3 Reasons Humana Inc. Stock Could Rise

Humana's focus on Medicare insurance products means that it's well positioned to benefit from retiring baby boomers.

Aug 29, 2014 at 6:30PM

Investors have a lot of choices when it comes to investing in healthcare insurers, but considering the specific markets targeted by each insurer may make it easier to find the right investment. For example, investors interested in insurers benefiting from Medicaid expansion may be more interested in specialty healthcare insurers like Molina Health that get most of their revenue from running state health insurance programs.

Investors looking for diversification may be better served by UnitedHealth Group because its customers include individuals, small and big businesses, and those enrolled in government programs. If, instead, investors are looking to own a Medicare-based insurer that is likely to benefit from aging baby boomers, they may find that they're best served by focusing on Humana (NYSE:HUM), which gets more than 75% of its revenue from Medicare-related products.

Of course, there's no telling whether any of those stocks will go up or down -- Humana included. After all, stocks rise and fall based on any number of factors, and that's particularly true of insurers, given that they're highly exposed to regulatory risk. With that in mind, let's consider three reasons why Humana's shares may go up, rather than down.

Humana Exterior Angle

Source: Humana.

1. Millions of potential new members
Insurance is a business of scale. The more members you have, the more money you can make.

Because the over-65 population is expected to double as 10,000 baby boomers hit that milestone every day between now and 2029, demand for Medicare is likely to surge. That could mean good things for Humana, given that it markets Medicare Advantage plans that can be purchased by boomers as a Medicare alternative.

Just how much potential demand for Medicare products could there be? Consider that, in 2010, 11% of all Americans were age 65 years or older, and by 2030, that percentage will increase to 18%.

That trend is already benefiting Humana. Membership in Humana's individual Medicare Advantage plans grew 16.4%, or 333,300 members, to 2.36 million people in the past year, lifting Humana's revenue from Medicare plans to $8.8 billion in the second quarter from $7.5 billion a year ago.

2. Strength on the edges
During the coming decade, Medicare is going to be the biggest reason for Humana's success or failure; but that doesn't mean that insurance exchange marketplaces won't have an impact on Humana in the short term. Currently, sales from the ACA marketplace represent just 1% of sales, but increasingly more members coming from the exchanges still means revenue growth for the company.

Thanks to the exchanges, Humana's individual membership jumped by 122%, to 1.1 million people during the second quarter. That helped its sales of fully insured products climb from $1.6 billion a year ago to $2.2 billion during the quarter.

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Source: Humana.

3. Controlling costs
Providing care to seniors isn't cheap. Older patients require more services, and tend to take far more prescription medications than younger patients. That means that Humana will need to be creative if it hopes to keep its expenses in check.

One way it may be able to reduce its cost of care is by increasing its buying power. Currently, Humana operates its own pharmacy benefit manager, which negotiates prices with drugmakers. While Humana's PBM isn't small -- Humana serves 13.6 million members -- it's not nearly as big as CVS Caremark or Express Scripts. If Humana can partner with a larger PBM, it may be able to negotiate lower prices for medicine.

Humana is also rolling out cost-saving programs that boost preventative care, particularly in high-risk patients, or patients with chronic conditions. Those programs are designed to reduce hospitalizations and readmissions, which can go a long way to lowering Humana's expenses.

For example, healthcare costs for members enrolled in Humana's Chronic Care Program, or HCCP, are 40% lower than costs for those who haven't enrolled in HCCP. Results for Humana's Transitions program are similarly impressive. Transitions members are 50% less likely to be readmitted to the hospital after being discharged than those who haven't enrolled in the program.

Fool-worthy final thoughts
It's not all clear sailing for insurers. Humana's profit is being squeezed on one side by the approval of next generation, high-cost medicine, and on the other side by members demanding lower monthly premiums. That suggests that pressure on insurer margin isn't going to ease anytime soon.

However, the significant opportunity for membership growth suggests that, as long as margins remain similar to current levels, earnings should continue to trend higher. If so, investors willing to take the long view on Humana may find that they're rewarded with higher share prices.

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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 has no position in any of the stocks mentioned. 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.

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