Managed Care
Managed Care Primer 2018 – Drivers of a
dynamic and growing sector
Industry Overview Equity | 08 May 2018
Managed Care Primer – in-depth industry overview United States
Managed Care
In our seventh annual Managed Care Primer, we provide an overview of the $1 trillion
managed care industry and a detailed analysis of the industry’s growth drivers. This
Kevin Fischbeck, CFA
report is organized to help investors understand how managed care organizations Research Analyst
MLPF&S
(MCOs) make their money and what competitive advantages are necessary to succeed +1 646 855 5948
long term for each product type (commercial, Medicare, and Medicaid). In addition, we
review Health Care Reform, dual eligibles, investment portfolios, capital requirements, Catherine Anderson
Research Analyst
accounting nuances and non-core products. Finally, we lay out the case for sustained MLPF&S
earnings growth in the low double digits over the long term with mid-teens total returns. +1 646 855 4345
Low-double-digit long-term EPS growth, mid-teen returns
We believe that the group could show 10-13% long-term EPS growth. Top line growth Table 1: Managed care subsectors
of 6-9% appears achievable driven by 3-4% enrollment growth (well above population Market
cap
growth driven by strong government growth) and 3-5% net premium yields (5-7% cost
Ticker Company ($B)
trend less benefit buy downs and mix shift). While we’d expect a stable medical loss Diversified
ratio (MLR) within a given product, the shift toward government could drive MLR up for AET Aetna $56.8
a typical company. Meanwhile, modest leverage on G&A should offset this, leading to ANTM Anthem $61.3
EBITDA growth of 6-9%, in line with revenue growth. Finally, capital deployment through CI CIGNA $42.1
UNH UnitedHealth Group $232.8
a combination of share repurchase and acquisitions could push EPS growth to 10-13%.
In addition to this EPS growth, most large cap MCOs pay a dividend in the 1.5% range. Medicare
HUM Humana $39.9
Analyzing the impact of HC reform on each subsector
We provide a detailed review of Health Care Reform and the implications for the sector, Medicaid
CNC Centene Corporation $20.7
analyzing the outlooks for the exchanges, Medicaid expansion, and Medicare Advantage
MOH Molina Healthcare $5.5
(MA). We view MA as the fastest growing sector in managed care over the next 10+ WCG WellCare Health Plans $9.9
years, driven by aging baby boomers, increased penetration, and improving rates. Source: Bloomberg, BofA Merrill Lynch Global Research
Keys: Scale, medical mgmt and quality
Competitive advantages vary between products, but scale is a common denominator.
Companies with large membership bases can generate lower overhead costs per
member by leveraging technology investments and care management platforms. SG&A
leverage is even more important post Health Care Reform when gross margins are
capped through minimum MLR. Meanwhile, given that much of the future membership
growth is coming from government businesses where pricing is dictated to the MCOs,
medical management capabilities increasingly are a differentiator. Finally, quality is
increasingly being factored into the reimbursement system.
We address some commonly asked questions
We address a number of commonly asked questions including: If managed care
companies save money, why is commercial cost trend so high? How does Health Care
Reform impact managed care? What is the outlook for the public exchanges? What
indicates that a company is well reserved? How fast can Medicare Advantage grow as a
percentage of Medicare enrollment? Why would Medicaid Managed Care rates hold
steady during a time of state budget issues? What are block grants and what would the
impact be to Medicaid Managed Care? Vertical integration and what other areas are
MCOs investing in? How much of tax reform can MCOs keep?
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports.
As a result, investors should be aware that the firm may have a conflict of interest that could
affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision.
