What These Cuts Mean for UnitedHealth

UnitedHealth Group (NYSE: UNH) recently stated that funding cuts for private Medicare could negatively affect its 2014 earnings. The leading health insurer's recent earnings announcement warned that implementation of the Affordable Care Act along with Medicare Advantage cuts could hit United's earnings by as much as $1.50 in 2014. However, the company will be able to overcome possible losses in the long-term.

The company's reported fourth-quarter net income was $1.43 billion, or $1.41 a share. This is compared with $1.24 billion, or $1.20 a share for the fourth quarter of 2012. Meanwhile, revenue was $31.1 billion compared to $28.8 billion for the 2012 period. Full-year earnings were $5.50 per share, up from 2012′s $5.28, and sales climbed to $122.5 billion against last year's $110.6 billion. 

United CEO Stephen Hemsley said during a recent conference call that the company intends to offset these reductions with other "plans and actions" while growing revenue to a range of $128 billion to $129 billion.  

While this may comfort analysts and investors this year, the Centers for Medicare and Medicaid Services is due to announce a proposed funding rate for 2015. Mr. Hemsley also noted United Health is "in discussions" with the agency on the anticipated funding levels.

Why Medicare Advantage cuts matter
As has been reported, government funding for Medicare Advantage plans (which are privately run versions of the federal Medicare program) is being significantly cut to help fund the health care overhaul. UnitedHealth, the biggest provider of Medicare Advantage plans, has warned in prior earnings reports cuts will put pressure on earnings as enrollment in these plans starts to slow.

UnitedHealth's key rival in the Medicare Advantage market is Humana (NYSE: HUM) (NYSE: HUM  ) . Humana's share price grew by more than 50% in 2013. The company's management noted in its most recent earnings announcement that Humana anticipates slower growth in its Medicare Advantage offerings, however. The company also faces the possibility of market share losses because of greater competition through the health care exchanges.

Humana has taken steps to overcome these hurdles by diversifying. The objective is to capitalize on inevitable changes to the health care sector as the ACA takes shape. For example, the company's foray into the mini-clinic sector with the Concentra acquisition in 2010 puts Humana in a good position in the long run. As for the extent to which Humana's Medicare Advantage program will take a hit in 2014, investors should pay attention to the next earnings announcement on Feb. 5.

The silver lining
UnitedHealth's "plans and actions" referred to by the insurer's CEO include the health care services unit Optum, where revenue jumped 26% to $37 billion in 2013. The pharmacy services division is also part of Optum's operations where revenue grew by 31%. Optum is also comprised of the Quality Software Services division, the overseer of remedies for the ACA website Healthcare.gov. 

UnitedHealth is also participating in the ACA's health exchange scheme. The company's participation has been limited thus far, however, and the insurer intends to study the development of the exchanges as the year progresses.  Given the spotty roll out of the ACA and enrollment targets coming up short, United Health's cautionary approach is a smart play.

Meanwhile, a competitor like Aetna has a greater stake in the exchanges because the company is participating in more exchanges. If enrollment numbers start to dramatically improve, Aetna will capitalize on subsidies that are part of the ACA package for individuals who cannot afford the premiums. It is unclear at this juncture what the prognosis is for future enrollments, however. Aetna is also facing earnings losses related to its Medicare Advantage plans.

Going forward, UnitedHealth reaffirmed its full-year fiscal 2014 forecast which calls for revenue of $128 billion to $129 billion, showing 5% year-over-year growth. The company also anticipates earnings per share to hold steady this year despite the possible Medicare Advantage losses. 

While the ACA funding cuts to Medicare Advantage will be a drag on UnitedHealth's earnings, the company has actions already in play like the services offered by Optum to offset these losses. Moreover, the company's cozy relationship with the Administration as a fixer of the Healthcare.gov website and the insurer's participation in the health exchanges should give UnitedHealth some leverage as the ACA reforms kick in.

The bottom line
The ACA mandated funding cuts to Medicare Advantage offerings by health insurers will affect earnings in 2014. Moreover, the competition being ushered in by way of the health care exchanges will also influence market share. But the long-term future of the health care reform measure is also uncertain.

Obviously, the ACA rollout has been troubled. It is highly unlikely that the law will be repealed as GOP lawmakers once championed, however. Insurers are working with the government behind the scenes since it is in their mutual best interest to do so.

In the final analysis, UnitedHealth has a long track record of solid growth and currently has more than 83 million subscribers. The insurer should remain a key player in the managed health care industry. With a market cap of about $72 billion, the company can tap into a healthy cash flow to implement other diversification strategies. In short, these factors should position United Health to continue to prosper as health care reforms are implemented.

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