Expert Commentary

Valuation of Health Insurers: 2013

This article is an update to my November 2011 article, "Recent Trends in the Valuation of Health Insurers." My analysis will consider how current economic, demographic, and regulatory trends impact health insurance companies' profitability, growth, and risk.

Valuation of Insurance Organizations
May 2013

The effect on health insurers of the various industry trends will become clearer over the next few years as the population continues to age and healthcare reform is fully implemented. In reviewing these trends, I will analyze how valuation metrics are affected by each value driver.

Socioeconomic Trends

Trends in medical care costs and the rising age of the population have strengthened demand for health insurance and are expected to continue to do so. According to the Congressional Budget Office's projections, if current laws remain in place, spending on the major federal healthcare programs alone will grow from more than 5 percent of gross domestic product (GDP) today to almost 10 percent in 2037 and continue to increase thereafter.1 Escalating medical care costs as a percentage of GDP will drive growth for the insurance industry as insurers pass cost increases on to policyholders in the form of higher premiums. Additionally, as the baby boomers continue to increase the median age of the population, more individuals will qualify for financial subsidies, enhancing the demand for both government programs and private insurance as many people will supplement their government-funded coverage.2 As mentioned above, much of this growth is due in part to government healthcare programs and subsidies, which are discussed in further detail below.

Patient Protection and Affordable Care Act

Although portions of the new federal healthcare regulation have yet to take effect, it is clear that existing provisions are influencing both demand and profitability within the health insurance industry. On March 23, 2010, President Barack Obama signed the Patient Protection and Affordable Care Act (PPACA) into law.3 Since the law was enacted, numerous provisions have been implemented that increased the amount of claims paid out by insurers including expanding the dependent coverage age, eliminating certain annual and lifetime limits, and removing preexisting condition limits for enrollees under age 19. Although the removal of these limitations has increased health insurance demand, it has also raised the number of risky policyholders that insurers are required to serve.

Furthermore, the PPACA requires insurers to meet new requirements regarding their medical loss ratios. A medical loss ratio refers to the percentage of premium dollars that an insurance company spends on providing health care and improving the quality of care, versus how much it spends on administrative and overhead costs. As of 2011, the law required that 80 to 85 percent of the money collected by insurance companies be spent on healthcare services and healthcare quality improvement.4 These restrictions have placed a strain on insurers' profitability.

Starting January 1, 2014, insurers will encounter both higher demand and increased competition generated by the establishment of state health insurance exchanges.5 Although it is estimated that 12 million consumers will generate $60 billion in premium revenues through use of the exchanges in 2014, this growth does not come without risk.6 For health insurers participating in exchanges, the increase in potential revenue is accompanied by a reduction in switching costs for customers, allowing policyholders more bargaining power and the ability to generate greater price competition.

Additionally, although the exchanges are designed to spread costs incurred by those with expensive medical needs across large groups, providers of health insurance fear there might be an issue with adverse selection.7 Adverse selection is the tendency for people to not attain health insurance until they fall ill, which results in a greater total cost to be shared by the pool of policyholders.8 This concern is a valid one, as an insurer cannot adequately hedge its risk of large claims associated with greater numbers of unhealthy and high-risk policyholders entering the marketplace. Although the results of the health insurance exchange provision remain uncertain, insurance companies are concerned about the effects competition and riskier demand will have on pricing and profitability.

In summary, about 30 million Americans are expected to gain coverage as a result of the PPACA through Medicare and Medicaid, exchanges, and employer-sponsored coverage.9 While potential revenue increases as the universe of policyholders expands, the higher risk policyholders receiving coverage and the restrictions surrounding the medical loss ratios could create potential risk and profitability challenges for insurers.

Growth through Consolidation

Although the trends discussed above are generating demand for the health insurance industry overall, the aging population and the PPACA are generating greater demand for government-funded insurance and subsidy programs, specifically. For those health insurance companies that have not historically provided insurance in the form of Medicare and Medicaid, acquisition of such providers has become an important avenue for growth. The following are three significant acquisitions that have occurred since October 2011 within the industry:10

  • Aetna Inc. acquired Coventry Health Care Inc. for $7.3 billion;
  • WellPoint Inc. acquired Amerigroup Corp. for $4.4 billion; and
  • Cigna Corp. acquired HealthSpring for $3.8 billion.

I analyzed the implied price-to-earnings (P/E) multiples for each of the transactions and compared them to a set of publicly traded companies described in further detail below.

Price-to-Earnings Valuation Analysis

I analyzed the following publicly traded companies (the "Industry Group") for the purpose of this article as these companies provide insight into valuation trends within the health insurance industry.