Refer to important disclosures on page 342 to 344. Analyst Certification on page 340. Price
Objective Basis/Risk on page 339. 11872349
Timestamp: 08 May 2018 12:05AM EDT
W
,Contents
Industry overview 3
Commercial business 7
Medicare business 75
Medicare Part D business 121
Medicaid business 128
Dual eligibles 149
Other services 155
Capital analysis 170
Tax reform 183
Health care reform 198
Evolving payment models 238
Accountable Care Organizations 246
Capitation 252
Accounting 275
Valuation 299
Company snapshots 304
Glossary 335
2 Managed Care | 08 May 2018
W
,Introduction
In our seventh annual Managed Care Primer, we provide an overview of the $1 trillion
managed care industry and a detailed analysis of the industry’s growth drivers. This
report is organized to help investors understand how managed care organizations
(MCOs) make their money and what competitive advantages are necessary to succeed
long term for each product type (commercial, Medicare, and Medicaid). In addition, we
review Health Care Reform, dual eligibles, investment portfolios, capital requirements,
accounting nuances and non-core products. Finally, we lay out the case for sustained
earnings growth in the low double digits over the long term with mid-teens total
returns.
If managed care companies save money, why is commercial cost trend so high? See
Commercial cost trends
How does Health Care Reform impact managed care? See Health care reform
What is the outlook for the public exchanges? See What is the outlook for the public
exchanges?
What indicates that a company is well reserved? See Accounting: Reserves
How fast can Medicare Advantage grow as a percentage of Medicare enrollment? See
CBO projects MA enrollment will continue to rise
Why would Medicaid Managed Care rates hold steady during a time of state budget
issues? See Rates are more closely tied to MCO margins than state budgets
What are block grants and what would the impact be to Medicaid Managed Care? See
Impact of Medicaid block grants
Vertical integration and what other areas are MCOs investing in? See Other services
How much of tax reform can MCOs keep? See Tax reform
Industry overview
Managed care organizations (MCOs) provide and administer health insurance through
risk-based and administrative services only (ASO) products. Most of the publicly traded
companies primarily focus on the U.S. managed care industry, which has a market size
of over $1 trillion. There are multiple products in the managed care industry with
fundamentally different characteristics (see Table 2). Accordingly, it is important to
recognize the varying product mixes at the publicly traded companies when analyzing
industry trends.
There are three main business categories:
• Commercial. Health insurance for employees and individuals/families.
• Medicare. Health insurance (Medicare Advantage) and drug coverage (Medicare
Part D) for seniors (age 65+).
• Medicaid. Health insurance for low income individuals.
The publicly traded companies are most exposed to the commercial business on a
market weighted basis, so the prospects of the commercial business will generally drive
group stock performance. However, the government businesses are the fastest growing
and are therefore increasingly important. We review the different products in more
detail below.
Managed Care | 08 May 2018 3
W
, Table 2: Product Overview
Commercial Non-
Commercial Risk risk Medicare Advantage Medicare - Part D Managed Medicaid
Health insurance for poor
Administrativ e services
Health insurance for Health insurance Prescription drug plans people; administrativ e
Description for employ ers with self-
groups and indiv iduals for Seniors for Seniors serv ices for state
funded plans
Medicaid programs
Customer Groups and indiv iduals Employ ers Federal gov 't/Seniors Federal gov 't/Seniors States/poor people
Market size (est. 2018) $390bn $30bn $230bn $110bn $310bn
Total enrollment 81m 95m 21m 45m 55m
Revenue PMPM (est. 2018) $400 $25 $900 $120 $200-$2,000
Pre-tax margin (est. 2018) 4-7% 15% 5% 3% 3%
Profit PMPM (est. 2018) $16-28 $4 $45 $4 $6-60
% of core medical enrollment
AET 19% 58% 6% 9% 8%
ANTM 18% 63% 2% 1% 16%
CNC 17% 0% 4% 0% 79%
CI 18% 75% 3% 5% 0%
HUM 12% 4% 31% 50% 3%
MOH 18% 0% 1% 0% 81%
UNH 20% 43% 10% 11% 16%
WCG 0% 0% 11% 26% 62%
Source: BofA Merrill Lynch Global Research
Companies generally don’t break out earnings exposure by product. However, below we
show our estimates for 2019E standalone earnings exposure by product by MCO.
