Health Reform Good News for Insurers

When the Affordable Care Act passed last year, health insurers cried. All the way to the bank.

They will continue to do so.

Shares in the largest health insurers are up an average of 50% over the last year, the gains ranging from Wellpoint's (WLP) 35% to a nearly 64% jump at UnitedHealth (UNH). Aetna's (AET) gain has been near the median at 49%.

That hasn't been all speculation, either, as shown by Humana's (HUM) latest quarter, a 35% increase in profit that topped analysts' estimates by nearly one-fourth, which let it raise its guidance for full year earnings by 11%.

Humana's improvement was nearly matched by its major competitors, all of whom gave strong quarterly reports.

This was not what was predicted.

The bearish case is that insured patients are postponing check-ups and expensive medical procedures that aren't fully covered. The price-earnings multiples of all the insurers listed remain in the very low teens. With a dividend. United Health pays 16 cents. Aetna pays 15 cents. Wellpoint pays 25 cents, as does Humana.

But there are some fundamental reasons to be bullish on the future of this sector:

• Information Technology (IT) systems, many bought with stimulus money, are reducing back-office costs and helping tie clients closer to the insurer.
• The sector has been able to push through steady price increases despite the recession.
• Medicare “gap” coverage continues to be a source of profits, and predictions of Medicare's doom should help those profits continue to increase.
• The insurers can expect to get more clients over the next several years as health reform kicks in.

There is also the chance for some M&A buzz to hit the industry. Consolidation has long been expected in the insurance market, and most nations' health insurance markets are far more consolidated than the U.S. one.

So let's see. A low PE, an ability to maintain prices, automation that is partly paid for by the government, which reduces costs, customers more reluctant to tap health insurance because of deductibles and co-pays, the promise of some merger action, plus a guarantee of more customers down the road. Oh, and regular dividends.

There will always be headwinds. The market caught some yesterday, with lower reimbursement rates for nursing home facilities. But that's a threat to the product mix of providers, not the rates charged by insurers. Political analysts like John R. Graham also continue to predict doomfor the sector.

But I don't. There will be consolidation. But there will also be profits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.