Healthcare Stocks: Testing the Vital Signs of Managed Care Providers

May 15, 2024
4 min read

Questions are being asked about the US managed care industry, but some businesses are equipped to rise to the challenge. 

Managed care providers, an important private-sector component of the US healthcare system, have been under pressure because of disappointing reimbursement rates from government-backed programs and rising utilization trends. But we believe companies that can surmount these obstacles should play a role in a diversified allocation to healthcare stocks. 

In the US healthcare system, managed care groups are companies that deliver integrated patient care and health insurance to members. They provide a network of doctors and service providers such as general practitioners, physiotherapists and specialists. This approach is widespread in the US, not least because the country lacks a centralized public health system.

Healthcare stocks have had a weak start in 2024. In the first four months of the year, the MSCI World Health Care Index advanced by just 3.2% in US-dollar terms, underperforming the broad MSCI World Index, which gained 4.8%. Perhaps the healthcare sector’s defensive characteristics just aren’t what equity investors need as concerns about macroeconomic growth fade.

We disagree. In our view, healthcare stocks offer a potent combination of offensive and defensive features that tend to capture a solid proportion of market gains while also curbing downside risk. Generating long-term outperformance through up and down markets requires a diversified approach to the sector that looks beyond the large pharmaceutical groups that often grab headlines with new treatments and blockbuster drugs. 

Understanding the US Managed Care Industry

US managed care organizations are large companies that serve their members through a network of providers and offer a variety of health plans. Select businesses generally enjoy stable, recurring sources of revenue, as well as attractive growth rates and profitability, as measured by return on capital (Display).

Managed Care Companies Have Posted Solid Profitability
Line chart compares return on capital for the largest US managed care providers with the MSCI World Health Care Index and the MSCI World Index.

Past performance and current analysis do not guarantee future results.
Return on capital measures the return that an investment generates for capital contributors, which indicates how effective a company is in turning capital into profit. US managed care includes the seven largest publicly traded US managed care companies by market capitalization: Centene, Cigna , CVS Health, Elevance Health, Humana, Molina Healthcare and UnitedHealth Group. Return on capital for these companies is computed as a simple average, not weighted by market capitalization.   
As of December 31, 2023
Source: Bloomberg and AllianceBernstein (AB)

Yet two major challenges have hurt managed care stocks this year. First, medical costs have risen because of post-COVID normalization trends, as many older members seek elective medical procedures that were deferred during the pandemic. 

Then, in early April, the industry was disappointed by the annual update to Medicare Advantage (MA) rates. MA is a health insurance plan for senior citizens and people with certain disabilities offered by managed care companies, which are paid by the government to administer the plans. Each company must factor in expected costs and reimbursement rates to generate a profit. In mid-2023, managed care companies began to see MA utilization trends running higher than anticipated—meaning more costs. So when the 2025 MA payment-rate announcement was lower than expected last month, shares across the industry took a hit. 

Diversified Businesses Can Cope Better 

While the concerns are legitimate, investors shouldn’t draw blanket conclusions from recent events. We believe the MA rates will affect managed care companies in different ways. Investors who are familiar with the industry know that the government resets these rates every year—so lower-than-expected rates are a known risk factor in a company’s earnings forecast. 

Less-diversified companies that rely more on MA are more exposed to unfavorable rate changes and elevated MA utilization trends. That’s why Humana, a managed-care company that derives a large share of its business from MA plans, slashed its earnings forecast earlier this year and suffered large share-price declines. CVS Health, another big MA player, also cut its earnings forecast in May due to pressure from higher cost trends. 

Diversified managed care companies with a strong track record of execution are better positioned to cope. These include UnitedHealth Group and Elevance Health, which have relatively modest exposure to MA plans along with many levers to pull across their other businesses to help offset unfavorable MA rates and utilization trends. These companies also have a history of disciplined pricing and stronger MA margins, which should help them protect profitability without cutting benefits significantly.

Supporting the Virtuous Healthcare Ecosystem

When investing within the healthcare sector, we believe it is crucial to identify companies that operate within what we call a virtuous ecosystem. That means companies should deliver a product or service that benefits the patient, which helps to reduce costs for the patient and the system while generating a profit. 

The ability of diversified managed care firms to adapt to lower rates is supported by their essential role in the operation of a virtuous healthcare ecosystem. In the US, select managed-care firms have made efforts to vertically integrate their businesses, including building a vast network of doctors and medical practitioners. Doing so has created benefits for members that help improve access to and quality of care, while reducing costs for the healthcare system. This supports business advantages that help these managed-care companies gain market share while generating strong profitability and growth. 

We believe companies that operate in this virtuous ecosystem offer equity investors an attractive opportunity to capture durable long-term return potential in industries across the healthcare sector. 

A Risk-Aware Approach to Growth Potential

Of course, prudent investors must consider the risks, including rate changes, higher utilization of services and the US elections. But we believe that short-term volatility related to these issues does not derail the long-term case for the industry. For example, our research suggests that healthcare stocks are not more volatile in a US election year, despite conventional wisdom that the sector is vulnerable to political and policy risk.

Like in any sector, some diversified managed care companies have stronger vital signs than others, affording them greater latitude to cope with shifting industry dynamics. By focusing on businesses with competitive advantages to support consistent profitability through market controversies, we think healthcare investors will find that select managed care stocks offer an attractive combination of features to fuel a portfolio’s long-term growth potential.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

References to specific securities discussed are for illustrative purposes only and are not to be considered recommendations by AllianceBernstein L.P.

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