Broad line health insurance firms represent one of the havens of safety during a period of high inflation and full employment.
Private health care coverage providers are one of the few business sectors relatively insulated from the current spell of demand-based commodity price inflation. To some extent, this may be attributed to the nature of health care coverage; employers, seeking to entice current employees to not jump ship for competitors, typically bump up health coverage as a perk for employees. Increased coverage per employee serves to maintain profit margins at the HMO level. Additionally, HMO firms, particularly when they are of size, have decades of experience in attempting to wring out costs from hospitals, pharmaceutical companies and every cost component within the health care system; effectively fighting cost inflation is what they do. So, while the vast majority of publicly traded businesses have professed, to great surprise, that they were caught completely unawares by inflationary pressures, the spate of publicly traded HMO in the United States consider this to be another day, just another week, just another fiscal quarter; it is their ongoing state of affairs.
The data put forth by the US Bureau of Economic Analysis, in their most recent inflationary report, indicates that pharmaceutical and hospital costs have only advanced by a level in the 4% range, year over year. This is a far cry from the 9% plus comprehensive inflation rate posted a few days ago. This sets up publicly traded HMO of all stripes for the potential to at least meet earnings guidance, if not surpass them. Furthermore, with, thus far, muted cost inflation within the HMO business model, there is a potential set-up for accretive price hikes in the fall renewal periods.
The largest HMO in the United States and a core holding in the Gnostic Model portolio, UnitedHealth, did not disappoint with their fiscal report for the period ended June 30th. Revenue was on point, margins were completely as expected, 2022 guidance was raised; most importantly, there was no evidence of softening margins, which represents the bane of any long thesis in this highly inflationary cycle. A potentially accretive acquisition, potentially on hold by US antitrust authorities, was a source of pressure on the shares in the last six months. As an offset, the fiscal result was sufficiently strong that pushback against the end of potential growth via accretive acquisition appears to have been blunted.
I would expect more good results in the weeks ahead from large HMO firms, particularly those who have maintained a strong balance sheet. Cigna Corp. (CI-$269.71, NYSE) will also be a firm that potentially has the ability to wring extra profits out from careful cost controls.
Overall, the HMO sector seems to be deserving, even in rampant commodity inflation, of its attributes to large cap investors as a defensive haven. Where things may get dicey in publicly trade health maintenance firms will be when unemployment starts to climb rapidly, should a full blown economic recession lead to cutbacks in private sector employment. Thus far, that seems a little less than certain.
One potential area of profit, not picked up on as yet by major investment houses, is the potential return of “disabled” employees to the workforce based upon cost inflation.
It is estimated that as much as 7% of the total potential private US workforce is receiving some sort of short, medium or long term disability benefit. Private insurance benefits represent a cost to HMO insurance firms. Benefits, dollar wise, are not well indexed to inflation, sometimes not at all. Therefore, the lifestyle afforded to those on disability gets chipped away in the current environment.
In the case of the current full employment labor market and the wages being offered by employers, a percentage of those on long term disability might be sufficiently enticed by the wage packages, contrasted by a declining standard of living generated from a largely fixed disability payment, that some might miraculously recover sufficiently from their disability to opt for a partial or full reinstatement into the workforce. To those on stress leave, it might be that the increasing mental duress of obtaining a fixed payment with rapidly diminishing value can easily be remedied by a higher wage with full benefits and a choice of employers.
To an HMO, a return to gainful employment of someone on disability represents a double win for the top and bottom lines; the top line goes up by a new employee paying into an HMO and the bottom line is swelled by the removal of a disability expense.