April 25, 2024. How does United Health Group (UHG) drive its competitive strength in the US healthcare market?

United Health Group comprises two distinct, complementary business platforms, United Healthcare and Optum.  UnitedHealthcare offers health insurance benefits under 3 divisions. UnitedHealthcare Employer & Individual serves employers of every size and private or public sector.  United Healthcare Medicare & Retirement serves Medicare beneficiaries, including Medicare Advantage, and retirees. United Healthcare Community & State manages benefits for state Medicaid and community programs. 

Market Share drives scale and derivative network advantages.  Through organic growth as well as serial acquisitions, United Healthcare has become the largest insurer in the US, by premiums written and number of lives covered.  Of note, it has the greatest number of Medicare Advantage clients.  Its market share in a number of local markets is large enough to drive competitive advantages of scale; with a majority local market share of customers insured, it can demand lower prices from medical providers.  Accordingly, it can offer lower insurance premium prices to payer clients such as employers.  The low prices resulting from scale advantages, support the competitive advantage of network effect.  The employers attracted by low premium prices, attract providers who need access to the population of insured patents.

Business diversification confers economic resiliency

Optum contains 3 segments: Optum Health, Optum Rx, and Optum Insight.  These are diverse businesses that reinforce the business agility and competitive strength of each other and the United Healthcare insurance platform. 

Optum Rx is a Pharmacy Benefit Manager (PBM) which creates switching costs competitive advantage related to contracts with employers.  PBM scale attracts drug makers and pharmacies who need access to the insured patient population. Low Cost competitive advantage results because the PBM can demand lower prices from these pharma companies and pharmacies.  These lower prices attract employers, which attracts drug makers in a virtuous cycle.  UNH actually ranks third in market share, among large US PBMs

Optum Health operates medical care providers; chiefly primary care, urgent care and outpatient surgeries, as well as a wide range of ancillary care  services.  Optum Health operational efficiency is guided by data, technology and analytics of Optum Insight, described below. These tools improve care practice and reduce cost. When patients covered by United Healthcare insurance use care from Optum Health, the relatively favorable value/cost ratio obviously reduces costs for the insurance group.  But these attractive margins also attract business from  other insurers. 

The business diversification brought by Optum Health benefits UHG by increasing revenue when medical care utilization increases, such as during seasonal epidemics.  This gives UHG an advantage which pure play insurers do not have because their medical loss ratio (MLR), the proportion of revenue paid in claims, must increase during such episodes.

Optum Health includes Optum Financial, including Optum Bank. With over 24 million consumer accounts, nearly $22 billion in assets under management, Optum Financial facilitates payment flows for consumers, via tools which include Health savings accounts, Flexible Spending Accounts, Health Reimbursement Arrangements and other financial benefits. Optum Financial charges fees and earns investment income on managed funds

Optum Insight is an analytics and consulting service business made possible by the digitalization and exploitation of data resulting from the considerable experience of UHG.  It has likely the largest medical records data collection in the health insurance market, including over 285 million lives of clinical data and claims (URL 2023 10K) In this division, data is harnessed to various important applications for insurers, providers and patients.  Meanwhile, the evolution and growth of the Optum Health care provider business gives United Health Group an experiential advantage that pure play insurers do not have. It serves as a living laboratory of the Optum Insight management intelligence.

In essence, the Optum Insight business consists in harnessing data to increase economic efficiency and consumer, payer and provider engagement in healthcare. Increasingly, this consists of the application of digital tools, with Artificial Intelligence (AI) in an important role. Software tools obtain a higher gross margin than the healthcare provider business they are deployed in.  By reducing friction, improving the patient and provider experience and reducing costs of inefficiencies in the US healthcare system. Optum creates value which drives its competitive advantage.

For providers and insurers, Optum optimizes revenue cycle including coding, billing, utilization review.  Medical records and claims data is exploited using AI, including novel natural language recognition software which it patented. It provides management consulting and clinical quality guidance resources to enable modernization of  administration and improved business efficiency including value based care. Digital transformation reduces administrative costs and delays.

