Humana Inc (HUM), CIGNA Corporation (CI): Obamacare is No Bust for Insurance Stocks

Thought Obamacare was sure to crush the insurance industry?

Think again.

After the markets closed Monday, the US government reversed its decision to lower payouts to Medicare Advantage plans, offering a 3.3% increase in payment rates instead of the 2.3% decrease it had previously announced.

Why Medicare payment rates matter

Falling reimbursement rates can crush health insurance companies like Humana Inc (NYSE:HUM) or United Healthcare of the Midwest, Inc.. Health insurance companies generate their profit from the spread between premiums and expenses, including medical costs and operating costs.

In a typical health insurance company, one would expect approximately 80% of premiums to be paid out in medical costs, and 15% in operating costs. The remaining 5% is the tiny leftover profit margin for insurance companies.

This slim profit gives little room for error. Assuming a 5% gross profit margin, an increase in medical costs of 2% would cut an insurance company’s profits by 40%.

Insurance companies don’t need to sweat Uncle Sam’s next move, though. Despite all the hooplah about cutting the cost of health care in the United States, there doesn’t seem to be much more than a boondoggle behind tough campaigning against health care inflation.

Why expensive healthcare is here to stay

You know what they say – there is a correlation between cost and quality.

Politicians may act tough when it comes to slashing the cost of healthcare, especially healthcare services tied to the entitlement system, but recipients of entitlements are much more likely to be consistent voters – older retired Americans who turn out to the polls in droves.

Who’s going to let grandma and grandpa have a bad trip to the doctor’s office over a few billion bucks? Here’s a hint: it won’t be your congressman.

So let’s look at how investors can play healthcare in the current political environment. Here are three stocks to think about, all with varying exposure to Medicare Advantage.

Humana

This company is the king when it comes to making a profit on entitlement programs, generating 66% of its net revenues and 58% of its total profits from Medicare Advantage. It isn’t turning away from a reliance on government money, either. Humana Inc (NYSE:HUM) recently doubled down by acquiring a leader in low-cost healthcare, Metropolitan Health Networks, Inc. (NYSE:MDF), in a deal worth $500 million.

The upside for investors is in the roll out of Metropolitan’s coding skills to Humana Inc (NYSE:HUM)’s vast network, lowering the medical loss ratio on all its managed accounts.