In a Million Dollar Nutshell ? How to Invest in Managed Healthcare ?
Understanding how to invest in managed healthcare begins by acknowledging the depth of that undertaking. The industry’s massive. And it’s crucial too, people will always need healthcare. Managed care is about making healthcare work financially for people. Pick a type of health plan such as Medicare or Medicaid and specialise further in that. Each niche is prone to catalysts, with the complex interplay of clockwork going on but also the potential to shift as massively as a tectonic plate when politics weighs in. Thinking about the third, fourth, fifth order of effects from changes you see you rumbling deep in the underworld of this industry. That’s what I think will put you at the front of the line to capitalise on such change. That’s how you invest in managed healthcare.
Time to Really Learn How to Invest in Managed Healthcare Providers!Disclaimer: I do not own any managed healthcare investments at the time of writing. Disclaimer: chrismorrissey.money does not provide financial advice. All content is purely informational. Consult independent advice.
This is a big one. If you’re an American reader, your health care plan gives you access to hospitals, surgeries, and doctors. The system runs deep. When investing, it’s another string to have on your investing bow and I’ll make it easy. I’ll explain the business of managed care from the ground up and where it fits into the wider health care sector. We’ll do billions of dollars of our own surgery on the balance sheet and see what a great insurer stock looks like. We’ll discover where catalysts can be found to move these stocks. And we’ll complete a reserve analysis. All this and we can value US managed healthcare stocks. This is your US managed healthcare primer. Let’s get started!
Health Care Sector
You’re a US citizen. You fall ill. You look around you at what’s out there to help. What do you see? A healthcare sector of biotech companies making medicines. Pharmaceuticals making drugs. The industry of equipment and supplies too offers the highest quality needles, knives, and lab equipment. And hospitals and nursing homes are provided and decked out with healthcare IT systems. To meet your need to be treated, the health care sector has to stretch far and wide. But then you realise that even though these things are all coming together to help you. You have no way of accessing them.
Health Care Providers and Services
That’s where MCOs come in. Managed Care Organisations . They exist within the ‘healthcare providers and services’ industry, but they occupy their own subindustry beneath that. This is the health insurance business, and it’s absolutely critical to keep you alive!It’s the business of health care plans . Plans which buy you access to all of the treatment you need. Your health care is “managed” by these companies. They basically take your money and use it to pay everyone else in the health care sector to band around and help you. There are some countries (like the UK) where you won’t find MCOs to invest in. But in the US, they’re like middlemen in-between you and the doctor. As I said, it’s the business of health care plans. Different folks need different plans. You can group them into 3 types, and stocks in this industry tend to orbit and be differentiated by these 3 types of plan. Let me give you a rundown of what they are.
Health insurance for the typical individual. Plans for the average American , employee or otherwise. Most stocks are heavily exposed to the commercial segment of managed care because it’s the biggest. Anthem and UnitedHealth, case and point.
Think of the core offering a health care plan as propped up by another service. Firms in the commercial area also offer administrative services for employers. These services help employers set up a health insurance plan for their employees. Simple as that.
Health insurance plans for seniors over the age of 65 . ‘Medicare Advantage’ is the name of the plan for the elderly, but there are actually two different products in this segment. Just as there were in the commercial segment.
‘ Medicare Part D ‘ is the second, and it’s all about prescribing drugs to these senior citizens. The main Medicare weighted stock is Humana.
Health insurance plans for poorer folks on lower incomes. The government gets partly involved in this. It doesn’t want vulnerable people taken advantage of by profit-seeking firms. The government’s involvement makes it pretty interesting, and pretty confusing.
Purely Medicaid intensive stocks are WellCare and Molina.
These three areas of managed care exist because there are 3 distinctly different groups of Americans. Three different groups the country has to serve. The commercial plans just won’t hack it for the elderly or the poor. However, most stocks in the managed care industry will be serving all the three different groups in their own mix of different products.
Commercial PlansHalf of all Americans find themselves on a commercial risk plan. As I said, this is for the typical American, probably an employee. Here’s how the business model works:
You pay $400 every month to a managed care organisation (MCO). Let’s presume it’s Anthem because we know they’re heavily involved in the commercial segment. We’re saying $400 because that’s what the average monthly premium runs at . For that money, Anthem will cover all of your medical costs for that month. They’ll negotiate those costs of any care you need with hospitals , doctors and other providers in the sector. If your care at the end of the month amounts to less than $400. Anthem bags a profit. However, if care costs amount to more than $400; you pay the excess.