  • Aetna Inc. (AET)
  • Cigna Corp. (CI)
  • Centene Corp. (CNC)
  • Coventry Health Care Inc. (CVH)
  • Health Net, Inc. (HNT)
  • Humana Inc. (HUM)
  • Molina Healthcare, Inc. (MOH)
  • UnitedHealth Group Incorporated (UNH)
  • WellCare Health Plans, Inc. (WCG)
  • WellPoint Inc. (WLP)

Figure 1: Average Forward P/E Multiples for Publicly Traded Health Insurers

graph of average forward P/E multiples and long-term expected earnings per share

As illustrated in the graph above, forward P/E multiples have been fairly volatile over the past 5 years. However, an upward trend since the third and fourth quarter of 2011 reflects not only general economic recovery but also growth expectations, particularly for the government-funded segment of the health insurance industry. Industry participants have recognized this growth, as noted previously, and capitalized on it through consolidation. Implied transaction P/E multiples for the three acquisitions mentioned above ranged from 12.0 times to 30.6 times, whereas the most recent P/E multiple average shown in the graph was just over 12.0 times. I noted that the targets were purely Medicare- and Medicaid-focused companies with elevated growth expectations, which may be a key contributor to the higher multiples observed for these companies.

Superior growth expectations are also reflected in the long-term EPS growth rates that have been steadily trending upward toward pre-recession levels. As the PPACA generated greater demand for health insurance, earnings expectations rose. Additionally, steadily increasing healthcare costs contributed to revenue growth for the health insurance industry. However, as the industry shifts toward publicly funded insurance comprising a greater portion of premium revenues, operating margins could experience downward pressure. This phenomenon could be a factor captured in the slight decline in EPS growth expectations over the past few quarters.


The future of the health insurance industry will depend on how states address the adverse selection problem associated with health insurance exchanges. To alleviate this associated risk, the PPACA established a risk adjustment procedure of charging a fee to those members that have lower than average risk scores to fund payouts to those members with higher than average risk scores. Additionally, insurers may temporarily elect to reinsure.11

Going forward, higher healthcare costs are expected to continue to be the primary driver of growth for the health insurance industry. Additionally, with approximately 8.6 million more people expected to enroll in Medicare by 2016, demand for government-funded programs is increasing exponentially.12 Accordingly, as stated in a report given by the Congressional Budget Office, both the aging population and the rising cost of health care should cause spending on federal healthcare programs to grow rapidly over the next 25 years.13 Nevertheless, the shift toward more individuals being insured by government-sponsored programs in addition to government restrictions on the medical loss ratio may limit profitability in the future.14

1Douglas W. Elmendorf, "The 2012 Long-Term Budget Outlook," Congressional Budget Office (June 6, 2012).

2Doug Kelly, "IBISWorld Industry Report 52411b Health & Medical Insurance in the US," IBISWorld (March 2013).

3National Federation of Independent Business Research Foundation, "PPACA Timeline," NFIB (July 27, 2012).

4Richard Sorian, "What Is a Medical Loss Ratio and Why Does it Matter?" (October 21, 2010).

5National Federation of Independent Business Research Foundation, "PPACA Timeline," NFIB (July 27, 2012).

6PricewaterhouseCoopers LLP, "Change the channel: Health insurance exchanges expand choice and competition," PwC Health Research Institute (July 2011).

7PricewaterhouseCoopers LLP, "Change the channel: Health insurance exchanges expand choice and competition," PwC Health Research Institute (July 2011).

8Mark A. Hall, JD, "The Constitutionality of Mandates to Purchase Health Insurance," O'Neill Institute for National and Global Health Law.

9PricewaterhouseCoopers LLP, "Top health industry issues of 2013: Picking up the pace on health reform," PwC Health Research Institute (January 2013).

10Pamela Tabar, "Aetna buys Coventry Health Care in latest deal to divvy up Medicare/Medicaid expansion market," Long-Term Living (August 20, 2012).

11PricewaterhouseCoopers LLP, "Change the channel: Health insurance exchanges expand choice and competition," PwC Health Research Institute (July 2011).

12Tara Lachapelle and Alex Nussbaum, "Coventry Signals Health Net, WellCare Takeovers: Real M&A," Bloomberg Businessweek (August 21, 2012).

13Douglas W. Elmendorf, "The 2012 Long-Term Budget Outlook," Congressional Budget Office (June 6, 2012).

14Aetna Inc, "Form 10-K for the Year Ended December 31, 2012," US Securities and Exchange Commission (April 5, 2013).

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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