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Health insurers make money amid M&A deals

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Amid a flurry of consolidation, the five largest publicly traded U.S. health insurers posted strong first-half revenue and net income, due in part to pricing and utilization improvements.

The group had combined revenue of $187.95 billion through the year's first two quarters, up 10.4% from midyear 2014, driven mainly by medical membership gains and higher insurance premiums.

UnitedHealth Group Inc., Anthem Inc., Aetna Inc., Humana Inc. and Cigna Corp. did even better on their collective bottom line with a 17.9% jump in first-half net income, which surged to $8.21 billion (see chart page 30).

Analysts said the net income jump was driven primarily by insurers' conservative approach to pricing, better utilization management strategies and slower-than-expected medical expense growth.

“A big part of it is the overall medical cost trend, which has held pretty steady and, in fact, better than what I think most of the companies were expecting,” said James Sung, an associate director at Standard & Poor's Financial Services L.L.C. in New York. While insurers the past several years have priced health insurance expecting medical cost trends to return to “normalized levels,” that “just hasn't happened yet.”

Also considering fees associated with the health care reform law, health insurers' improved profit “speaks to the strong operating performance of the industry as a whole,” Mr. Sung said.

Among the five, only Cigna failed to report a double-digit percent increase in first-half 2015 profit, which grew just 1.8%. Results for Cigna were held down primarily by a $65 million after-tax charge related to its early redemption of long-term debt.

From a strategic perspective, analysts said UnitedHealth's focus on expanding its pharmacy benefits, technology and health services arm, Optum Inc., has positioned it for sustainable revenue and profit growth, especially given the prospect of increased competition from Anthem and Aetna should their respective mergers with Cigna and Humana gain regulatory approval.

“They see Optum as the driver of future value, given the dynamics and trends within the health care market overall, and I believe it's a good strategy for them,” said Vishnu Lekraj, Chicago-based senior research analyst at Morningstar Inc. “Those services fit very nicely with where the health care market is headed. Not only can they package those services with their core insurance products, they can also sell them to other small and medium-sized insurers.”

Optum generated $26.4 billion in first-half 2015 revenue, up 15% from a year earlier. It accounted for 36.7% of UnitedHealth's total revenue, up from 27.3% in 2011 — the first year UnitedHealth reported the segment separately.

“The services lines entail a whole host of ways to generate revenue that's both higher-margin and largely unregulated,” Mr. Sung said. “Optum is certainly going to be a growth engine for UnitedHealth for the next five-10 years.”

Analysts said even if the mergers among UnitedHealth's closest rivals are approved, the combined companies are unlikely to pose a significant near-term competitive challenge to UnitedHealth's noninsurance services segments.

“The other players are going to have to spend the next few years working on integrating their health insurance operations, which is going to be a very significant job when you look at the size of the deals,” Mr. Sung said. “Meanwhile, UnitedHealth can really focus on selling what they already have in place with their Optum business.”

Following their respective integrations with Cigna and Humana, analysts said one noninsurance segment they do expect Anthem and Aetna to target more aggressively to keep pace with UnitedHealth is pharmacy benefits management.

Anthem's current PBM services contract expires in 2019, and if brought in-house and combined with Cigna's wholly-owned pharmacy benefits segment, “could become a formidable competitor to the independent carve-outs and to Optum,” said Ed Kaplan, New York-based senior vice president and national health practice leader at The Segal Group Inc.

In July, Optum completed its $12.8 billion purchase of Schaumburg, Illinois-based pharmacy benefit manager Catamaran Corp., making UnitedHealth's PBM business much closer in size and scale to the nation's largest PBMs, Express Scripts Holding Co. and CVS Health Corp.

“The addition of Catamaran accelerates our efforts significantly,” Optum CEO Larry Renfro said during a July conference call. “Together, we believe we would better serve people through a comprehensive whole person approach that integrates data, information, analytics and clinical care insight to support care treatments and compliance rather than just filling prescriptions.”

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