For much of 2016, talk about health insurer Anthem (ANTM +2.28%) has centered on its merger discussions with industry peer Cigna (CI +0.00%). Yet with no decision expected from the U.S. Department of Justice on whether it will give its approval for the merger to go ahead, investors can't afford to lose sight of the insurer's fundamentals.
Coming into Wednesday's third-quarter financial report, Anthem investors were prepared to see declines in earnings from year-ago levels despite modest revenue growth, and that's largely consistent with what Anthem's results final results were.
Let's take a closer look at how Anthem did during the quarter and what investors should expect for the rest of 2016 and beyond.
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Anthem deals with a falling bottom line
Anthem's third-quarter financial results were mixed in the eyes of most investors. Operating revenue climbed 7% to $21.2 billion, outpacing the $20.8 billion consensus forecast among those following the stock. However, net income fell 6% to $617.8 million, and after taking account of certain extraordinary items, adjusted earnings of $2.45 per share were down about 10% from year-ago levels and were $0.02 per share less than shareholders had expected.
Taking a closer look at Anthem's results, the biggest issue that the insurer faced was a substantial rise in its benefit expenses. Anthem spent $16.92 billion on benefit payouts during the quarter, up 9.4% from year-ago levels and outpacing the rate of growth in overall revenue. That sent the company's benefit expense ratio, or expenses as a percentage of premiums, up by almost 2 full percentage points to 85.5%. Anthem said that poor medical cost experience in the Medicaid business, especially in the state of Iowa, exacerbated what is already traditionally a higher-cost segment. Also, unfavorable loss experience in the individual segment was only partially offset by lower cost experience in the local group segment.
Yet Anthem's overall enrollment figures continued to climb. Overall, Anthem counted 39.9 million members at the end of the quarter, up by 1.2 million since this time last year. Medicaid enrollment was the biggest gainer, climbing 554,000, but substantial gains in national corporate customer counts amounted to nearly 530,000. Smaller gains in local group and individual coverage also added to Anthem's enrollment totals. Financially, the government business saw greater revenue gains than the commercial and specialty segment, but operating gains climbed in the commercial business even as they slid by nearly a quarter on the government side of Anthem's business.
CEO Joseph Swedish was happy with how Anthem performed. "Our third quarter results reflected our focus on improving affordability for our members and capitalizing on growth opportunities across our businesses," Swedish said. "The strong membership growth across the majority of our lines of business this year is further testament to the value proposition we bring to the marketplace."
Can Anthem help its earnings bounce back?
One concern that investors should keep in mind is that medical cost inflation continues to outpace the overall rate of rising prices in the economy by a substantial margin. Anthem said that it believes that medical cost trends in its local group segment should come in between 7% and 7.5% for the full 2016 year, which is quite high in a 2% inflation environment for the broader economy.
Anthem's guidance remained largely similar to its previous predictions. The insurer now expects GAAP net income to be about $9.28 per share, but that came from upward revisions to its total expected unfavorable extraordinary items of $1.52 per share. That allowed Anthem to keep its projection for adjusted net income of $10.80 per share, which it has had for most of the year. On the membership front, Anthem expects between 39.65 million and 39.85 million members, and full-year expense ratios should come in between 84.6% and 85.2%.
Anthem shares didn't respond dramatically to the news, climbing higher by about 0.5% in pre-market trading following the announcement. With so much uncertainty about the eventual fate of mergers in the health insurance industry, Anthem investors will need to keep watching the company's operations closely to make sure that it can keep up enough positive momentum to be comfortable going forward on its own if the DOJ eventually rejects its deal with Cigna.
