Humana's Medicare Advantage Growth Looks Likely to Rebound in 2023

Senior Equity Analyst

Julie Utterback

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Humana is a top-tier medical insurer and pays U.S. caregivers to provide services through an integrated and value-based approach while also making the insurance experience easy to navigate for end users. Perhaps not surprisingly, given its founding as a nursing home in the 1960s, Humana places a special focus on serving elderly people, especially in its top-tier position in Medicare Advantage plans. Given U.S. demographic trends and the increasing penetration of Medicare Advantage plans in the eligible population, Humana remains at the forefront of one of the fastest-growing areas in U.S. health insurance.

Within Medicare Advantage, insurers like Humana are paid the same amount that the traditional Medicare program pays to provide benefits for its consumers on a risk-adjusted basis; then the insurer aims to lower the costs associated with caring for users by making them healthier while also providing additional benefits and generating a profit. Given that dynamic, incentive alignment with care providers appears more important in this product than in other health insurance products, and Humana sees this alignment as its key differentiator from other health insurance players, and the company aims to place Medicare Advantage members with primary-care physicians that operate in value-based arrangements, which can encourage those caregivers to improve quality and costs. Humana owns some of these caregivers, including primary-care practices and the recent acquisition of the largest home healthcare provider in the United States, Kindred at Home. Also, the firm provides pharmacy benefit management functions, managing that key health input in an integrated fashion primarily for internal members.

While especially powerful in the Medicare Advantage market, this integrated approach benefits Humana in its other target markets too, including Medicaid, military, and small-employer plans. With large opportunities in its target markets, management aims to continue growing at a fast pace with a long-term annual earnings per share growth goal of 11%-15%. While Humana appears focused primarily on organic growth, it remains open to partnerships and acquisitions, too.

Business Strategy & Outlook

Humana earns a narrow moat rating from us, which reflects its top-tier position in the U.S. private health insurance market. Like many of its peers, Humana benefits from local scale-related advantages, although its focus on Medicare-related plans makes it somewhat unique in the industry. Overall, with its ongoing competitive advantages in the U.S. health insurance industry, we expect Humana to typically produce excess returns of roughly 2 times capital costs during the next 10 years.

Our narrow moat rating for Humana is informed by an analysis of potential changes to the U.S. healthcare system, which is the key environmental, social, and governance risk that Humana faces in our opinion as efforts to achieve universal coverage may continue. During the next 10 years, we view scenarios where Humana profitably provides medical and pharmaceutical benefits through employers and government programs, such as Medicare Advantage and Medicaid managed-care plans, as much more likely than not. Potential policy changes in the intermediate term appear more likely to give managed-care organizations opportunities in the form of serving more insured people in the U.S. than create substantial risks for its economic profitability, but the latter is possible eventually.

Beyond our policy analysis, we continue to see two major moat sources--cost advantage and network effect--at top-tier insurance companies like Humana. Humana’s cost advantages relate primarily to scale in its local markets. While the firm's medical membership rolls are smaller than some of its more integrated peers, the development of a core competency in Medicare-related products, particularly Medicare Advantage, combined with its geographic concentration has been difficult to replicate. Humana enjoys the number-two position in Medicare Advantage plans with 18% of that program’s enrollees in 2022, behind only UnitedHealth (28% share). While Humana’s national scale is generally impressive in this program, that scale is even more admirable considering it competes primarily in retiree-friendly Sunbelt states, including Florida and Texas, versus UnitedHealth that has a broader national network. Humana is typically the number-one or -two Medicare Advantage insurer in the counties in which it offers plans, and Medicare Advantage enrollment share can rise closer to 30% and above in those core local markets. This local scale is important in developing a broader local membership base as it creates efficiencies in that population and creates negotiating power over local service providers. For example, for small employers, Humana is typically able to price its plans significantly lower than the average employer-based premium in the U.S., which we believe is related to Humana’s local scale advantages. 

