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Are private health insurance shares a buy?

A surprise coalition victory saw the share price of private health insurers on the ASX rally hard yesterday. Medibank Private Ltd (ASX: MPL) and NIB Holdings Limited (ASX: NHF) shares soared 11.5% and 15.1% respectively, whilst health insurer beneficiary Ramsay Health Care Group Limited (ASX: RHC) also gained 7%. Given the positive outlook, the share price of companies engaged in the health insurance sector could be a potential buy.

Why the rally?

Leading into the federal election, Labor proposed a plan to cap private health premium increases at 2% for 2 years. The surprising coalition victory saw shares in Medibank, NIB, and health insurance beneficiary Ramsay Health rally strongly.

Analysts and industry specialists regarded Labors proposed cap on the $22 billion private health sector as an unnecessary market intervention. If enacted, the cap on premiums was designed to make private healthcare more affordable whilst also buying time for a Productivity Commission to review and find a sustainable solution to rising costs of private cover.

The sector feared that a 2% cap on premiums would be below the costs of services and result in a short-term earnings crunch. As a result, insurers would have to either instill catch-up hikes on premiums following the 2-year freeze, reduce their level of coverage or go into debt.

Traditionally increases in health premiums are driven by increasing cost of services that funds pay for which include the price of medical devices, fees charged by medical professionals and hospital accommodation.

The coalition government does not support the freeze on increasing health insurance premiums, which are the lowest they have been in 16 years. The 1st of April is the annual date for government-approved premium-rises which saw the price of health insurance for the average consumer increase by 3.25%.

Future of affordable care

The cyclical nature of health insurance makes long-term and sustainable affordability a concern for the sector. As healthier and younger people opt out or reduce their cover, insurers are forced to either tighten benefits or increase premiums.

Currently, private health insurers only cover hospital procedures and are unable to fund out-of-hospital specialist appointments or GP visits. Industry experts believe that expansion into primary care coverage could result in sustainable, affordable health insurance, whilst also reducing volatility in the growth of the sector.  Recently NIB announced implementing reforms that include discounts for members under the age of 30 and streamlining packages to make them easier to understand.

Is it a buy?

In my opinion, given the cyclical nature of the industry, growth should not be the primary reason for buying shares in either health insurance company. The fluctuations in the cost of services and the future of affordable care reforms make earnings and growth volatile. However, both Medibank and NIB offer fully franked dividend yields of 4.4% and 3.5% respectively, which could make them an attractive buy for income investors.

Alternatively, shares in Ramsay Health could present a buying opportunity for growth. The nations largest private hospital investor also benefits from uncapped health premium increases as they derive most of their revenue from health insurers.

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Motley Fool contributor Nikhil Gangaram has no position in any of the stocks mentioned. The Motley Fool Australia has recommended NIB Holdings Limited and Ramsay Health Care Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.