Obamacare Helps Profit Soar At This Big Insurer

Much has been said and projected about the Affordable Care Act and its impact on health insurers. A number of insurance companies' guidance foresaw losses as new regulations went into effect, but Anthem (ELV 1.11%) had no such qualms and predicted gains even as enrollment and risk pools underwent change.

Anthem's most recent results bear out this confidence, with adjusted net income up $3.14 per share over last year, but can it last? Tune in to this health care edition of Industry Focus to learn what Anthem's results can teach investors about the sector as a whole, and whether its success story can be expected to continue into the future.

A full transcript follows the video.

Michael Douglass: A leader in the health insurance space reports, and what it tells us about the Affordable Care Act. This is Industry Focus.

[INTRO]

Hi Fools, health care analyst Michael Douglass here today. Back to our regularly scheduled programming with Todd Campbell, from New Hampshire. Todd, welcome back!

Todd Campbell: Thank you, thank you.

Douglass: Fantastic. Let's jump right into it. We wanted to talk a little bit today about Anthem, which some of you may have known by its previous name, WellPoint.

They reported earnings very recently and we wanted to just go through their earnings and talk about what those earnings indicate for health insurance companies as they work in this new environment, with the Affordable Care Act.

When I say "new" -- comparatively new. The ACA, various pieces of it, have been taking effect over the last couple of years.

I think Anthem really shows how an insurer can operate in that environment -- that, in some ways, more closely regulated environment -- and do a really good job for its shareholders. Let's jump right in. You look at the headline numbers; adjusted net income up what, $3.14 per share, up 30% year over year?

Campbell: Yes, you can't complain about these numbers.

Douglass: It's hard to be unhappy with that number!

Campbell: Yes, and you're right. In the history of health insurance, this is relatively new territory.

We're at version 2.0 of the ACA, for the enrollment in the exchanges. Of course everybody's been thinking ahead and saying, "What's that going to mean? Is utilization going up to a level where they're not going to be able to price these things accurately? If they don't price them accurately, are they going to end up losing money?"

It just shows that, when it comes to insurers, never doubt their ability to price products correctly.

Douglass: Yes, and I'd say particularly that's the case with Anthem. You had a bunch of the other insurers guiding that they expected to lose money, or that they were going to have trouble with understanding the risk pools and the ACA.

Anthem basically just said, "No." This was back when they were WellPoint, of course. They just said, "You know what? We think we've priced to make a little bit of money. We'll see, but we're going to play aggressively in what could be a really big growth space."

The Affordable Care Act, as background, has resulted in many millions of new Americans getting insurance, and that has really been a big boon for the insurance companies that have been aggressive in seeking that membership.

I think there are few more so than Anthem that have really been aggressive in playing in the exchanges and ramping up the Medicaid business. Anthem bought Amerigroup a few years back, to really ramp into that government business, and it's paid off very well for them.

Campbell: One of the things I think people tend to ... when they think of the ACA, they think of the exchanges only. They kind of forget about the fact that, "Oh yeah, we also expanded Medicaid."

Obviously, we only expanded Medicaid in the states that were willing to adopt it, so it really fell along party lines. But there were still enough states that expanded it, and still enough follow-on effects from those states that did expand it, that membership has soared in Medicaid programs, and that's been a huge win for companies like Anthem.

In the quarter ... to break down the nuts and bolts, because a $3.14 just net income number, that's excellent.

Douglass: Yes, that's fantastic.

Campbell: We're not going to complain about that.

Medical membership, if you look at where they were at the end of December, to where they are at the end of March, they added a million people. That's a lot of new lives that they're covering.

Not all of those people came from the exchanges. In fact, where they added a lot of people was in the Medicaid business. There were an extra 429,000 lives added in the Medicaid business.

Some of that came courtesy of the acquisition, but the reality is that since Medicaid expansion went into effect back at the end of 2013, they've added 11.2 million people nationwide to Medicaid programs.

Those programs are run, in many states, by private insurance companies like Anthem, that are being hired by the state to more efficiently serve these members. This is a big business, and it's accounting for a significant amount of Anthem's success in the last two years.

To your point though, yes the exchanges have also been a big win for them.

Douglass: Yes, and I think that's a good point, that Medicaid expansion has certainly been a lot bigger for a lot of companies.

I think they key question investors have to ask, though is, "Cool, so you've gotten all these new members. Did you price correctly for them?" Benefit/expense ratio is what Anthem calls it. Other people call it the Medical Benefit Ratio, the Medical Loss Ratio.

Whatever way you slice and dice it, essentially it's percentage of premiums that you take in, that you pay out for care, for drugs, for medical expenses of one sort or another.

Their benefit expense ratio -- lower is better, in the insurance industry, and you saw their decline. It was 80.2% in the first quarter of 2015, which was down from almost 83% in the first quarter of 2014.

It's clear that not only have they grown, but they've grown in such a way that they're still able to price correctly and make sure that money is flowing down to the bottom line.

Campbell: One of the things, Michael, that you and I always try to do when we have these conversations is pull out one thing that investors should really have a takeaway on, when it comes to investing.

I think you just touched on something that's really important for people to be aware of when they're investing in health insurance stocks, and that is if you're going to know any ratio that is reported in these reports -- and it doesn't matter if you call it the Medical Loss or Medical Care Ratio, or what you call it.

