Australia | Nov 07 2019
The trajectory of Medibank Private's margins is worse than many anticipated, after the company flagged higher claims inflation.
-Downside risk to the dividend heightened for FY20
-Difficult for government to obtain an approved premium rate increase under 3%
-Are industry pressures catching up with all health insurers?
By Eva Brocklehurst
Claims inflation has provoked Medibank Private ((MPL)) to shore up reserves in FY20. This implies underlying claims trends in FY19 were worse than previously estimated, signalling margin pressure.
This is the second consecutive half-year of reserve increases, Credit Suisse points out, following 10 halves of reserve releases, and implies underlying claims growth per policy unit was 2.4% in FY19 vs the 2.0% reported at the results.
Medibank Private has flagged an under-provision of -$21m as of June 30 and revised claims inflation in the second half to 2.8%, a level expected to persist through FY20. Hence, UBS calculates revenue growth per policy will contract to around 1.5% in FY20. The trajectory of margins without any further action is worse than Ord Minnett had assessed and a slight improvement in expenses and volumes is only a small offset.
Macquarie asserts there is downside risk for the FY20 dividend. Moreover, if the claim cycle has now turned, a PE multiple de-rating for the sector would also be appropriate. The next round of premium price increases are due for submission to the health minister on November 12.
Macquarie believes investors have been attracted to the stock because of consistent earnings and a high fully-franked dividend yield. Based upon its forecasts, Medibank Private would need to pay out around 90% of FY20 earnings to maintain its dividend.
Credit Suisse explains, while there is standard volatility in health insurance claims quarter to quarter, the ability to absorb this becomes more difficult at the top of the cycle. The broker points out insurance cycles run through a standard pattern, where the profit margin gradually increases to an elevated level and quickly steps back down. Then the process repeats.
Picking the exact timing of a correction is always difficult, the broker adds, and does not believe the shares have pulled back far enough for Medibank Private, given the near-term earnings risk. While appreciating a potential takeover premium may exist in the share price the broker finds it hard to ascribe to to such an investment thesis.
Medibank Private believes the higher claims are being driven by the increase in average benefits per private hospital episode. The company stressed that this was an issue of mix, with stronger growth in high-cost procedures and a contraction in low-cost procedures.
Morgan Stanley agrees a behavioural response to prosthetics reform, i.e. a lift in volume, has meant savings have largely disappeared and little weight is likely to be placed on the next $100m of planned benefits ensuing from February 2020.
Medibank Private has blamed a failure by government in procuring prosthetics savings. Ord Minnett suspects there has been a meaningful reduction in inflation in prosthetics but perhaps not the deflation Medibank Private was assuming. Lengthening payment patterns from hospitals have also been cited.
Ramsay Health Care ((RHC)) has highlighted a new claims processing system slowed its cash collection and this may have hurt insurers, although Medibank Private believes the issue is industry-wide.
Medibank Private does have levers to manage the pressure, Ord Minnett points out, including product rationalisation and reducing payments to private patients treated in NSW public hospitals. Still, the pressure on premium rates appears very stark.
Citi agrees it will be difficult for the government to obtain an approved premium rate increase under 3% and allows for 3% vs the 2.85% forecast previously. The broker suspects the insurers will request a higher increase. Morgan Stanley opts for a 3.0% premium increase in its forecasts.
Macquarie's discussions with industry indicates the issue of claims inflation is widespread, while UBS cites recent feedback from unlisted hospital operators which provides a more mixed operating outlook, although subdued trends are expected to continue. Brokers note Medibank Private is yet to finalise a new agreement with Ramsay Health Care.
Nib Holdings View
Ord Minnett highlights nib Holdings ((NHF)) has maintained FY20 guidance in response to the downgrade by its competitor, although has also made reserve increases. The company has noted an increase in underlying margins stemming from mental health costs, as opposed to the prosthetics which Medibank Private cited as its main concern.
The broker suggests nib Holdings is in a stronger position in FY20 vs Medibank Private, having been more conservative in calculating guidance, which allowed the late reporting of claims to be absorbed without downgrading the margin outlook. Still, Ord Minnett believes industry pressures are catching up with all health insurers and underlying margins will likely trend lower.
Morgans suspects Medibank Private was less across the issue of an uptick in claims inflation compared with its peer and considers the former's more optimistic outlook at the FY19 result raises some questions about reporting systems and processes.
Still, this is a minor bump in what is been an otherwise impressive turnaround and the broker continues to like the exposure to longer-term structural growth areas, although acknowledges margins remain elevated vs historical levels. FNArena's database has three Hold ratings and four Sell for Medibank Private. The consensus target is $2.99, indicating -2.8% downside to the last share price.
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