Competitive pricing and enhanced product benefits for Medibank
Recently announced plans by Medibank Private (ASX: MPL) to grow it near 30% market share of the health insurance market – by lowering premium increases – plus upgrades to its profit outlook by $100 million, have seen the share price in Australia's largest health insurer jump 16% since the beginning of the year.
While Medibank announced marginally slower revenue growth (from 4.5%-5%, down from 'above 5.5%') and a slightly higher management expense ratio (8.5%, compared to 8.3% forecast previously), its operating profit is now expected to be significantly improved at above $470 million in the first half of the current financial year.
Recent announcements are great news for shareholders and policyholders alike, but with competitors likely to deploy similar pricing manoeuvres, it's hard to see how the Medibank can hold onto any long-term advantage here.
Given that Medibank is currently producing a record net margin, there is no urgency for premium rates increases any time soon. By lowering premium increases, Medibank managing director George Savvides says the company has made the conscious decision not to chase growth for the sake of it, and instead select risk that suited the insurer's portfolio.
However, with earning growth expected to slow markedly (by up to 7%) in the 2017 financial year – due to peaking margins and regulatory pressure – upward pressure on prices appears inevitable, and this will dilute any competitive advantage Medibank may currently enjoy on the premiums front.
But pricing aside, what's generating a more sustainable competitive advantage for Medibank is its data analysis team, which helps to maximise efficiencies through better claims monitoring.
The $5.7 billion that Medibank has invested in data systems replacement since listing in 2014 has dramatically improved its data analysis capability, and this has significantly improved its claims control.
The net effect is simple; being able to offer policyholders more relevant products is a win-win. While product cost should continue to drop, it should in turn generate sufficient customer volumes to deliver system growth.
Like the industry at large, Medibank does face some ongoing challenges imposed by state and federal governments, and organisations of medical professionals. Then there are market forces, including price competition and switching by customers.
But over the long-term, the company does seem to have the capacity to improve its profitability through smarter data system and other initiatives.
For example, It's understood Medibank could 'unlock' up to $3 billion by preventing the costly treatment of private patients in public hospitals (estimated $1 billion in savings), reducing the cost of prosthetics (estimated $800 million in savings), and several other initiatives.
There's mounting pressure to prevent health insurers from issuing health policies that exclude common procedures within them. And unlike other types of insurance, health insurers are currently prevented by law from charging premiums based on age, health risks, and lifestyle factors, and premiums cannot increase after a claim is made.
While these factors make is more difficult for the health insurers, there's still enormous potential to improve profitability through innovation, cost-cutting, marketing and clever branding strategies. As a case in point, Medibank is pushing some of the cost back on private hospitals.
With payments exceeding $3 billion to private hospitals annually, and $5.1 billion in claims during 2014-15, Medibank has been looking for ways to cut costs and limit soaring premiums.
Having succeeded in cutting its management expense ratio as a private enterprise, Medibank posted a net profit of $285 million in full year 2015.
Despite having a long-term funding gap of around $537 million, Medibank has a cash balance that exceeds debt, and while earnings per share (EPS) growth has been poor over the last five years, return on equity (ROE) is expected to continue improving; with ROE of 20.12% in 2015 jumping to 24.15% by 2018.
On the strength of Medibank's recent $100 million profit upgrade, price targets on the private health insurer vary between $2.63 per share and just under $3.
Given Medibank's market dominance and what appears to be an emerging competitive advantage through its dramatically improved data analysis capability, the stock doesn't appear to be significantly overly priced at current levels.
But given that the stock is trading at around five times its book value, it isn't exactly cheap either. Due to downward regulatory pressure, this is not a stock you can park in the bottom draw and forget about.
Look out for greater disclosure on recent attempts to reduce claims.