA reform: betting odds are that more prior authorization (PA), risk adjustment, payment, Star, marketing, and benefit reforms will occur. This is regardless of who is president or who controls Congress.
- Medicaid and the Exchanges: These programs are likely to be negatively impacted if Donald Trump again is president. Even under Harris, budget pressures at the state and federal levels could mean tighter times.
Conclusion
Big healthcare will be around for many years, but regulator and congressional actions could begin to slow down the frenzy to acquire and consolidate. It is a sure bet that massive consolidation is increasing not lowering healthcare prices. Investors tend to bow to short-term gains. So, big healthcare will likely still drive CEOs and boards for now until these external factors begin to take hold. The budding service entities of Optum, Evernorth, and Carelon are sure to grow as they are relatively unconstrained by regulatory margin restrictions and less impacted by rate and other pressures.
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— Marc S. Ryan
