Cigna Group (CI-NYSE, $310.61) is Less Than one Quarter Away From Commencement of the Centene PBM Contract Start.

Cigna reported a strong earnings result for Q3.

The commercially focused health insurer and second largest PBM (pharmacy benefit manager) in the United States produced a Q3 fiscal result ahead of Wall Street expectations.

Cigna’s newest PBM contract win begins on January 1, 2024.

Express Scripts, a division of Cigna, was awarded a contract to operate the entire pharmacy benefit business for Centene, a rival health insurer. It was was nabbed from CVS Pharmacy, which, for now, remains the #1 PBM in the USA.

20 million customers, almost 6% of the entire US population, will shift to Cigna’s PBM from CVS in 2024.

CVS is in a bit of a pickle as far as the business model is concerned. They are a high cost health insurer, a high cost PBM and a high cost front end retail operation, all lumped together in an unwieldy structure. The PBM operations of CVS have been under pressure for several years, with the loss of the Centene contract to Cigna representing a significant blow for the top and bottom lines going forward.

As for Cigna, the contract win will add a full 20% to annual PBM revenues within the corporate umbrella, offering gross profit accretion, once startup costs are normalized, potentially in the range of $800 million per annum or about $2 per share. The full impact is expected to be evident for fiscal 2025. The last quarter of 2022 and all of 2023 was a period of expenditures on behalf of Cigna to set up the systems and network infrastructure to handle the Centene volumes; in 2024, the front end expense ends and revenue begins. For 2024, Cigna is guiding analysts to a break even assumption on the Centene contract, but that still represents an improvement over 2023 due to the fact that about $200 million is being expensed on the set-up (about $.67 per share on a gross basis). Cigna tends to not mess up back office administration on the PBM book. I’m betting real money that they will become profitable on the contract sooner than forecast.

Almost all of the CVS external PBM business should be seen as potentially in play for Cigna.

CVS is, in my estimation, a uniquely terrible company; operating in a freely competitive sector is tough enough, but being the highest cost producer in the space, with the highest prices in the space, makes it difficult to maintain or grow third party business. A loss of the Centene account to Cigna is more than a revenue blow, it has a potential domino effect, placing additional pressures on CVS to attempt to increase the profitability of remaining third party contracts via pricing initiatives, which then increases the likelihood of further contract losses to Cigna in the years to come. Rule #1 in freely competitive industries, is to never, ever, own the high cost producer. Always own the low cost producer.

Cigna sticks to its knitting.

The vast majority of the HMO business of Cigna is commercial, rather than individual or government payor (Medicare/Medicaid/VA). This results in less sensitivity of the business by the periodic payment revision schedule of government funded plans; instead, there is a greater exposure to direct economic growth or contraction in the US economy. A US economy that features full employment represents a sort of “Goldilocks” scenario for CI, one where increased hiring levels per commercial employer results in growing numbers of covered employees at a negligible acquisition cost. Every new commercial customer turns to profit within year one

As for the PBM operation of Cigna, it represents the logical option for any third party HMO seeking to outsource. The two major competing pharmacy benefit managers run by UNH and CVS aggressively bid, on a national basis, for government payor individual plans, generally directly against the very same HMOs that they are hope to serve through the PBM contracts. Cigna understands this issue fully and while it does operate a smallish government payor business, the company is quite careful to maintain a geographic map which stays largely clear of account regions coveted by third party PBM contracts. They are more of a collaborator with external HMOs, less a direct competitor.

For Cigna, it doesn’t matter much whether their own health business operates in a specific region or whether coverage is supplied by a third party contract, the goal is primarily to generate the scrip volumes. So, outside of the commercial markets, the only interest Cigna has in government payor markets are underserved locations that can drive the PBM volumes, why bid against the third party contracts on health insurance when the goal of capturing pharmaceutical scrips for the PBM has already been achieved?

PBM operators will have a rather interesting business development, via growth of GLP-1 medication distribution, in the years ahead.

A pharmacy benefit manager is a very poorly understood business by investors in general as the big three PBMS, who control more than 80% of the total prescription flow for health insurers in the United States, operate within a larger corporate structure. They are akin to a wholesaler within the health insurance industry, offering to include a specific drug for members (inclusion in the formulary of covered medications) in exchange for a discount schedule off of list pricing based largely upon access to the coverage pool and volumes. The PBM typically rebates the discount back to the plan sponsor to offset costs and earns its fee by keeping a smallish sliver of the discounts. With the major pharmaceutical producers, the larger the PBM, the larger the unit volumes to be distributed and the larger the discounts offered. So, any PBM is a business of scale with profits earned by a strict focus upon efficiency. Cigna is the #2 PBM in the field, smaller than CVS but larger than the subsidiary of UnitedHealth. Of the big 3, Cigna is the fastest growing.

The class of drugs known as GLP-1 is the 800 pound gorilla in the US health care economy as we now know it. There are at present just two players selling the GLP-1 medications, Novo Nordisk and Eli Lilly. The drugs within that class are extremely expensive, so much so that coverage is challenging within the government payor programs and volumes of scrips are largely (but not exclusively) a class offered within the private commercial payor plans. This makes Cigna, through its Express Scrips division, better positioned than either CVS or UNH to benefit because Cigna specializes in commercial accounts; they do more commercial business than the competitors and therefore have a greater volume flow of Novo Nordisk and Eli Lilly GLP-1 prescriptions, not just on a relative basis, but on an absolute basis. A fortuitous virtuous circle may be present with the advance of public interest in GLP-1 drugs due to the fact that discounts on these drugs, as with all drugs, are based upon volumes. Volumes drive the discounts, the discounts save a corporation an expense vs other HMOs, all else being equal.

