Medibank & NIB: Interim results 2017

Earlier this month, the Minister of Health approved 2017 average premium increases of 4.8% across Australia's private health insurers – the lowest in more than a decade, and down from 5.6% last year. Medibank Private, Australia's largest private health insurer, received approval for a 4.6% increase, while smaller competitor NIB was allowed a 4.5% rise in prices.

This tells us a couple of things. Firstly, if the trend is for premiums to rise more slowly, it means Medibank and NIB will be increasingly reliant on growing their number of policyholders. Secondly, raising premiums at three times the rate of inflation isn't a great way to do that. Declining affordability makes attracting new customers a bigger challenge every passing year.

Or, at least, it has been for Medibank. A whole stadium full of customers – 29,000 of them – left the company in the six months to December. And it's easy to see where they're going: just over 11,000 signed up to NIB.

Indeed, NIB accounted for 50% of total industry growth in the first half of the financial year, despite having a market share of just 8.2%. NIB's strategy of targeting young people by offering cheaper products with lots of exclusions has increased its market share for 17 consecutive years.

Market share is a big deal in the health insurance industry. Medibank has 3.8 million members, while NIB has just over a million. Just two companies, however – Ramsay Health Care and Healthscope – control nearly half of Australia's private hospitals. Medibank's loss of market share undermines its negotiating position with the hospitals, while NIB's gain strengthens it, which ultimately feeds back into better service prices and lower claims inflation.

Interim results

As you might have guessed, NIB reported a strong interim result – roughly a bazillion times better than Medibank's – with premium revenue increasing 7% to $995m, compared to revenue growth of just 1% for Medibank.

As you make your way down the companies' income statements, the disparity only grows: management expenses rose 8.2% for Medibank compared to 7.6% for NIB, and the overall gross margin went in opposite directions – Medibank's fell from 17.2% to 16.9%, while NIB's grew from 15.1% to 17.3%.

Net profit rose a modest 2% to $232m for Medibank – despite a 6% decline in operating profit – thanks to a jump in income from the company's investment portfolio. The company has been increasing its allocation to growth assets, such as shares and property. That's good when asset prices rise, as they did this period, but Medibank's 26% allocation also makes for more volatile results than NIB's 19% allocation.

NIB, on the other hand, achieved a 65% increase in net profit to $71m, driven by fewer claims in Australia, a strong result from its small New Zealand operations, and a turnaround in the inbound international health insurance division. The 7% increase in premium revenue was matched by a modest 3.5% increase in claims expense, which led to a 43% jump in operating profit.

Baby boomers

Interestingly, NIB's sales to over-55s saw the greatest uptick during the period, with total policyholders in this demographic rising 5%, compared to no growth in the under-40s.

NIB's ability to grow this demographic at the expense of Medibank is impressive, as it has historically been the latter's domain; Medibank has a strong focus on service and benefits over price. That older demographics are switching from Medibank to NIB suggests affordability is becoming an issue all the way up the income ladder. People still want health insurance, they just can't afford the bells and whistles anymore. 

Unfortunately, Medibank's cheaper 'ahm' brand didn't gain much from the changing consumer preferences, with total policyholders for the brand increasing a modest 4%. NIB is clearly doing something right on the marketing front, too. 

NIB's management expects underlying operating profit of $140-150m for 2017. Although declining affordability is undoubtedly a growing issue for the private health insurance industry, the higher churn rates seem to have benefited NIB so far given its cheaper products. We're increasing NIB's price guide and, with a forward price-earnings ratio of around 20, we continue to recommend you HOLD.

Medibank's management expects an underlying operating profit of $490m in 2017. ‘Customer experience, value and outcomes are all improving, but it will take time to turn around the historical market share trajectory,' said management. We expect NIB to continue to outperform Medibank on both the customer acquisition front and in terms of earnings growth. With this in mind, Medibank's lower price-earnings ratio of 18 isn't enough to tempt us and we're sticking with HOLD.