Outlook. S&P Global Ratings is maintaining its stable outlook on the U.S. health insurance sector for 2020.
Rating changes. We expect limited rating movement this year, given that about 90% of insurer ratings currently have stable outlooks.
Credit fundamentals and macroeconomic trends. We expect near-term macroeconomic factors and cost trends to support stable operating performance, adequate capitalization, and a growing membership base.
Deleveraging. We expect publicly traded health insurers coming off large merger and acquisition (M&A) deals to lower leverage to their long-term targets.
Growth. An aging population, socioeconomic trends, and gradual Medicaid expansion will spur growth in Medicare and Medicaid lines.
M&A. Industry M&A will continue as competition heats up for Medicare, Medicaid, and vertical integration assets.
Policy and regulation. A split Congress is unlikely to pass major health care legislation in a general election year. However, states will continue to make tweaks that affect local enrollment and costs.
Legal challenges. The appeal of Texas v. U.S. may be decided in 2020 if the Supreme Court agrees to an expedited hearing.
What Major Changes Do We Expect Over The Next Decade?
Health care legislation. The likelihood of another round of federal reform is high, but the timing is equally uncertain. This uncertainty will fuel investor anxiety until such reform is completed.
Business models. Pure-play health insurers may become a thing of the past as insurers expand their business models to grow and acquire more health care services.
Technology. The use of artificial intelligence and advanced technology will become imperative to maintain a competitive edge and defend market share.
Disruption. Employers facing increasing costs will be key proponents of disrupting traditional health care contracting and delivery models. Additionally, advances in medical science may disrupt the current health care structure.
Social determinants of health. Additional benefits that go beyond just direct medical benefits will become more common for policyholders.
Climate risk. Climate change will require newer approaches to morbidity management and health care access.
2020: Steady As She Goes, Though Resolution Of Legal Challenge May Rock The Boat
We expect limited rating actions in 2020. Almost all the U.S. health insurers rated by S&P Global Ratings are rated investment grade ('BBB-' or higher), with the median financial strength (operating company) rating in the 'A' category. This indicates favorable credit quality for the industry and the ability to manage a moderate-stress credit event. Approximately 90% of current insurer ratings have stable outlooks, indicating a low likelihood of rating changes in the near term.
Credit fundamentals will remain strong in 2020. We are forecasting stable return on revenue (ROR) in 2020, supported by disciplined pricing and stable medical cost trends. However, RORs will continue to diverge across the industry.
Profitability differs by ownership structure: Publicly traded insurers have higher median RORs than private Blue Cross Blue Shield plans, for example. It also differs by line of business: Government-funded lines like Medicare Advantage (MA) and Medicaid often have lower margins than the group- or employer-based segment.
We do note that the individual market segment, though stable, may see a decline in ROR compared to 2019. Insurers have moderated their pricing in this segment for 2020, and though margins will still be strong, they will be lower than in 2019. However, for the industry overall and most insurers, this segment is not the driver of earnings, so there shouldn't be much margin compression in 2020.
|Operating Margins Expected To Remain Stable In 2020 For U.S. Health Insurers|
|Operating performance (%)||2018||2019f||2020f|
|Median ROR for all rated insurers||4.2||3-5||3-5|
|Median ROR for publics||5.5||5-6||5-6|
|Median ROR for privates||3.8||2-4||2-4|
|f--S&P Global Ratings forecast. ROR--Return on revenue. Sources: Company GAAP or statutory financials and S&P Global Ratings Research.|
Capitalization is expected to remain supportive of ratings in 2020. We expect strong internal cash flow will continue to support insurers' capital needs. Additionally, similar to the divergence noted in profitability, capitalization also differs across the industry. As per our capital analysis, publicly traded insurers (in aggregate) hold near the 'BBB' level of capital, while private insurers (in aggregate) hold higher capital with redundancy above the 'AA' level. Publics have more mouths to feed (multiple stakeholders) and have been more active in M&A, so it isn't surprising that they run their capital leaner than privates do. Rather, it is the better business diversification that in most cases balances the leaner capital levels.
Macroeconomic trends support our stable outlook. The S&P Global Economics team is forecasting unemployment will remain low in 2020, which is a positive for the sector. Given the majority of the U.S. insured population gets insurance via the workplace, low unemployment numbers indicate stable membership rolls for the health insurance industry.
We expect deleveraging in 2020, though overall leverage will remain relatively high for most publicly traded insurers. M&A has become a way of life for most publicly traded insurers, and transactions are often funded with debt. We expect this trend to continue with debt-funded M&A creating a short-term spike in insurers' leverage ratios, followed by active deleveraging for 12-24 months after the transactions, until companies get back to their long-term targets.
