Even though the share prices of the seven largest health insurers in the US nearly doubled on average since March last year, we think there is still great value to be found in the sector. Although referred to as health insurers, they are better known as managed care organisations as their business models are different to the likes of Medibank and nib in Australia, which are pure health insurers. Under the managed care model, these organisations actively seek to reduce the cost of providing care as well as improving the quality of the care and that is why we think this should in theory be more sustainable.
A quick overview of US health insurance coverage
Unlike Australia, the US doesn’t have a single payer system. The majority of individuals in the US get their health insurance through their employer (~180 million). On top of that, seniors and low-income earners are insured by the government through the Medicare (~60 million) and Medicaid (~60 million) programs respectively. The remainder of the population get their health insurance through health insurance exchanges, directly from the health insurer, or are simply uninsured (~30 million).
An industry that demonstrates sustainable long term growth
The health insurance industry in the US has demonstrated steady growth for long periods of time and should continue to do so sustainably through both volumes and pricing. The number of individuals insured should continue to increase as an aging population should increase the number of individuals covered by Medicare and the expansion of Medicaid should increase the eligibility of low-income individuals.
Insurance obtained through employers are renewed annually with low to mid-single digit premium increases and with high retention rates, while Medicare payments by the government to the health insurers are reviewed annually with low-single digit increases.
What’s the downside?
Despite the positive backdrop, many investors are weary of investing in the health insurance industry particularly in the US due to the ever-persistent regulatory risks but there are significant logistical and political challenges to implementing health care policies of any kind.
For example, Senator Sanders and Warren built their presidential platform around Medicare for All but neither were successful in winning the Democratic nomination. The Republican party tried many times to repeal and invalidate Obamacare while President Obama was in office but even with the subsequent control of the Presidency, the House of Representatives, and the Senate, failed to get anything done. The recent challenge to Obamacare was rejected by the Supreme Court in a 7-2 ruling despite the bench having a very conservative leaning.
Cigna – the medical cost trend leader
Cigna is one of the largest diversified health care companies in the US providing health insurance and health services to individuals, employers and governments. Cigna has consistently delivered industry leading medical cost trend of ~4% versus ~6% for peers, helping to lower costs for Cigna’s customers, who are predominantly employers that self fund the risk.
Post the merger with Express Scripts, Cigna is now vertically integrated and much more than just a health insurer, with more than half of its earnings generated from the provision of pharmacy care services. Cigna’s vertically integrated business model has further helped to reduce costs, with Cigna now targeting a sustainable medical cost trend at or below CPI over time and this competitive advantage allows Cigna to increase both revenues and earnings by an attractive 6-8% per year.
Solid ESG credentials and a look through into current controversies
Cigna received an ESG rating of A from MSCI in June 2021, having been downgraded from the previous year’s rating of AA. When we actively explore and dive deeper into these credentials our view is that Cigna’s ESG rating scorecard has actually improved slightly from the previous year and Cigna’s positioning in five of the six key issues identified by MSCI remain above peers. Cigna scores strongly in both the governance and environmental criteria, but poorly in the social criteria due to Cigna’s involvement in several controversies, including an investigation into the role it played in contributing to the opioid epidemic in the US and a proposed class action suit filed by patients over the high insulin prices.
Opioid epidemic
In response to the opioid epidemic in the US, Cigna collaborated with more than 1.1 million clinicians to reduce prescription opioid use among its customers by 25% and has set a goal of reducing opioid overdoses by 25% among its customers in targeted communities by year end 2021. Recent lawsuits and settlements have targeted drug manufacturers as well as distributors and it is unclear whether Cigna or Express Scripts will ultimately be penalised. Cigna’s scoring in the social criteria will likely remain low until this is fully resolved.
High insulin prices
In response to the high prices of insulin, Cigna announced the Patient Assurance Program in April 2019 by partnering with participating insulin manufacturers to ensure eligible people with diabetes in participating plans would not pay more than $25 for a 30-day supply of insulin. The Patient Assurance Program was launched on January 1, 2020 and delivered $3.7 million in savings to more than 40,000 members in the first four months, or an average savings of 48 percent per 30 day prescription. Beginning July 1, 2020, Cigna expanded the program to include non-insulin diabetes therapies that can lower blood sugar and the risk of hypoglycaemia in place of or along with insulin.
Value and values
Pella specialises in responsible investing as well as meeting financial objectives. We emphasise delivering on both financial results and social responsibility. We focus equally on value and growth and Cigna is a stock example that demonstrates these targets.
Cigna is currently trading on an adjusted forward PE of 10.8x and a forward free cash flow yield of 7.4%. Given Cigna’s record of solid execution and industry leading cost trend, we think the market has overly discounted the business for its regulatory and other associated risks. We believe Cigna has solid ESG credentials and is a great investment at current valuation.