Seize the Moment: Why Humana’s Recent Decline Spells Opportunity

Summary

• The aging baby boomer generation significantly contributes to Humana’s growth, with Medicare Advantage enrolments increasing as more baby boomers reach the eligible age for Medicare.
• UnitedHealthcare and Humana dominate nearly half of the Medicare Advantage market, showcasing the concentrated nature of the industry.
• Medicare Advantage penetration has risen from 19% in 2007 to 51% in 2023, with projections indicating it could reach 62% by 2033.
• Factors such as advancements in medical technology, better access to healthcare, reduced smoking rates, and improved chronic disease management are driving increases in life expectancy in the U.S., further expanding Humana’s potential customer base.
• Humana faced a downturn in its financial performance due to unexpected increases in inpatient and non-inpatient costs towards the end of the year, leading to a significant revision of its earnings forecast below Wall Street expectations.
• The company plans to address these challenges through pricing actions and benefit adjustments aimed at restoring margins.
• Despite the near-term financial setbacks, demographic trends and healthcare sector dynamics offer strong growth potential for Humana in the expanding Medicare Advantage market.

Investment Thesis

#1: Baby Boomers are driving significant growth for the healthcare and insurance industries and the trend is expected to continue

• The aging of the baby boomer generation, which refers to individuals born between 1946 and 1964 (As of 2024, aged 60-78)
• As baby boomers reach the age of 65, they become eligible for Medicare. This has led to a surge in Medicare enrolment, expanding the customer base for Medicare Advantage

• The Medicare Advantage market is highly concentrated, with UnitedHealthcare and Humana together holding nearly half (47%) of all MA enrollments nationwide
• Humana generates most of its revenue from Medicare Advantage (Part C) plans, which encompass both Part A (hospital insurance) and Part B (medical insurance) services, often with additional benefits like prescription drug coverage (Part D)
• Someone might choose Medicare Advantage (Part C) over just having Part A and B for several reasons: Medicare Advantage plans often include additional benefits like dental, vision, and prescription drug coverage (Part D), which aren’t covered by Original Medicare. Additionally, these plans may offer lower out-of-pocket costs and provide all your coverage under one plan for convenience

• Medicare Penetration has increased from 19% of eligible Medicare beneficiaries in 2007 to 51% in 2023
• The overarching reason for the challenges and dissatisfaction with Medicare Advantage (Part C) plans, compared to traditional Medicare, lies in the stringent network restrictions, prior authorization requirements, and the potential for delayed or denied care. These factors significantly impact the flexibility and timeliness of receiving healthcare services

• Over half of eligible Medicare beneficiaries, amounting to 30.8 million out of 60.0 million with Medicare Parts A and B, have opted for Medicare Advantage plans over traditional Medicare. This signifies a striking climb from 19% in 2007 to 51% in 2023, with projections suggesting an increase to 62% by 2033

• Since Humana’s primary source of revenue growth is mainly dependent on the growth of the Individual/Group Medicare Advantage program, the thesis is that a higher population that will be eligible for the medicare program combined with a growing enrolment penetration will provide a strong tailwind for Humana going forward

#2: The projected year-over-year increase in life expectancy is expected to significantly boost Humana’s revenue by expanding the customer base eligible for Medicare Advantage

• Since the 1870s, expectancy in the United States has been growing linearly year over year, and the trend is expected to continue
• Key factors driving increased life expectancy in the USA include advancements in medical technology, improvements in healthcare access, reduced smoking rates, better management of chronic diseases, and increased awareness of health and wellness

• As life expectancy rises, the number of individuals eligible for Medicare Advantage increases, boosting enrolment potential for Humana. Longer lifespans also results in prolonged customer retention, enhancing lifetime value per customer for Humana
• In recent years, health trends in the United States indicate a mixed picture regarding the general state of health and the prevalence of illness among the population. A significant statistic to consider is the increase in the age-adjusted death rate, which rose by 13.8% from 2012 to 2022
• The prevalence of multiple chronic conditions among U.S. adults has been a growing concern. More than half (51.8%) of adults had at least 1 of 10 selected diagnosed chronic conditions (arthritis, cancer, chronic obstructive pulmonary disease, coronary heart disease, current asthma, diabetes, hepatitis, hypertension, stroke, and weak or failing kidneys), and 27.2% of US adults had multiple chronic conditions
• Despite projections that life expectancy in the United States may continue to increase, healthcare providers like Humana are confronted with escalating operational risks and costs, primarily due to the rising prevalence of chronic diseases. This situation presents a complex challenge, as the burgeoning burden of chronic conditions not only strains the healthcare system’s capacity to deliver effective care but also significantly impacts the financial sustainability of healthcare insurers