Cigna, with a commercial payor emphasis, finds the lane is pretty much all its own; they have an ability to generate a higher profit than peer PBMs on the GLP-1 class and also have a marketing opportunity to obtain new business. Any Cigna salesperson can presently knock on the doors of a corporation with a benefit plan and definitely state that they can provide the lowest net price for Ozempic, Mounjaro and/or any other hot selling GLP-1 within the drug formulary. Heading into 2024 and beyond, private corporations, shocked as all get-out on the expense of these drugs for the commercial plans, may consider reducing or eliminating GLP-1 coverage, but that represents a risk for employers in a hot labor market. Cigna, via its Express Scripts division, will get a very hard look by corporations that don’t already use their service, because if nothing else, the PBM within the Cigna umbrella can reduce the per scrip cost and that can, theoretically, provide CI with an opportunity to scoop up additional corporate accounts. The efficiency of the Express Scripts PBM largely silos the existing commercial book from external competition.

The risk to the Cigna PBM business is less economic, more regulatory.

Politicians hate HMOs in general, and find PBMS to be an easy target for political scrutiny; the big 3 avoid public attention and must pay hefty lobby fees to insulate their business from the attack of the day. So, every several years, congressional oversight zeroes in on the sector, pile on media attention for a time, threaten additional regulations, get bored or get paid off, and then they go away. Those periods are trying times for investors in HMOS and for the big 3 on a share price basis and this will never change. Political interest in the sector is a periodically present crosswind and investors in the space ignore the timing risks at their peril.

There is also an occasional media flurry of interest in companies that attempt to innovate in the space, such as Amazon or other online retail operations. However, the problem all of the new entrants face is that they have nothing to offer to existing health insurers, because a PBM obtains discounts from a drug manufacturers based entirely upon volumes and any new entrant cannot offer present volumes, just a vague assurance that should all go well, some undeterminable future discount might be had, if a health insurance company can wait long enough. The PBM business, much like the payment duopoly of Visa and Mastercard, is largely unassailable by external competition because the business has a barrier to entry that is largely impossible to overcome; any PBM features a massive upfront expense to set up, generates a low per ticket value and only after an extremely high hurdle rate does it become profitable.

The PBM business is all about scale and efficiency.

When a PBM turns profitable, it is very profitable. Differing from CVS, whose front end retail pharmacies are subject to enormous shrinkage loss and whose inflationary staffing charges negatively impact the business model; unlike UnitedHealth, whose business model is based upon a 100% capture of the entire healthcare dollar, from doctors, to surgeries, to rehab clinics and to prescriptions, Cigna runs super lean; they offer healthcare plans for corporations, run a pharmacy benefit manager which protects that commercial market, and offers meaningful discounts to other HMOs on prescription drugs while only offering government sponsored payor plans in a handful of regions. Cigna has little of the extra staffing overhead of the two other competitors and this insulates the company from current labor inflationary pressures. The PBM at Cigna is run for the benefit of the HMO biz and for the shareholders; CVS, in contrast, runs its PBM to subsidize store theft, support pharmacist wages and make money losing acquisitions, none of which return one thin dime of profit for stockholders.

A medical secular tailwind, specific to Cigna, may soon be evident via a consumer demand push towards the GLP-1 class of prescription drugs.

Government payor based plans are having an extremely difficult time determining how to offer GLP drugs to enrollees because government funding is minimal but Cigna doesn’t care as the commercial plans do offer GLP-1 coverage. PBM discounts, anecdotally, on GLP-1 are running well above 40% of list prices and that permits any PBM with the ability to push volumes to shave off a few percentage points of that gross for themselves, and for their shareholders. To a PBM, it matters not whether Novo Nordisk, Eli Lilly or even another entrant wins the battle for written prescriptions; what matters to a PBM is just that prescriptions are written.

The Ozempic class of drugs (GLP-1, including Eli Lilly) is, to my way of thinking, a potentially meaningful tailwind for Cigna’s PBM in the years to come, based upon the mix of commercial accounts to government payor plans. Not every PBM is poised to benefit at present, or in the near term, until such time as broad government coverage comes into effect. For that to happen, list prices of the GLP class of drugs will need to fall, perhaps by 75% or more. So, any PBM operated by an HMO that primarily administers government sponsored programs will be watching from the sidelines, while Cigna, through their Express Scrips division, continues to gather traction in the commercial space.

Cigna represents my chosen vehicle in the PBM space.

I can model a time when the company supplants CVS for #1 spot in the pharmacy benefit manager volumes in the United States. With the Centene contract commencement set to turn to revenue in 2024, an actual tailwind exists to boost revenues and profits. They are scooping contract wins without having to buy competitors at outrageous premiums and the attendant goodwill that goes along with such buys. Cigna is growing the HMO division, all organic, at a faster pace than peers and the commercial sector looks pretty sound. To this, I am sniffing out an emerging tailwind, possibly a secular trend, that might soon be apparent to the remainder of Wall Street, the push by employees for expanded commercial coverage of GLP-1 drugs which may benefit Cigna more than peers. Based upon a revenue mix roughly 70% PBM related and just 30% generated on health care insurance revenues, Cigna might be the only company in the HMO space that is quietly rooting for more GLP scrips to be written.

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