NIB Holdings: Result 2014

The government’s healthcare budget is in crisis – and that’s good news for shareholders of NIB. The unprecedented growth in healthcare costs is forcing the government to loosen its grip on private health insurers, which it needs to help pay the bills.

The National Commission of Audit, which concluded in March, made a string of healthcare related recommendations, most of which would benefit private health insurers and NIB in particular.

The proposal that would most benefit NIB was to scrap ‘risk equalisation’ – a system that shares high-cost claims across the industry to prevent health insurers from cherry-picking only the young and healthy, which would make insurance unaffordable for the sick and elderly (see NIB: Interim result 2014 from 26 Feb 14 (Hold – $2.56)).

The proposed ‘prospective’ system directs payments between insurers based on the risk characteristics of their members, rather than the actual expenses incurred. As NIB has a younger member base and is the largest subsidiser under the current arrangement, it will benefit at the expense of the larger insurers.

Unfortunately, that probably also means the well-funded heavyweights will put up a fight to maintain the status quo. It may be years before the proposal is enacted, if ever.

Growing pains

The Commission also recommended that private health insurance be mandatory for high-income earners and that the Medicare Levy Surcharge be lifted to 3.0–3.5% from the current 1.0–1.5%. This would encourage people to buy private health insurance by effectively making use of the public system more expensive.

These changes, should they be enacted, will help NIB’s net policyholder growth, which was sluggish at just 3% for the year to 30 June.  Even so, revenue increased 16% to $1.5bn due to a good result from its small New Zealand business and an 8% regulated price increase (see NIB’s Christmas surprise from 8 Jan 14 (Hold – $2.63)).

However, price increases are a mixed blessing. Large regulated premium rises boost NIB’s top line. But as the cost of health insurance rises, people become discouraged from using it. This was probably what caused a spike in the number of policy cancelations to 12%, up from 10% last year.

Deregulation

The government knows it can’t afford for people to shift back to the public healthcare system and the Commission has recommended replacing Ministerial control of pricing with a ‘price monitoring arrangement’, which would let insurers set their own premiums.

What’s more, it has proposed that insurers be allowed to charge higher premiums to people where poor health is a result of lifestyle choices, such as smoking. This practice is currently forbidden even though it results in higher premiums for members who live healthy lifestyles.

The deregulation of pricing would help NIB improve its margins by giving it greater control to set premiums that match expected claims. The company’s 2014 underwriting margin was disappointing at 4.2%, down from 5%, mainly due to higher risk equalisation and hospital costs, which couldn't be passed on to policyholders during the Ministerial approval process.

The flip-side of deregulated pricing is that it could encourage more price competition, especially if Medibank is hungry for growth after its float early next year (see Health insurance cage match: NIB vs Medibank from 20 Nov 13 (Hold – $2.56)).

Capital management

The government requires that private health insurers maintain certain levels of capital to ensure they’re always solvent. However, new standards were introduced in March that actually reduced the amount NIB must hold.

This freed up $58m and we were pleased to see management electing to return the bulk of it to shareholders as a 9 cent special dividend. NIB still has $19m of surplus capital.

Management has signaled its intention to increase the amount of debt the business carries. This should help increase the insurer’s return on equity from its already respectable 21%. Normally we shy away from debt but given NIB’s steady income, limited exposure to catastrophic losses and the lower capital requirements, it’s a sensible move.  

Management expects 2015 operating profit to rise 4–13% to between $75m and $82m. We expect continued policyholder growth, but NIB’s costs are creeping up faster than it can increase premiums under the Ministerial approval process. The Commission’s proposals, though positive, are still just proposals so that trend may continue for some time.

We’re reluctant to increase the price guide without more regulatory certainty. With its share price up 22% since 26 Feb 14 (Hold – $2.56) and a current price-earnings ratio of 20, NIB is starting to look expensive. If its share price moves much higher members should consider taking some chips off the table, but for now we’re sticking with HOLD.