#3: The oligopolistic structure of the health insurance market limits buyer bargaining power, thus enhancing Humana’s ability to strategically adjust pricing

• To understand Humana’s bottom line, here’s a simple example: Humana offers a $0 premium Medicare Advantage plan. The government pays Humana a fixed amount per member to manage their healthcare. If it costs $800 per month to cover your healthcare, Medicare might pay Humana $900. Humana uses that extra $100 for administrative costs, profit, and extra benefits like dental care. They keep costs down with managed care techniques, like requiring prior approvals for services, to ensure treatments are necessary, which helps them profit even with $0 premiums from members
• Payments from the Federal government are determined through a bidding process, based on average healthcare costs in a region, and adjusted for each beneficiary’s health status
• If there were costs increase, the fundamental question would be whether if it’s an industry wide increase, or internal issues within Humana that drove an increase

• For Industry-wide cost increases, it typically lead to higher bids across all competitors, allowing Humana to adjust its pricing in line with or ahead of market trends without losing competitive edge

Risk Assessment

• High Risk: Jan 25, Humana shares plunged around 14% after the U.S. health insurer issued an annual earnings forecast that was far below Wall Street estimates. Firm expects approximately $16.00 in adjusted earnings per share for full year 2024 compared to analysts estimates of $28.91.
• These trends were driven by higher than anticipated inpatient utilization, notably in the final months of the year, along with a rise in non-inpatient costs. Humana reported an increase in annual revenues to $106.374 billion in FY 2023 from $92.870 billion in FY 2022. However, the benefits expense ratio also rose to 90.7% in Q4 2023 from 87.3% in Q4 2022
• Management believes that the seasonal factors are not driving the increase, hence a shift in the industry as a whole. The mitigation is through pricing actions to quickly restore our margins, and/or benefit adjustments

• On an EPS perspective, forecasting a P/E of 22 and using management guidance of $16 EPS, Humana is priced $352 / share. This is only a 1% upside of the current price of $348
• Med Risk: The U.S. is a world outlier when it comes to health care spending. In 2021, the U.S. spent 17.8 percent of gross domestic product (GDP) on health care, nearly twice as much as the average OECD country. Health spending per person in the U.S. was nearly two times higher than in the closest country, Germany, and four times higher than in South Korea. 

• The U.S. healthcare expenditure stands out due to: Nearly double the per capita spending compared to peers ($10,637 vs. $5,527). A significant portion allocated to inpatient/outpatient care ($6,624 per person in the U.S. vs. $2,718). Higher administrative costs, over four times more per person than peers ($937 vs. $201). Spending more on preventive care ($309 in the U.S. vs. $175 per capita). Less expenditure on long-term care compared to peers ($516 in the U.S. vs. $1,111 per capita)​

• Inpatient care refers to medical treatment provided in hospitals or health facilities where the patient stays overnight or for an extended period. Examples include surgeries, childbirth, and severe illness treatments. Outpatient care, on the other hand, involves medical services received without staying overnight, such as routine doctor visits, minor surgeries (like mole removal), diagnostic tests (like blood tests or X-rays), and therapy sessions
• The risk is this: there has been growing demand to reduce healthcare costs is substantial, as highlighted by recent polling data. About half of U.S. adults report difficulties affording healthcare costs, with one in four having problems paying for healthcare in the past year. Additionally, one in four adults have skipped or postponed healthcare due to costs, and about 41% of adults report having healthcare debt. There’s definitely risk of a healthcare reform that might negatively impact the industry as a whole as a wide effort to reduce the cost of healthcare so that the U.S is comparable to the rest of the world
• High Risk: The Medicare Advantage rate increase for 2025 is set at an average of 3.7%, but when excluding an estimate of how plans code for patient illnesses—a method often used by companies and analysts to gauge the impact—this effectively translates into a 0.16% decline
• This rate decision has had a tangible impact on the stock prices of major health insurers, with significant declines observed immediately following the announcement. Companies such as Humana, UnitedHealth, and CVS Health saw sharp drops in their stock prices, underscoring the market’s reaction to what many perceived as a less favorable outcome than anticipated.
• This market response reflects broader concerns about the sustainability of Medicare Advantage plan offerings in the face of what is essentially a tightening in government funding