Investors' Biggest Misconception About Obamacare

This investor concern about Obamacare isn't really much of a concern at all if you understand the big picture.

Feb 19, 2014 at 2:10PM

By the numbers, Obamacare has failed to live up to its billing thus far, at least in the eyes of more than half of Americans.

Opposition to this transformative health law is at or near an all-time high, and total enrollments of 3.3 million people are tracking below the targeted 7 million offered up by the Department of Health and Human Services before the state and federal marketplace exchanges were launched on October 1. Furthermore, a plethora of deadline delays have eroded the urgency needed to get young adults and the currently uninsured to sign up prior to the March 31 coverage cutoff for obtaining health insurance in 2014.

Looking in all the wrong places
In spite of these figures and a number of heated exchanges between Obamacare proponents and opponents, one gigantic misconception about this law is still prevailing. This "biggest misconception," as I like to call it, is none other than the belief that Obamacare could wreak havoc on U.S. health insurers' profits, and that Obamacare will be a make-or-break program for our national insurers.

There is, in some small context, truth to this statement -- but not really for the reasons you're probably thinking of.

The traditional view of Obamacare proponents and skeptics is that few young adults will sign up for health insurance, causing insurers, which are now required under the Patient Protection and Affordable Care Act to accept citizens that have preexisting conditions, to pay much more out of their own pockets. As these medical expenses rise, insurers' profits will fall.

However, I'd interject that insurers' profits could fall for a number of other reasons. Perhaps the largest of those reasons is simply health-care sector uncertainty. No one really understands how Obamacare is going to directly affect hospitals or insurers yet, so hospitals have been a bit tighter with their spending on new equipment, and insurers have been a bit less enthusiastic about approving expensive surgeries for patients or prescribing branded medication. This ripple effect of expense-holstering has a negative effect on much of the sector, including insurers.

Obamacare's biggest misconception
Perhaps the biggest misconception for investors with regard to Obamacare is that individual exchange enrollment represents a big chunk of revenue to insurers. With the exception of WellPoint (NYSE:ANTM), which purchased Amerigroup for $4.5 billion last year and purposely targeted as many new enrollees as possible, Obamacare enrollment represents but a blip for most national insurers.

As my Foolish colleague and health care analyst David Williamson pointed out recently, CIGNA (NYSE:CI) and Aetna (NYSE:AET) have only witnessed approximately 20,000 and 200,000 enrollees from Obamacare -- and they're both admittedly losing money from the exchange, which again is not surprising given the high levels of uncertainty abounding. To add context to these figures, Aetna's revenue exposure to the exchange is just a mere 3%, and CIGNA's is even less than that. Yet, for all intents and purposes, investors appear ready to knock down the gates with fire and pitchforks in hand because Aetna and CIGNA are cautious about their near-term growth.

Health Piggy Bank

Source: Tax Credits on Flickr.

The truth of the matter is that Aetna and CIGNA can comfortably deal with losses in their relatively small Obamacare segments because of three factors.

One, the percentage of revenue generated from Obamacare doesn't perfectly correlate with the percentage of impact witnessed in these companies' bottom lines. All things considered, Aetna's Obamacare enrollment, which comprised 3% of its revenue, only has a plus or minus 1% effect on its EPS. What we're really talking about here is just a few pennies in EPS at most.

Two, these insurers derive a majority of their income from the commercial side of the business. This is why we saw a number of big-name insurers, such as CIGNA, Aetna, and UnitedHealth Group (NYSE:UNH) drop out of competitive marketplaces such as California in May of last year, because it's not worth fighting incumbent insurers in those states for what amounts to a low single-digit, and still relatively uncertain, revenue stream.

Finally, provisions built into Obamacare's reinsurance fund protect insurers against steep losses. If an insurers' medical expense ratio tops 108% -- meaning it spends $1.08 or more in medical costs for every $1 in premium it brings in -- a reinsurance fund kicks in that provides a failsafe subsidy to the insurer, thus encouraging it to remain on the exchange.

Stay the course
If you're an investor in national insurers like CIGNA, Aetna, and UnitedHealth Group, my suggestion would be to stop worrying so much about these initial enrollment figures and instead focus on what these companies do best, which is move premium pricing to their advantage and grow the commercial side of their business.

At 10, 10, and 12 times forward earnings, respectively, CIGNA, Aetna, and UnitedHealth Group are still in control of their premium pricing and are producing healthy profits. Once the uncertainty around Obamacare clears, these companies, whether they remain a part of Obamacare's exchanges or drop out as Aetna has threatened to do under the right conditions, could become targets for value-seeking investors.

Still trying to figure out the big picture of how Obamacare will affect you? Let us help!
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of, and recommends WellPoint. It also recommends UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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