Douglass: Whatever.

Campbell: It's got to be that number. It's going to tell you whether or not the companies are doing a great job on pricing, and whether or not they're doing a really good job on launching programs to help educate their members and help to keep costs down.

The last thing you want to do is end up with one of your members having something that's not a serious issue, become a serious issue, that ends up in hospitalization or even more costly care, or a chronic disease, or whatnot.

You look at that number and you say, "Wow ..." Typically speaking, I like to see between 80% and 85%. You're going to get fluctuation, quarter to quarter. I see 80.2% and I'm like, "Well, that's a slam dunk. It was a great quarter."

There's no getting around it. They're executing. They've priced their products well, they're getting more members, they're making more money on each one of those members. It's hard to imagine that that's going to end, given that we still have millions more people that haven't gotten insurance.

It's unlikely that we're going to see, in my opinion, something significant shift, that would eliminate the provisions of the ACA for these millions of people who have recently signed up.

I guess that would be the biggest risk that people would throw out there is saying, "I don't necessarily want to buy a health insurer. What happens if they repeal ACA and millions of people are no longer receiving the insurance?"

I don't think investors should be focusing on that. I think investors should instead by saying, "You know what? The trend over time is going to be for an increasingly insured America." As long as companies like Anthem can price appropriately and can keep a lid on those costs like they have been, investors should feel pretty confident owning stocks like Anthem.

Douglass: It's also one of those things where, my sense is that a lot of the same folks who would make the argument that, "Maybe we should be worried about health insurers because of ligatory issues around the ACA," are a lot of the same folks who are saying, "Well, the ACA amounts to a government takeover of health care, and health insurers aren't going to benefit from it."

Certainly not all health insurers have benefited equally from it but some, like Anthem, have done a really good job of it. I think folks who were naysayers about Anthem's ability to price profitably and to really make a lot of money from the Affordable Care Act, have largely been disproven at this point.

As you pointed out earlier, never doubt a health insurer's -- and I would say particularly Anthem's -- ability to find a way to make sure they're delivering good value for shareholders.

Campbell: Right. While Warren Buffett doesn't traffic in the health insurers per se, there's a reason that he happens to love the insurance business.

Property and casualty insurance, a lot of times you'll get into storm season and people will worry, "That hurricane is going to cause problems for profit ..." It's always a short-term event. They always are able to fix their pricing, and then when things normalize they get more profitable and they deliver more to the bottom line over time.

I think that you have to look at it and say, "What's the overall population growth trend?" which is up. "Is it more or less likely that those people will be insured or uninsured?" I think that if you come to the conclusion that a larger population that's increasingly insured is the most likely scenario, then it's hard to debate being long a company like this.

You look at it and you say, "It's really not even that expensive." The stock has, what, doubled in the last year, year and a half? But it's still trading at 14 or 15 times next year earnings and I think it's got a price to sales ratio that's still below 1.

Douglass: Yes, so still definitely some, perhaps, concerns priced into it. Let's face it, just net income they're guiding for I think $9.90 a share this next year, which is a nice bump from the $8.85 last year total.

It does appear to be a company that's firing on all pistons, and has some really good opportunities.

Me personally -- Todd, I think you disagree -- but Anthem is certainly my favorite of the diversified insurers. I'm not sure if there's a niche player I like better, but certainly among the diversifieds I think this is my favorite company.

They've shown the leadership, they've shown the chops to take a risk and to do very well because of it.

Campbell: Yes. I don't own Anthem currently.

Douglass: Nor do I.

Campbell: Right. Anthem and UnitedHealth (UNH 1.35%) are probably my two favorite picks in the space, and I've been wrong to wait and hope for an opportunity for shares to come back down so I could buy them!

Douglass: Sure.

Campbell: I wish I could have my Wayback Machine for that decision.

You mentioned the guidance. Anthem did a phenomenal job last year. They upped their guidance throughout the course of the year. Now we're seeing the same thing happen, at the start at least.

They came out in December thinking, "We'll earn at least $9.70" is what they said, in adjusted net income per share. Now they're saying, "We're going to earn $9.90" per share in adjusted net income.

Frankly, given their past history it wouldn't shock me if, when all is said and done, we're much closer to $10.00 or a little bit north of $10.00 at the end of the year. We'll have to see for that, though.

Douglass: Yes, they have a bit of a history of sandbagging. They adjusted up, I think two or maybe three times last year. Anyway, that's all neither here nor there.

Todd, as always, thanks for your 2 cents on the company. Definitely a big one we want to be watching moving forward, as a leader in the health insurance industry, and one that I think has very intelligently followed the money and seen where services are growing, and where they've got a good opportunity to go ahead and benefit from that.

Folks, as always, here at The Motley Fool we believe in diversity of opinion, and also making sure that you do your own due diligence. Never, ever, ever buy a stock just based on what you hear.

We want you to do your own research, know that people who are on the show -- both me and Todd, and perhaps others -- may have positions in stocks that we mention, and The Motley Fool may have positions or active recommendations on stocks that we mention, so always make sure to do your own due diligence before buying, selling, shorting, longing, etc. a stock.

With that said, as always, please come back to Fool.com and the daily Industry Focus podcast for all of your investing needs, and Fool on!