Notably, UNH has the largest “other” exposure by far, driven by Optum, while we
estimate that CNC also derives a substantial amount of its earnings from its services
business.
Table 3: Earnings exposure by product estimates
2019E pretax
earnings % by Commercial Commercial Medicare Medicare - Managed
product Risk Non-risk Advantage Part D Medicaid International Other
AET 36% 23% 24% 1% 5% 2% 9%
ANTM 42% 22% 9% 1% 17% 0% 10%
CNC 14% 18% 2% 0% 20% 2% 44%
CI 26% 21% 6% 1% 1% 15% 31%
HUM 12% 1% 62% 3% 2% 0% 19%
MOH 8% 0% 9% 0% 61% 0% 23%
UNH 12% 4% 19% 1% 7% 3% 52%
WCG 0% 0% 38% 3% 49% 0% 10%
Source: Company reports, BofA Merrill Lynch Global Research estimates
Primarily a U.S.-focused industry
Most of the publicly traded managed care companies have limited international
exposure with the exception of CIGNA (CI) and UnitedHealth Group (UNH). More
recently, other companies have indicated interest in expanding their international
businesses in a more meaningful way.
The international business represents a faster revenue growth opportunity than the U.S.
business given the nascent market for health insurance in many countries. However,
there is significantly less visibility into the operating fundamentals of international
business given significant health care system differences between countries.
Long-term EPS growth of 10-13%
We believe that the group could show 10-13% long-term EPS growth. Top line growth
of 6-9% appears achievable driven by 3-4% enrollment growth (well above population
growth driven by strong government growth) and 3-5% net premium yields (5-7% cost
trend less benefit buy downs and mix shift). To the extent that companies focus more
on government growth, membership growth will be higher but rate growth will be lower.
Overall, while we’d expect a stable medical loss ratio (MLR) within a given product, the
shift toward government should drive MLR up for a typical company. Meanwhile, modest
4 Managed Care | 08 May 2018
W
Managed Care Primer 2018 – Drivers of a
dynamic and growing sector
Industry Overview Equity | 08 May 2018
Managed Care Primer – in-depth industry overview United States
Managed Care
In our seventh annual Managed Care Primer, we provide an overview of the $1 trillion
managed care industry and a detailed analysis of the industry’s growth drivers. This
Kevin Fischbeck, CFA
report is organized to help investors understand how managed care organizations Research Analyst
MLPF&S
(MCOs) make their money and what competitive advantages are necessary to succeed +1 646 855 5948
long term for each product type (commercial, Medicare, and Medicaid). In addition, we
review Health Care Reform, dual eligibles, investment portfolios, capital requirements, Catherine Anderson
Research Analyst
accounting nuances and non-core products. Finally, we lay out the case for sustained MLPF&S
earnings growth in the low double digits over the long term with mid-teens total returns. +1 646 855 4345
Low-double-digit long-term EPS growth, mid-teen returns
We believe that the group could show 10-13% long-term EPS growth. Top line growth Table 1: Managed care subsectors
of 6-9% appears achievable driven by 3-4% enrollment growth (well above population Market
cap
growth driven by strong government growth) and 3-5% net premium yields (5-7% cost
Ticker Company ($B)
trend less benefit buy downs and mix shift). While we’d expect a stable medical loss Diversified
ratio (MLR) within a given product, the shift toward government could drive MLR up for AET Aetna $56.8
a typical company. Meanwhile, modest leverage on G&A should offset this, leading to ANTM Anthem $61.3
EBITDA growth of 6-9%, in line with revenue growth. Finally, capital deployment through CI CIGNA $42.1
UNH UnitedHealth Group $232.8
a combination of share repurchase and acquisitions could push EPS growth to 10-13%.