Where local scale advantages are significant enough, we think Humana’s insurance operations benefit from a network effect. For example, in communities where Humana already has substantial market share, it is able to offer lower-priced products or more benefits per member to existing and potential clients than its peers. If that offering is compelling enough, more customers will be attracted to Humana’s insurance plans in those communities, and local service providers, such as hospitals and physician groups, will have more incentive to work with Humana’s insurance networks to gain access to its large membership rolls. As Humana’s local market share rises, its negotiating leverage with healthcare suppliers also rises, which can create a virtuous cycle where Humana attracts even more clients and more providers to its insurance network. In general, we think network effects like these create barriers to entry for new competitors in local markets where Humana already enjoys significant scale advantages. Also, in Medicare Advantage, the government pays insurers bonus payments related to star ratings achieved by each insurance plan (1 being the worst and 5 being the best) on measures of outcomes, processes, patient experience, and access. About 97% of Humana's Medicare Advantage enrollees for the 2024 bonus year are in 4-star plans or above, which remains the highest percentage of the major managed-care organizations that we cover and well above the national average of 72%. That means providers that work with these Humana plans should be able to generate higher inflows from star-related bonuses with Humana plans going forward than most other plans, which gives providers continued incentive to work with Humana and enhances the network effect, in our opinion.

Within Medicare Advantage specifically, insurers like Humana are paid roughly the same amount as the traditional Medicare program pays to provide benefits for its consumers on a risk-adjusted basis; then the insurer needs to lower the costs associated with caring for users by making them healthier in order to provide additional benefits (dental, vision, pharmacy, and so on) while also generating a profit. Within this framework, insurers like Humana need specialized expertise in managing the needs of seniors to improve their health outcomes and ultimately lower costs. Humana has built up this expertise over decades, which helps it create a better experience for end users from beginning to end. For example, Humana devotes significant resources to helping seniors navigate the complex Medicare system to choose a plan that is right for them through both technology- and human-based interfaces. Once on a Humana Medicare Advantage plan, the company encourages preventative care, medication adherence, and improvement of other determinants of care, such as food insecurity and transportation concerns, to control chronic conditions better and prevent a cascade of more costly interventions. With its focus on making the complex healthcare system simpler and driving better health outcomes for end users, Humana generally leads the health insurance group in terms of customer satisfaction, which contributes to some intangible assets, in our opinion. Although we do not view intangible assets as a moat source for Humana overall, they can be important in the more concentrated Medicare Advantage marketplace because factors like brand, reputation, and differentiated services play a stronger role for these plans, which are typically sold directly to consumers rather than through intermediaries, like employers. From a retention perspective, the company claims that once a customer is on one of its Medicare Advantage plans for two years, that person is usually a customer for life, and retention rates for Humana’s plans average about seven years per beneficiary, including involuntary terminations. Profitability tends to rise with time during that retention period, so maintaining those relationships is especially important to Humana. 

While not moatworthy on a stand-alone basis, in our opinion, Humana's ownership of the fourth-largest pharmacy benefit manager and its growing presence in the provider space help support the strong outcomes and cost management needed to run successful health insurance plans. Through both direct ownership and partnerships, Humana remains at the forefront of encouraging value-based offerings in order to boost health outcomes and better manage costs. Notably, management recently highlighted that it aims to reach at least 40% of members under full-risk arrangements with providers, which could lead to higher profits and better health outcomes than unaligned relationships. Its proprietary provider relationships (which include fully owned and other partnerships) enjoy even higher profitability and better health outcomes than those full-risk relationships.

Narrow

Economic Moat

Humana

Humana Inc. engages in the provision of health insurance services. The firm operates through the following segments: Retail, Group and Specialty and Healthcare Services. The Retail segment consists of products sold on a retail basis to individuals including medical and supplemental plans such as Medicare, and State-based contracts. The Group and Specialty segment contains employer group fully-insured commercial medical products and specialty health insurance benefits marketed to individuals and groups, including dental, vision, military services and other supplemental health & voluntary insurance. The Healthcare Services segment offers services such as pharmacy solutions, provider services, clinical care, predictive modeling and informatics to other Humana businesses, as well as external health plan members, and other employers. The company was founded by David A. Jones, Sr., and Wendell Cherry on August 18, 1961 and is headquartered in Louisville, KY.

Earnings data Q2 2023

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Humana Inc. engages in the provision of health insurance services. It operates through the Insurance and CenterWell segments. The Insurance segment consists of Medicare benefits, marketed to individuals or directly via group Medicare accounts, as well as contract with CMS to administer the Limited Income Newly Eligible Transition, or LI-NET, prescription drug plan program and contracts with various states to provide Medicaid, dual eligible demonstration, and Long-Term Support Services benefits, which refer to as state-based contracts. The CenterWell segment represents payor-agnostic healthcare services offerings, including pharmacy dispensing services, provider services, and home services. The company was founded by David A. Jones, Sr., and Wendell Cherry on August 18, 1961 and is headquartered in Louisville, KY.

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