Sounds a bit one sided, right? But wait. Health care reform. These are 3 key words central to investing in this area: Medical loss ratio . Sounds complex but don’t panic. It means the percentage of a monthly premium (the $400) that Anthem (the MCO) has to spend on your medical care . Since the reform, it’s minimum 80%. So to the extent that Anthem pays less than 80% of what you paid them in monthly premiums, actually on your medical care… it has to rebate that money back to you as a customer.
How We Make Money
Socially good. But it’s a permanent cap on the gross margins that our MCO stocks can achieve. MCOs obviously want as many people enrolled on their plans as possible, to make the most money. Revenue in this business is measured by revenue PMPM. Meaning revenue per member, per month. $400 feeds into this running total.
What about the other service offered by commercial plan-based MCOs, the administrative services? This is equally important for a company like Anthem’s earnings and the more popular they grow their main commercial plans, the more they can grow this side of their business as well. Employers pay for some or all of their workers care, on their own deals with the MCO. So it’s really the same offering through and through, just a different customer (employer not citizen). Revenue PMPM isn’t $400. It’s only $25 dollars per head that employers will pay. However, enrolment figures nationally are much higher and there’s no rebate rule. Margins are uncapped.
The dream MCO pays so low medical costs for its enrolled members care, they can theoretically net the full 20% available gross profit margin after the healthcare reforms cap of 80%. Make sense?
What to Look For in The Commercial Plan Space
The real competitive advantage you’re looking for is a cost advantage .
The doctors and hospitals need to stay competitive too, don’t forget. They need patients. If you’re an MCO that provides many many patients for a particular hospital, you’re going to have the bargaining power against that hospital when it comes to negotiating costs for your plan members care. MCOs do not waste that power. You can assess which stocks have the most leverage in what states by looking at the commercial market share in local states .
You don’t want the MCO to be spread thin. Scale in states matters and hospitals only care about the biggest provider of patients in their own state. Cost advantages can also be found by spreading out the other main drag on margins. That would be SGA costs. These are selling, general and administrative costs. If you spread those out over a large nationwide base of enrolled members on your plans, that’s a cost advantage. So economies of scale matter too .
This is health insurance for people aged 65 and over . The plan is called ‘Medicare Advantage’. It’s federally backed by government-based, CNS, who pay for all seniors health insurance .
The business model is exactly the same as the commercial plan. The only pivotal difference is that the government tells the MCO exactly what it’s going to pay them in monthly premiums. The government is in control of every cost input and output . Anthem would offer a level of care to the senior which is adjusted to what monthly premium the government is to pay them. The government sets the costs (“unit costs”) of the healthcare as it relates to seniors. And it sets the gross margin cap on MCOs with, again, a minimum medical loss ratio. This is just the nature of the beast. It’s how things work protecting people who are older in the healthcare system.
‘Part D’ – Prescription Drugs
There’s also the business of prescription drugs to consider. The same business model applies, it’s just that instead of any health care, we’re only on the topic of drugs . MCOs get slightly more control over the premiums, and also the costs of the medical care as well.
Despite it being government controlled, the monthly premiums we’ll be receiving are more than $400. Much more. They’re more like $900 on average. This is because older people just have higher health needs. That’s unlikely to change anytime soon (people living longer). So despite enrolment being lower for Medicare. Because revenue is much higher and the margins are about equal to the commercial segment, it’s still very incentivising to have a long stock position in this space. The MCOs do have less control over their business, of course.
Medicare Advantage vs Fee-For-Service
Your attention should be at more a social level because when you’re over the age of 65, and you’re an American, you have 2 options. Medicare Advantage or fee for service. Imagine if the government did the job of the MCO, that’s what fee-for-service means.
With fee for service, the senior can have any doctor or hospital they like but they’ll need to sign up for a drug prescription separately. Which is a hassle. Medicare Advantage acts as a one stop shop on the other hand, including their prescription drugs. This population that operates on a fixed budget finds huge value in having an out-of-pocket costs maximums with Medicare Advantage which helps them save paying the big excesses on out-of-pocket medical bills.
Fee-for-service leads right now in terms of market share with 65%. For a Medicare Advantage focused stocks, this showdown is one to watch with a very keen eye.
What to Look For in The Medicare Space
‘Health Care Effectiveness And Information Data Set’. As ‘HEDIS’ scores grow, that signals better medical management. That means lower costs and better care offered to seniors.
Quality bonus points compound this. Yes, the government controls monthly premiums now at $900 on average for Medicare. But the health care reform act really spiced things up in Medicare by rewarding better plans with higher rates. You need 4 out of 5 stars in order to earn yourself a 5% higher monthly premium , but 5% is a lot.