Private insurers with integrated systems (for example, Kaiser, HealthPartners, and Highmark) also have debt outstanding to fund their operations. For them, however, we don't expect spikes in leverage, but rather a continuation of current levels. The private Blue plans, meanwhile, have minimal to no debt on their balance sheets.
S&P Global economists forecast recession risk (the probability of recession in the next 12 months) at about 25%-30% (as of November 2019), down from their previous expectation of 30%-35% (in August 2019). Although this risk has slightly abated, it hasn't evaporated. So how would a recession affect health insurers?
We think the impact would be relatively low. Revenue from group/employer business would decline, but a portion of the newly unemployed would likely look to the individual market, offsetting some of the revenue declines from the group segment. We view the individual market as more robust, though not inexpensive without a subsidy, than it was before the Affordable Care Act (ACA) was implemented.
Another risk during a recession is the possibility of a spike in medical cost trends. Individuals afraid of losing their jobs and the related insurance may increase their health care utilization. However, insurance plans have increasingly moved to higher deductible structures, pushing more of the initial cost onto the consumer. This higher cost-sharing will reduce the potential of a spike in cost trends during the next recession.
Policy and regulation risk are limited in 2020. An election year, split houses of Congress, affordability concerns, and uninsured numbers will continue to fuel the health care debate. However, the likelihood of major health care policy garnering enough votes to pass Congress is unlikely this year.
Instead, we expect to see continued policy updates at the state level. Reinsurance programs, enhanced individual market subsidies, work requirements for Medicaid (currently being challenged in the courts), and introduction of an individual mandate are some examples of recent state-level actions.
|Examples Of Recent State-Based Actions Related To Health Insurance Markets|
|Introduction of the individual mandate||New Jersey, Rhode Island|
|Work requirements for Medicaid (currently being challenged in the courts)||Arizona, Arkansas, Indiana, Kentucky, Michigan, New Hampshire, and Wisconsin|
|Expansion of subsidies for individual market||California|
|Reinsurance program for individual market||Alaska, Colorado, Delaware, Hawaii, Maine, Maryland, New Jersey, Rhode Island, Oregon, Wisconsin|
|Source: S&P Global Ratings Research.|
Although we expect limited policy movement at the federal level in the near term, one specific federal rule is worth highlighting. It relates to the expansion of health reimbursement accounts (HRAs). Instead of offering an employer-based health insurance plan, employers can choose to provide funds to employees via HRAs, which employees would in turn use to buy insurance in the individual market.
If heavily utilized, this will increase enrollment in the individual market while reducing the size of the employer-based market. Of course, the quality of insurance plans that the HRA funds can afford, compared with employer-based plans, could result in differences in coverage and out-of-pocket costs. Although we don't expect any meaningful impact over the next two to three years, we will watch closely to see if this expanded HRA regulation garners more employer support in the longer term. This could be a major avenue for employers looking to move to a defined-contribution model instead of the current defined-benefit system for their employee health insurance coverage.
The timing and results of legal challenges are the biggest near-term risks. We are closely watching two lawsuits that could meaningfully affect parts of the industry: an ACA-related lawsuit (Texas v. U.S.) and the Blue Cross Blue Shield antitrust lawsuit.
A group of state attorneys general have filed an appeal of the lower court ruling on Texas v. U.S. to the Supreme Court. This case relates to the constitutionality of the ACA individual mandate and its severability from the rest of the ACA. If the court agrees to hear the appeal and undertakes an expedited hearing, a ruling will likely come in 2020. Previous Supreme Court challenges left the ACA mostly intact, but every case presents its own set of arguments.
The two segments most affected by any major disruption to the ACA would be the individual market (including the exchanges) and the Medicaid expansion market. We currently view both these markets as stable. We estimate these two segments account for about 20 million enrollees. If the ACA is ruled unconstitutional, and assuming no immediate backup plan at the federal level, we would expect some states to attempt accommodating the affected population.
But without the funding provided by the ACA, most of the affected population would drop off insurers' membership rolls. We expect the more diversified insurers or ones with limited exposure to Medicaid and individual segments to see limited impact. However, those heavily concentrated in these two segments would feel the squeeze and have to quickly find ways to offset the loss of revenue and earnings.
The antitrust lawsuit has been pending against the Blue plans for close to eight years. This class action lawsuit, currently pending in the U.S. District Court for the Northern District of Alabama, alleges that among other things, certain arrangements in the Blue system, including the geographic allocation of markets through license agreements, best-effort rules limiting non-Blue revenue, and restrictions governing the BlueCard program, are in violation of the Sherman Act.
These arrangements go to the very core of the Blue Cross Blue Shield system. If ruled in favor of the plaintiffs, this case would require a meaningful redesign of the Blue system.