Optum thus provides diverse resources to enable client insurance or care provider businesses to  improve their performance.  Especially the smaller companies in these industries tend to have thin margins. A contract with a consulting client may include a financial or performance outcome which must be attained in order for Optum to be paid for practice changes or software tools it advised and managed.   At times, the Optum Health segment acquires businesses that were not financially successful enough to remain independent, as in the recent case of the national physician practice network of Steward Health.

Optum Insight reinforces the competitive advantage of the United Healthcare Group by increasing efficiency and raising margins of all UHG business segments.  And Optum’s management consulting services do not benefit UHG just by compensation for the services rendered. Contracts whereby Optum Insight is deeply involved in clients operations likely have advantages of switching costs.  Moreover, a client such as a medical provider group which increases profitability because of Optum management consulting, can raise United Health insurance margins by tolerating lower insurance reimbursement, in order to serve the patient population of United Health insured consumers. This is where the larger amounts of revenue is created, as a result of the work Optum does to reduce business costs for the care provider entity, such as hospital or practice. The management consulting work of Optum reinforces the scale and low cost competitive advantages that enable UHG to attract employers and other payers of health insurance.

Of the 4 business segments of UHG, Optum Insights has the highest operating margin.  However, because of recurrent acquisitions, Optum Rx and Optum Health segments have grown faster in size.  Nevertheless, as I described, I feel the business activities housed in this smallest segment are key to sustaining the company’s competitive advantage.

Over 10 years from 2013 to 2022 (I read 10 years of annual reports for this), UHG Operating Earnings were contributed by the 4 business segments in proportions which  changed as follows.  In 2013: United Health: 74%, Optum Health: 9.85%, Optum Insight: 8.6%, Optum Rx: 7.4%.   In 2022: United Health: 50%, Optum Health 21%, Optum Insight: 13%, Optum Rx 16%.  Over the decade, the percentage of Operating Earnings provided by United Health insurance segment declined from 74% to 50% of the corporate total, with those of the other three segments increasing. Earnings of Optum Rx and Optum Health rose more than those of Optum Insight, because they included the earnings of newly acquired companies.

The Operating Margins of the 4 segments have changed as follows: 2013: United Health insurance: 6.4%, Optum Health: 9.9%, Optum Insight: 19%, Optum Rx: 3.1%.  2022: United Health: 5.8%, Optum Health: 8.5%, Optum Insight: 24.6%, Optum Rx: 4.4%. Optum Insight is the most profitable as a business, although it produces the smallest proportion of operating profits.

Regarding current valuation of the stock, the price/earnings (PE) ratio is currently 21, approximately the same as the average of the last 10 years.

From 2014 to 2023, annual diluted EPS rose 4.186 times over, from 5.7 to 23.86 dollars per share.  Meanwhile, ROIC, in mid-teens, and ROA, over 20%, have been quite consistent. Discovering United Health Group (UNH), a Novel Portfolio Holding. | amateurinvestor.net In recent quarterly earnings reports, the stock sells off somewhat when the medical loss ratio (MLR) is reported to exceed analyst expectations, regardless of the fact that UNH beats earnings expectations. It also declined when CMS raised Medicare reimbursement less than expected.  Thus, the stock price is essentially unchanged for the year.

As we intimated previously, a preeminently successful health insurance company such as UHG has a history of continuing to raise revenue and profitability despite the apparently ever-present nemesis of medical costs, and ever reluctant (but inevitably materializing) payment for these costs. Having started a position in UNH about a year ago, ideally I would have waited until some of these transient misfortunes occurred, in order to obtain a lower price.  Apparently, we do not live in an ideal world.

In Optum Insight, digital transformation, including AI, will continue to progress into the healthcare industry, liberating value, and no doubt United Healthcare Group will continue to lead here. Whereas AI is now a “hot topic” and expected to create vast stockholder wealth in a rush, healthcare insurance companies never seem to be popular.  It seems UNH stock is held hostage to expectations regarding the MLR, regardless of its ability to consistently beat earnings expectations. The advantage of this is that it is less likely to rise euphorically, with subsequent dramatic drops in price. Instead, it must earn its way up in price through demonstrated, sustained earnings growth. As it has done, with an average annual return of 25.18% as of April 24, 2024, since March 1990. The total return calculator (including dividend reinvestment) only goes back to that date. But the stock had doubled between IPO on October 16, 1984, and April 1990.