Thinking bigger picture, higher points and scores will help convince seniors to go for Medicare Advantage over fee-for-service. That helps stocks because it reduces risks associated with the prospects of Medicare Advantage. Ask yourself, are high scores inaccessible to competitors? Because they need to be for it to be a true competitive advantage. They will move stocks, but are they long term durable competitive advantages?
Medicaid helps those on lower incomes in poor situations. Commercial health plans were completely private. Medicare was completely public. Medicaid is a halfway thing. The individual states set the monthly premiums and MLR . These monthly premiums are more affordable, about $350 dollars on average. The rebates depend on the state, as do the medical costs themselves.
Don’t fear that state budget pressures are going to lead to lower monthly premiums. If it’s not profitable for Anthem to be offering Medicaid plans (and the same goes for any other MCO), they’re going to exit the market. That would leave the state’s poor population with more unaffordable options and the state just can’t afford for that to happen. So they pay the smallest possible monthly premiums to Anthem to get them to stick around, so it’s economically justifiable.
In fact, the state trend is to expand eligibility for Medicaid nationwide . 70 million Americans are on Medicaid right now and its there for people when they need it if they experience hard times. There’s a correlation between unemployment/general economic prosperity and the number of people enrolled on Medicaid plans. That makes Medicaid MCO stocks a more defensive investment. Better medical management still delivers benefits to those stocks who can achieve it.
Based on all the information surrounding these 3 areas of managed care, you can decide how much of each you want in your stock selection for the managed care industry.
|Com. Plan||Com. Admin||Medicare||Medicare Pt. D||Medicaid|
MHC An Investor’s Haven?
It’s not demanding on your pocketbook to run a managed care company. The yearly upkeep (maintenance capex) is only about 15% of what the business makes (FCF) . A lot of shares get repurchased too. Acquisitions are possible and earnings can be reinvested. When managers do reinvest their earnings they usually achieve around a 15% (ROE) internal return which is what I would call good. 10% is average, 20% is incredible.Check your managed care stock is well capitalised . Risk-based capital levels can be found in the company’s filings. It’s subjective but above 200% is a probably a concern. We want our MCO to be able to front a financial hit in terms of debt as well. These companies target 40% as a debt to total capital ratio . I only found Molina wayward over at 60%.
How to Conduct a Reserve Analysis
A reserve is the money for care that an MCO owes to providers like hospitals for healthcare. The reserve is called the ‘medical claims payable’. A reserve means the money a hospital could claim for medical care that the MCO hasn’t paid yet . It’s a liability. 50% of this number is a best estimate ! That’s right. On Anthem’s financials that makes $3.5 billion dollars of guess work. The problem is that the MCO hasn’t received the bill yet from hospitals for a lot of the care that their customers have received over the past month. They haven’t received the invoice, yet! They can’t do better than an estimate.
Because of this, quarter to quarter earnings mean zilch, nothing ! The medical claims payable figure is such a big one that in fact, these firms can aggressively estimate their costs at whatever level they want. They can pull off essentially any earnings effect that they want. You can look at something called PPD in a reserve roll-forward table to normalise past results. But we’re not investing in the past, we’re investing in the long term future. So, here are some measures for a reserve analysis which will tell you whether your company is provisioning enough in reserves to cover the reality of what medical liabilities might add up to.
Days Claims Payable
Days claims payable. Root out this ratio and quarter to quarter earnings mean zilch, nothing . Even better is that management often comment on this ratio which is really useful. But be forewarned, there are pitfalls to days claims payable. Namely if you’re paying your claims faster (which is a good thing) that lowers DCP. You might be making improvements to your business. Making it more efficient by introducing technology to pay the claims faster, but because it lowers DCP you may get a misleading idea about reserves.
Relative Growth Rates
Reserve growth relative to premium growth. Hopefully our MCO stock is growing the amount of monthly premiums that it gets from Americans. If reserve growth is speedier than premium growth, that’s reserve strengthening going on. Just be careful that your managed care company isn’t lowering prices to gain enrolment share. If so, that could distort the picture.
When short term earnings are so dubious as I’ve alluded to, the replacement valuation metric for the static PE becomes PE10 . Otherwise known as the the Shiller PE or CAPE. It uses 10 years of earnings data instead of one in order to even out the manipulation. Find the multiple for the S&P at large and commercial-heavy managed health care stocks historically trade at 4/5th’s of that. Pure play Medicaid stocks trade on a range between 10 and 20 p10, and Medicare slightly cheaper at a range between 7 a 13.