Key Assumptions Supporting Our Stable 2020 Industry Outlook
Yoda said: "The dark side clouds everything. Impossible to see the future is." If the great Jedi Master had trouble seeing the future, we mere mortals can only dare make predictions based on certain assumptions. Below are the main assumptions supporting our outlook:
- Policy reform will be limited in the near term.
- Results of the ACA legal challenge will not push the ACA off a cliff, and the antitrust suit won't require significant changes to the Blue Cross Blue Shield system.
- Cost trends will remain stable and in line with the past five years, resulting in limited potential for pricing misses by insurers.
- Economic factors will remain supportive of the insurance market.
If actual events take a different path, we may revisit our industry and company outlooks.
Beyond 2020: Myriad Changes Await, Making Adaptability As Essential As Financial Strength For Survival
Beyond 2020, we expect pure-play insurers to become mostly a thing of the past as insurers expand their business models to grow and acquire noninsurance businesses. We can split health insurers' M&A targets into two categories: another health insurer in an attempt to gain scale in the industry, or noninsurance assets to manage the supply chain and gain diversification.
The first scenario (insurer buys insurer) has faced difficulty in receiving Department of Justice (DOJ) approval in some cases, while the second scenario (insurer buys noninsurer) has proved more successful of late. There is also a third scenario (noninsurer buys insurer), as was the case for CVS Corp. buying Aetna. We are still awaiting the DOJ decision on the Centene-WellCare (insurer-insurer) M&A transaction, which, if approved, may increase attempts at insurer-insurer M&A. But whether or not that happens, several of the larger insurers have already been increasing their noninsurance businesses, and we expect this trend to quicken over the next decade.
|Most Of The Large M&A Transactions Recently Have Been Insurers Buying Noninsurance Assets|
|Acquirer||Target||Ratings impact*||Size of transaction|
|Express Scripts||One-notch downgrade||$54 billion|
|WellCare Health Plans||Kept positive outlook§||$17 billion|
UnitedHealth Group Inc.
|DaVita Medical Group||No impact||$4.3 billion|
UnitedHealth Group Inc.
|Surgical Care Affiliates||No impact||$2.3 billion|
|Kindred Health (minority stake)||No impact||$4.1 billion|
WellCare Health Plans
|Meridian Health||No impact||$2.5 billion|
|Beacon Health Options (pending)||No impact||N/A|
|Note: All except for Centene and WellCare are acquiring noninsurance businesses. *Ratings impact on holding company ratings. §Positive outlook was maintained at time of announcement; Centene rating was raised at a later time. Source: S&P Global Ratings Research.|
Membership growth will continue, especially with government-sponsored business lines growing at a favorable clip. We view Medicare Advantage (MA) as the clearest area of growth for health insurers. As a program, it enjoys bipartisan support and relatively stable reimbursement rates (largely tied to Medicare fee-for-service rates). Additionally, we believe seniors have a greater comfort level with managed care products than previous generations, and they will increasingly choose MA over traditional Medicare. We believe MA penetration, currently at about 35%, may approach 50% in the next 10 years.
That said, Medicare growth continues to come with risks. These risks include the federal government's annual reimbursement and policy updates, intensifying competition (which may cause some insurers to underprice), the high cost needs of many Medicare members (which require strong medical management), and compliance risks (which can result in regulatory fines or sanctions).
We view Medicaid as another good growth area. Managed Medicaid penetration is already high, with roughly three-quarters of Medicaid members in managed care, but the industry manages only about half of total Medicaid spending. This means the industry still has significant growth opportunities. We believe some growth will come from states still open to Medicaid expansion (using ACA funding), but the bulk of growth may come from states that move their high-cost, high-acuity members into managed care.
We view the Medicaid reimbursement environment as generally benign, given that rates are statutorily required to be "actuarially sound." However, reimbursement varies by state, and managed care companies sometimes exit contracts for these reasons. Moreover, Medicaid contracts can be "lumpy," as new contracts can bring on a lot of revenue quickly but also require significant start-up costs (and vice versa).
Policy reform is highly probable over the long term, but timing remains uncertain. Over the next decade, we expect another round of health care reform to be implemented. Although the timing of such reform is unknown, it is worth understanding the reasons behind the current health care policy debate. Aside from partisan brinkmanship, the key factors underpinning this debate are:
- National health care expenditure (NHE): Although changes made under the ACA to MA reimbursement did somewhat slow the growth in NHE, it continues to grow faster than the Consumer Price Index (CPI) and is currently a tad below 18% of U.S. GDP.
- Consumer affordability issues: A solution is needed for the increasing out-of-pocket expenditure, especially for individuals with income levels that make them ineligible for a subsidy or government-funded programs.
- Uninsured level: The ACA took a major step in reducing the U.S. uninsured rate. But about 27 million remain uninsured, and we don't expect the current framework to be able to make a meaningful dent in that number.
