Medibank & NIB: Interim results 2018

Private health insurers aren't the coolest of companies. A lack of Netflix and Facebook spark, however, hasn't stopped NIB from attracting throes of young people away from the old guard using clever advertising. NIB increased its policyholder count by 65,000 over the past year – Medibank Private lost about 10,000. This trend has been in place for the better part of a decade.

The good news for Medibank shareholders is that the leak is slowly being patched by its late-to-the-party copy-cat brand, AHM, which increased policyholders by 14%. Although Medibank continues to lose market share to NIB, the rate of loss has more than halved over the past couple of years, so the company appears to be successfully redirecting customers to its lower-cost, thinner-margin alternative. That's not ideal, but it's better than customers going to NIB.

The other good news is that AHM's policyholder lapse rate has halved over that time, though it did notch up slightly to 7.5% in the six months to December. Customers aren't as loyal as those with the core Medibank brand, which has a lapse rate of 5.0% – or NIB at 5.6% – but things are moving in the right direction.  

Unfortunately, the cost of acquiring a new AHM customer is typically higher than a Medibank customer as the brand relies heavily on brokers, which take up to 30% of the first-year's premium as a commission. All things being equal, as Medibank's product mix shifts towards cheaper AHM policies, margins should decline. 

With this in mind, the fact that Medibank's gross margin for Australian residents increased from 16.4% to 16.8% this half is all the more impressive. Claims grew slower than premiums due to a decrease in hospital expenses and the average length of stay.

Slow claims growth

Medibank increased premium revenue by 2% in the six months to December, while claims rose just 1%. The company's underlying operating profit rose 4% to $244m.

NIB had a similarly low increase in underlying claims, though the acquisition of corporate health insurer GU Health late last year caused overall claims to rise 9.7%, while premium revenue rose 9.1%.

The jewel in NIB's result was the division covering international health insurance for inbound travellers, which increased premium revenue 27% (or 22% excluding the GU Health acquisition). Claims rose materially, though this was offset by a 30% drop in management expenses so underlying operating profit was still up 17%. The inbound international division helped to offset a 9% decline in operating profits for the Australian segment, so NIB's overall underlying operating profit rose 1% to $96m.

Good and bad investments

Curiously, the two insurers experienced even more divergent results from their large investment portfolios. Medibank's net investment income fell 22% to $60m due to ‘lower equity and fixed interest returns partly offset by stronger property returns'. NIB's net investment income grew 24% to $17m.

The ASX All Ordinaries index rose about 7% over the past year, most of it in the latter half. Ironically, Medibank's portfolio has around 20% of its capital in growth assets, such as equities and property, whereas NIB has taken a more conservative stance, allocating only 15% (the remainder in bonds and cash). We're not sure why Medibank had such a poor result relative to other insurers; however, the company had above-average returns this time last year, so we won't lose sleep over a little mean reversion.  

Both Medibank and NIB's portfolios only earned an annualised return of around 2% in the six months to December. However, since mid-December the 10-year government bond yield has risen from 2.5% to 2.9%. With 80–85% of their portfolios allocated to cash and fixed interest securities, if bond yields continue to rise, portfolio returns should improve as capital is rolled into higher-yielding investments.

Outlook

NIB's management expects underlying operating profit of at least $165m for 2018 and the stock trades on a price-earnings ratio of 23 based on consensus estimates for 2018 earnings. With a growing market share and excellent management, we're sticking with HOLD.

Medibank's management expects ‘similar underlying revenue trends to the first half, adjusted for the 3.88% rate change on April 1'. The stock trades on a price-earnings ratio of around 20 based on consensus estimates for 2018 earnings. That's a discount to NIB, but we think it's deserved given the ongoing – albeit easing – loss of market share.

We're pleased to see Medibank achieve a meaningful improvement in its handling of claims and the AHM brand successfully stemming the exodus of policyholders. We're notching up the price guide on account of the improved business performance and continue to recommend you HOLD.