Health Insurers Thrown Lifeline But Margin Headwinds Persist

This story features MEDIBANK PRIVATE LIMITED, and other companies. For more info SHARE ANALYSIS: MPL

-Policy downgrades, lapses continue
-Honeymoon period for margins
-Struggle to suppress claims inflation
 

By Eva Brocklehurst

Health insurers have received government approval for an annual round of premium increases that were lower than historically the case, but also greater than many brokers had feared. Is this a good outcome? It depends.

Lower premium increases mean lower revenue growth for health insurers, although there may be some offset in a stemming of the current rate of downgrades or lapses in cover. Morgan Stanley observes industry revenue growth fell below 7.0% in 2015, with this trend likely to continue as policy holder growth slows.

Yet, brokers also consider the government was generous with its increases, given the current strong profitability of the sector, albeit mindful that regulatory risks remain elevated. The minister approved a 2016 premium rate increase of 5.6% (versus 6.2% in 2014, 2015), well ahead of the inflation rate in claims of 1.4% in the past six month, Credit Suisse notes.

Medibank Private ((MPL)) achieved a rate increase of 5.64% while nib Holdings ((NHF)) has achieved 5.55%. The largest health fund in terms of premium value, non-listed insurer BUPA, achieved 5.69%.

The government has flagged reforms across the industry to save on the cost of claims. The first of these has been the change in prostheses claims, with nib noting the potential for $800m in annual savings. Credit Suisse observes these reforms will reduce claims costs but won't be factored into premiums until after the savings are achieved, providing a honeymoon period of inflated margins for insurers.

Moreover, consumers have shown a lack of willingness to absorb premium rate increases, with downgrades to cover at record levels. Credit Suisse observes the rate of increase achieved in 2016 effectively allows the insurers to recoup this lost premium but suspects lapse rates could accelerate.

Following the government's announcement, UBS believes the health funds have achieved a very good outcome, considering the minister's commentary in the months leading up to final submissions. UBS believes the government's “affordability” reform agenda is questionable over the short term with the major health funds likely to significantly “over-earn” well into 2017, and relative to its measure of a long-term sustainable margin.

The broker expects the 9.0% margins in the first half will be a high watermark, although 7.0% appears achievable in the medium term. UBS is yet to factor in any impact from the change to prostheses costs but notes some potential timing benefit should pricing reforms be implemented. Regulatory risks should persist and the affordability and channel constraints which have reduced policy numbers in the last two years are well entrenched in the broker's opinion.

Considering the increased political scrutiny, low 2015 claims inflation and calls for insurers to subsidise rates with capital, the approved increase was better than Deutsche Bank expected. The broker suspects the government was intent on not being too heavy handed in its efforts to improve affordability.

Still, despite the minister's call to utilise surplus capital, the broker notes only HBF's increase was below the industry average at 4.94%, with HCF at 5.42%. Moreover, despite a lower 2016 premium rise, lower rebates (indexed to CPI) for those on full rebates means they will still encounter an effective rise of 7.1%. Thus, combined with slowing wage inflation, this will exacerbate affordability issues and heighten the need for reforms.

Without significant savings in terms of prostheses the industry is likely to struggle to keep claims inflation below 3.9% and Deutsche Bank suspects this should lead to gross margin contraction in 2016. Further out, prosthesis reform could temper 2017 premium rate increases by 1-2%.

The backdrop is the most advantageous for Medibank, which is in the position to enjoy margin tailwinds from hospital contract renegotiations and savings from its claims integrity program. Deutsche Bank believes, over time, better margin trends should allow the company to seek below-industry premium rises and thereby boost its efforts to rejuvenate its brand and stem market share attrition. In comparison, nib appears to have few claims offsets.

BUPA, in releasing its 2015 results, was careful, given the margin performance of its listed peers and the trends in claims. The company has stated it is witnessing more downgrades and a discontinuing of health insurance as affordability pressures continue. Deutsche Bank suspects the advantages outlined earlier for Medibank could mean it displaces BUPA as the industry's most profitable operator.

As a corollary, with the sort of funding system in operation, the earnings trajectory of private hospitals cannot be maintained, in Morgan Stanley's opinion. The most rational outcome, the broker asserts, is for better-negotiated outcomes from the private hospitals on the proviso the insurers hand the benefits back to policy holders.

Morgan Stanley believes that rising demand elasticity from health insurers must translate to poorer outcomes for private hospital operators, Ramsay Health Care ((RHC)) and Healthscope ((HSO)). The broker envisages risks from FY17 onwards to rates paid by insurers to hospitals.

Two key health insurers in FNArena's database are Medibank Private and nib Holdings. There is one Buy rating, five Hold and one Sell for Medibank. The consensus target is $2.60, suggesting 7.2% downside to the last share price. For nib there are two Buy ratings and five Hold. The consensus target is $3.77, suggesting 4.6% downside to the last share price.
 

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