In addition to this EPS growth, most large cap MCOs pay a dividend in the 1.5% range. Medicare
HUM Humana $39.9
Analyzing the impact of HC reform on each subsector
We provide a detailed review of Health Care Reform and the implications for the sector, Medicaid
CNC Centene Corporation $20.7
analyzing the outlooks for the exchanges, Medicaid expansion, and Medicare Advantage
MOH Molina Healthcare $5.5
(MA). We view MA as the fastest growing sector in managed care over the next 10+ WCG WellCare Health Plans $9.9
years, driven by aging baby boomers, increased penetration, and improving rates. Source: Bloomberg, BofA Merrill Lynch Global Research
Keys: Scale, medical mgmt and quality
Competitive advantages vary between products, but scale is a common denominator.
Companies with large membership bases can generate lower overhead costs per
member by leveraging technology investments and care management platforms. SG&A
leverage is even more important post Health Care Reform when gross margins are
capped through minimum MLR. Meanwhile, given that much of the future membership
growth is coming from government businesses where pricing is dictated to the MCOs,
medical management capabilities increasingly are a differentiator. Finally, quality is
increasingly being factored into the reimbursement system.
We address some commonly asked questions
We address a number of commonly asked questions including: If managed care
companies save money, why is commercial cost trend so high? How does Health Care
Reform impact managed care? What is the outlook for the public exchanges? What
indicates that a company is well reserved? How fast can Medicare Advantage grow as a
percentage of Medicare enrollment? Why would Medicaid Managed Care rates hold
steady during a time of state budget issues? What are block grants and what would the
impact be to Medicaid Managed Care? Vertical integration and what other areas are
MCOs investing in? How much of tax reform can MCOs keep?
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports.
As a result, investors should be aware that the firm may have a conflict of interest that could
affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision.
Refer to important disclosures on page 342 to 344. Analyst Certification on page 340. Price
Objective Basis/Risk on page 339. 11872349
Timestamp: 08 May 2018 12:05AM EDT
W
,Contents
Industry overview 3
Commercial business 7
Medicare business 75
Medicare Part D business 121
Medicaid business 128
Dual eligibles 149
Other services 155
Capital analysis 170
Tax reform 183
Health care reform 198
Evolving payment models 238
Accountable Care Organizations 246
Capitation 252
Accounting 275
Valuation 299
Company snapshots 304
Glossary 335
2 Managed Care | 08 May 2018
W
,Introduction
In our seventh annual Managed Care Primer, we provide an overview of the $1 trillion
managed care industry and a detailed analysis of the industry’s growth drivers. This
report is organized to help investors understand how managed care organizations
(MCOs) make their money and what competitive advantages are necessary to succeed
long term for each product type (commercial, Medicare, and Medicaid). In addition, we
review Health Care Reform, dual eligibles, investment portfolios, capital requirements,
accounting nuances and non-core products. Finally, we lay out the case for sustained
earnings growth in the low double digits over the long term with mid-teens total
returns.
If managed care companies save money, why is commercial cost trend so high? See
Commercial cost trends
How does Health Care Reform impact managed care? See Health care reform
What is the outlook for the public exchanges? See What is the outlook for the public
exchanges?
What indicates that a company is well reserved? See Accounting: Reserves
How fast can Medicare Advantage grow as a percentage of Medicare enrollment? See
CBO projects MA enrollment will continue to rise
Why would Medicaid Managed Care rates hold steady during a time of state budget
issues? See Rates are more closely tied to MCO margins than state budgets
What are block grants and what would the impact be to Medicaid Managed Care? See
Impact of Medicaid block grants
Vertical integration and what other areas are MCOs investing in? See Other services
How much of tax reform can MCOs keep? See Tax reform
Industry overview
Managed care organizations (MCOs) provide and administer health insurance through
risk-based and administrative services only (ASO) products. Most of the publicly traded
companies primarily focus on the U.S. managed care industry, which has a market size
of over $1 trillion. There are multiple products in the managed care industry with
fundamentally different characteristics (see Table 2). Accordingly, it is important to
recognize the varying product mixes at the publicly traded companies when analyzing
industry trends.
