Recent funding for health-care co-ops designed to boost insurance competition hearkens back to post-Great Depression regulations that led to creation of hundreds of small health-care co-ops throughout the farm belt.
Although only a few of those New Deal co-ops have flourished and grown into dominant players, nearly two dozen new co-ops launched last year thanks to $2 billion in federal loans and grants.
Those new co-ops hope to serve as important health-care insurance alternatives to plans offered under the Affordable Care Act by large for-profit insurers including Aetna (NYSE:AET) and WellPoint (NYSE:ANTM). However, results for co-ops in the first open enrollment period were mixed.
In New York, Health Republic Insurance expected to sign up just 18,000 members, but ended up registering more than 112,000. Conversely, Health Alliance Mutual Insurance had hoped to sign up 25,000 people in Tennessee, but only ended up winning 325 members.
Those early hit-or-miss results suggest the jury is still out on whether co-ops can thrive on the marketplaces. If they can, they could win away valuable members from some of the industry's biggest players.
A bit of background
Providing a public option that would compete against private insurers like Aetna and WellPoint proved too risky for lawmakers, who compromised by providing funding to new member-owned and managed co-ops that could increase competition in smaller markets and help reduce premiums.
That compromise included access to loans and grants totaling $2 billion that co-ops could use to build their network and satisfy state regulatory solvency requirements. In total, 23 co-ops opened for business when Healthcare.gov, the federal health-insurance marketplace, went live in October.
A new way of thinking
Health-care co-ops operate differently than private insurers.
Co-ops are, by definition, not-for-profit. That means that all money above and beyond expenses must either be returned to members or used to improve members' health (including reinvestment in the business).
That's a stark contrast to the for-profit insurance industry that serves the vast majority of Americans.
Profit margin has always been scarce for insurers. Their operating margin is typically just in the mid-single digits.
Yet despite their thin margins, those companies use their scale to deliver billions of dollars in annual profit. Aetna, for example, provides insurance to over 20 million people and collected $14 billion in premiums in the first quarter. WellPoint, which serves nearly 37 million members, posted first-quarter revenue north of $17 billion.
The ability to leverage those billions in revenue across massive networks allowed both companies to generate significant earnings for shareholders. Aetna's first-quarter net income was $665 million, while WellPoint collected $885 million.
The profit produced by the for-profit insurers suggests there could be significant opportunity for co-ops to offer lower premiums. Despite having limited actuarial experience, co-op prices turned out to be very competitive this year.
According to McKinsey research, co-op insurance plans represented 37% of the lowest-priced plans offered in states in which they participated.
Fool-worthy final thoughts
On their own, co-ops won't necessarily solve the problem of skyrocketing health-care costs, but they could serve as part of a broader solution to slowing how quickly those expenses climb.
Although 2014 prices were very competitive, we don't know if those prices were sufficient to cover the cost of member care. If not, co-ops may be forced to increase premiums for 2015 to remain solvent.
If co-ops achieve enough scale to survive, they'll win away members who would otherwise end up on plans offered by insurers such as Aetna and WellPoint. While that would reduce revenue growth for those insurers, there appears to be plenty of marketplace members to go around. For example, in the first open enrollment period, WellPoint signed up more than 600,000 new members. That was handily higher than the 450,000 members that co-ops enrolled nationwide.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends WellPoint. The Motley Fool owns shares of WellPoint. 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.