NIB: Interim result 2014

NIB Holdings, Australia’s only listed health insurer, has reported a strong interim result with premium revenue increasing 20% to $735m over the previous year.

Net profit rose a more modest 9% to $40m due to high risk-sharing expenses (see below) reducing the underwriting margin from 6.4% to 5.8%. Earnings per share increased 8% to 9 cents and the company declared a fully franked interim dividend of 5.25 cents, up 5%, for a current yield of 4.0%.

NIB’s Australian business, which contributes 88% of total revenue, increased premium revenue 11% to $650m with an underwriting margin of 5.2%. The number of policyholders rose 2.6% to 484,541, compared to an industry growth rate of 1.1%, increasing NIB's market share to 7.8%. NIB’s strategy of targeting young people by offering cheaper products with lots of exclusions has grown its market share for 14 consecutive years.

Interestingly, sales to over-55s saw the greatest uptick during the period, thanks to a new distribution strategy that makes greater use of retail brokers. The slightly older cohort of new policyholders, as well as a 6.5% regulated increase in the price of premiums, helped increase the average premium for new sales by 21% to $2,301.

Spreading the risk

People tend to make more medical claims as they age. So, to prevent health insurers from cherry-picking only the young and healthy, which would make insurance unaffordable for the sick and elderly, a system known as ‘risk equalisation’ has been developed.

What essentially happens is that insurers with a low number of claims, due to a healthy member base, are made to pay into a special fund which is then used to subsidise those insurers with a relatively high level of claims, due to them insuring higher-risk groups.

NIB’s member base is relatively young, with an average age of 36 years compared to 40 years for the industry. This makes it a net contributor to the risk equalisation fund. In fact, NIB is the largest contributor of all insurers, even though it’s the smallest of the five major players.

The total risk equalisation payment this period came to $101m, a 20% increase on the previous year and well above the 10% growth in NIB’s own claims. We expect this trend to continue as general healthcare and hospital costs are growing much faster than the economy.

Risk equalisation is a double-edged sword for NIB. On the one hand, it has the benefit of being associated with the approval of above average premium increases, as was the case with this year’s 7.99% rise (see NIB's Christmas surprise on 8 Jan 14 (Hold – $2.63)). The downside is that NIB’s ‘value oriented’ members may find it increasingly hard to justify the higher costs and we’ll possibly see growth in policyholders slow.

New capital standards

Private health insurers are required to maintain certain levels of capital to ensure they’re always solvent. In a surprising twist of fate, new capital standards are being introduced in March that will actually reduce the amount NIB is required to hold.

Management hasn’t said what it plans to do with the $30m-$40m expected to be freed up beyond saying ‘a number of strategic opportunities are currently under consideration’. One thing is for certain, it won’t be left idle.

With a lower capital requirement, we expect to see return on equity gradually increase from its already lofty 22%. This assumes the regulator continues to target stable margins during the premium approval process, rather than a stable return on equity. It doesn’t disclose how it actually decides each increase, but industry profit margins have been stable at around 5% for a decade so this seems to be the preferred measure.

Management expects full-year net profit of between $73m and $80m, up from $69m last year, implying a price-to-earnings ratio of about 15 and price-to-book ratio of 3.5. That’s a premium to other listed insurers, such as QBE, IAG and Suncorp. However, this is probably justified by NIB’s limited exposure to catastrophic losses and subsequently lower capital requirements.

We expect NIB’s premiums to increase by around 6% over the medium term and, if the company continues to increase its number of policyholders, that should translate into fairly decent revenue growth. For these reasons we’re bumping up our price guide slightly. The share price is flat since 8 Jan 14 (Hold – $2.63) and we continue to recommend you HOLD.