- Government funding of the system: Who should pay for health care remains at the very center of the policy debate, and various policy proposals either meaningfully increase or reduce the government's exposure to health care.
We are at a fork in the road in terms of the impact on health insurers from these policy proposals. One path leads to a single-payer system (for example, "Medicare for All") where health insurers face extinction, while on the other path, private insurers could become more involved as the government rolls back its exposure (such as through ACA repeal). And, of course, several proposals are in the middle of those two extremes. The uncertainty around the future of health care will continue to cause anxiety for investors until a resolution is eventually reached.
Meanwhile, advancement in medical science, especially genomic-based medicine, will test current medical management practices. Today insurers focus heavily on evidence-based medicine or therapies when deciding on claims. Over the next decade, we expect advances in genomic-based medicine to require a very different approach to benefit management. Genomic medicine and molecular medicine represent developments in medical science that can provide more personalized therapy or cures for an ailment. We are still at early stages of these developments, but they will gain speed over the next decade. Such developments will require insurers to adapt to a new regime of drug pricing and delivery.
"Disruption" is mostly an overused word today, but it will also be a greater force in insurance over the long term. Disruption is often expected from start-ups coming from the outside to provide a solution that beats out the traditional players. Some newer entrants to the U.S. health insurance industry have emerged, but none that have had a large enough influence. Over the next decade, we expect employer groups, and not start-ups, to be the greater disruptive force in this sector.
Employer groups have increasingly self-insured themselves (meaning they use insurers for administrative services like claims management and network services, but actually insure their own employees), taking on greater insurance risk and looking to reduce their health care costs. Some have created partnerships, like Haven Healthcare, in an attempt to find better-quality and cost-efficient health solutions for their employees. On-campus health facilities may become more common, and the purchasing power of multiple groups coming together could be used for local health care contracting. We don't expect insurers to be cut off completely, but they will be forced to provide innovative health care contracting and delivery solutions to remain in the mix.
Technology and data capabilities will increasingly drive competitive advantage. We believe health insurers with large membership and capital bases are best positioned to invest in the evolving technologies needed to attract members, grow revenue, and enhance earnings. In our view, the industry's digital tools for its members and providers have lagged behind the consumerist bent of its product designs. However, we believe these tools are improving, and they may ultimately improve member satisfaction (an industry weakness) and member engagement (that is, the ability to proactively and intelligently manage their medical care needs).
Technology advancements will also be critical for the industry's big push toward value-based payment arrangements with providers. Improved digital infrastructure, backed by artificial intelligence and data analytics, will bolster providers' care coordination and population health management capabilities, allowing them to take on more comprehensive value-based contracts. We also see the industry continuing to partner with traditional technology players, particularly in areas requiring consumer retail expertise (such as wearables and equipment) and cloud-based computing work. This may open the door to technology players becoming more interested in the insurance segment, but we believe this remains a long shot.
Social determinants of health (SDOH) benefits will become common. A health insurance card today is limited to accessing health care, meaning strictly for medical benefits. However, health care needs of the insured may need to be addressed before and after they visit the doctor's office or the hospital. In an attempt to improve medical outcomes, control cost, and be more consumer-friendly, insurers will increasingly use social determinants (nonmedical benefits) in their products. We are already seeing some use of SDOH benefits, such as providing gym memberships, car rides to health care facilities, home delivery of meals, or even air conditioners for members where such use would reduce morbidity risks.
We expect MA to see a greater uptick in SDOH benefits since rules were recently expanded regarding what can be provided as a supplemental benefit. The employer market will follow suit with a focus on increasing the value of the insurance product for employees and using evidence-based social benefits to manage the cost of higher-morbidity cohorts.
Finally, the impact of climate-related events will require new strategies in medical management and access. "Steady as she goes" doesn't apply to the environment. Risks from climate-related events can affect morbidity (for instance, through a higher incidence of asthma attacks from forest fires or behavioral health needs after catastrophic disasters) and have often limited access to health care facilities. For example, some medical facility closures were seen in New York City after Hurricane Sandy and, to a much greater extent, in Puerto Rico after Hurricane Maria. Utilization trends would also be different with increased use of emergency room services, which are higher-cost facilities compared to primary care offices. Preparing for such events will become an inevitability for U.S. health insurers heading into the next decade.
This report does not constitute a rating action.
|Primary Credit Analysts:||Deep Banerjee, Centennial (1) 212-438-5646;|
|James Sung, New York (1) 212-438-2115;|
|Secondary Credit Analysts:||Ieva Rumsiene, Centennial + 303-721-4734;|
|Joseph N Marinucci, New York (1) 212-438-2012;|
|Francesca Mannarino, New York (1) 212-438-5045;|
|Support Analyst:||Zhi Fan Luo, New York (1) 212-438-1988;|
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