Published: 2009-09-05 18:40:49
Author: Brett Arends | Wall Street Journal | August 5, 2009
The public debate over health-care reform has been dominated in recent days by the issue of the so-called "public option" -- namely whether the government should offer an insurance plan that competes with those offered by private insurers.
It's not clear whether that plan will pass, but the proposed changes have made many investors question what reform could mean for health insurance company stocks.
Many on both the right and left think a public plan will wipe out the high profits in the private insurance industry. But that aspect of a public option may be more symbolic than substantive. Health insurance companies aren't quite as profitable as many critics seem to think.
"For every premium dollar that they take in, about 83 cents goes out in medical costs -- doctors, hospitals, and drugs," says Carl McDonald, health insurance analyst at Oppenheimer & Co. The rest is spent on overhead. Net income comes to just a few cents per dollar of premiums.
Consider WellPoint, the biggest private health insurer on Wall Street, which has about 35 million customers nationwide. Last year, it paid out 83.6% of revenues in expenses. Net, after-tax income as a percentage of total revenue came to a princely 4.1%.
In other words, simply eliminating profits would only allow the public option to undercut the private sector by 4% or so.
Returns on assets, a key measure of profitability, are typically pretty modest too. According to analysis by FactSet, WellPoint's ROA has averaged 5.8% over the past five years, Aetna's, 4.2%. Those were, remember, supposedly boom years. UnitedHealthwas higher, at 9.6%, but fell to 6.4% in 2008. These are reasonable, but hardly spectacular, results. By comparison, Wal-Mart averaged a 9.2% return on its assets and Dell, Inc. 12.4%.
The stocks don't look expensive at the moment. WellPoint, Aetna and UnitedHealth are each about eight to nine times expected earnings. Some analysts think the shares are being held back by the uncertainty and may pop if the picture improves.
They may be right. But those stocks are not without risks.
When it comes to health care, the really big cost savings are likely to be found at the level of doctors and hospitals, not in health insurers' 4% profit margins.