Friday, January 15, 2010

Address this Market!

Members of Congress have been in a huddle this week ironing out a compromise on the Senate and House bills aimed at health care reform. Majority Democrats decided to abandon the traditional process of a joint committee in favor of relatively private negotiations.

Insurers must be alternatively salivating in anticipation and groaning in agony as they wait for the process to conclude in early February 2009. What is in both bills and therefore likely to be in the final legislation are provisions that 1) extend coverage to an incremental 30 million Americans and 2) require insurers to cover pre-existing conditions suffered by policy applicants. What these provisions mean in dollars and cents must have insurers waiting with bated breath.

If signed by Obama the legislation would extend health insurance coverage to an incremental 30 million Americans, half of whom would be covered by Medicaid. The other half - 15 million people - would become new addressable market for the insurers. We estimate the value of this new market opportunity could reach $34 billion. (To come up with that figure we assumed half are individuals and half are families of four and that the average insurance premium is $3,000 per year for an individual and $6,400 for a family of four.)

In all the brouhaha over reform, the fact that insurers will reap huge new revenue opportunities rarely gets mentioned. That might be because as the health insurance industry goes, it is chicken feed. There are about 7,500 companies in the health insurance business with a combined annual revenue of $1 trillion. The incremental addressable market represents a 3.4% increase in opportunity.

The other provision of the legislation that is large on insurers radar screen is the requirement to cover pre-existing conditions. This will increase insurers costs compared to recent years, as insurers have become remarkably skilled at avoiding making payments. Just ask victims of rape or domestic violence or women who have delivered babies by Caesarian Section. They find themselves uncovered at the moment they need the health insurance most.

Insurers, such as Wellpoint (WLP: NYSE) and Humana, Inc. (HUM: NYSE) with their armies of actuaries probably have quite precise calculations on what their added costs will be to cover pre-existing conditions. According to Thomson Reuters, the overall operating gross profit margin for insurers in 2008 was 10.2%. Will that profit margin be trimmed by 50 basis points, 100 basis points?

Whatever it is, the insurers will be getting a windfall of $34 billion in new business to help make up the difference.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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