There are three main business categories:
• Commercial. Health insurance for employees and individuals/families.
• Medicare. Health insurance (Medicare Advantage) and drug coverage (Medicare
Part D) for seniors (age 65+).
• Medicaid. Health insurance for low income individuals.
The publicly traded companies are most exposed to the commercial business on a
market weighted basis, so the prospects of the commercial business will generally drive
group stock performance. However, the government businesses are the fastest growing
and are therefore increasingly important. We review the different products in more
detail below.
Managed Care | 08 May 2018 3
W
, Table 2: Product Overview
Commercial Non-
Commercial Risk risk Medicare Advantage Medicare - Part D Managed Medicaid
Health insurance for poor
Administrativ e services
Health insurance for Health insurance Prescription drug plans people; administrativ e
Description for employ ers with self-
groups and indiv iduals for Seniors for Seniors serv ices for state
funded plans
Medicaid programs
Customer Groups and indiv iduals Employ ers Federal gov 't/Seniors Federal gov 't/Seniors States/poor people
Market size (est. 2018) $390bn $30bn $230bn $110bn $310bn
Total enrollment 81m 95m 21m 45m 55m
Revenue PMPM (est. 2018) $400 $25 $900 $120 $200-$2,000
Pre-tax margin (est. 2018) 4-7% 15% 5% 3% 3%
Profit PMPM (est. 2018) $16-28 $4 $45 $4 $6-60
% of core medical enrollment
AET 19% 58% 6% 9% 8%
ANTM 18% 63% 2% 1% 16%
CNC 17% 0% 4% 0% 79%
CI 18% 75% 3% 5% 0%
HUM 12% 4% 31% 50% 3%
MOH 18% 0% 1% 0% 81%
UNH 20% 43% 10% 11% 16%
WCG 0% 0% 11% 26% 62%
Source: BofA Merrill Lynch Global Research
Companies generally don’t break out earnings exposure by product. However, below we
show our estimates for 2019E standalone earnings exposure by product by MCO.
Notably, UNH has the largest “other” exposure by far, driven by Optum, while we
estimate that CNC also derives a substantial amount of its earnings from its services
business.
Table 3: Earnings exposure by product estimates
2019E pretax
earnings % by Commercial Commercial Medicare Medicare - Managed
product Risk Non-risk Advantage Part D Medicaid International Other
AET 36% 23% 24% 1% 5% 2% 9%
ANTM 42% 22% 9% 1% 17% 0% 10%
CNC 14% 18% 2% 0% 20% 2% 44%
CI 26% 21% 6% 1% 1% 15% 31%
HUM 12% 1% 62% 3% 2% 0% 19%
MOH 8% 0% 9% 0% 61% 0% 23%
UNH 12% 4% 19% 1% 7% 3% 52%
WCG 0% 0% 38% 3% 49% 0% 10%
Source: Company reports, BofA Merrill Lynch Global Research estimates
Primarily a U.S.-focused industry
Most of the publicly traded managed care companies have limited international
exposure with the exception of CIGNA (CI) and UnitedHealth Group (UNH). More
recently, other companies have indicated interest in expanding their international
businesses in a more meaningful way.
The international business represents a faster revenue growth opportunity than the U.S.
business given the nascent market for health insurance in many countries. However,
there is significantly less visibility into the operating fundamentals of international
business given significant health care system differences between countries.
Long-term EPS growth of 10-13%
We believe that the group could show 10-13% long-term EPS growth. Top line growth
of 6-9% appears achievable driven by 3-4% enrollment growth (well above population
growth driven by strong government growth) and 3-5% net premium yields (5-7% cost
trend less benefit buy downs and mix shift). To the extent that companies focus more
on government growth, membership growth will be higher but rate growth will be lower.
Overall, while we’d expect a stable medical loss ratio (MLR) within a given product, the
shift toward government should drive MLR up for a typical company. Meanwhile, modest
4 Managed Care | 08 May 2018
W
