A lot of negative coverage of the private health insurance business has been dominating the news lately.
Take this report from ABC – which declares the private health business model to be in a ‘death spiral’ from increasing costs and more and more people abandoning coverage (especially the young). According to the report, just 44% of Australians now have basic hospital cover.
How does private health insurance work?
Like any insurance, private health works by collecting premiums from all customers and paying out those who make legitimate claims. The more people in the fund, the less the average premium should be (in theory at least).
The problem for private health insurers like Medibank Private and NIB is that this particular industry is heavily regulated by the government. Sure, on one hand, there are tax incentives such as the Medicare Levy Surcharge and Private Health Insurance Rebate that work to encourage customers to take out private health insurance.
But on the other, there are rules that limit these companies to how much they can raise their premiums every year as well as how much they are allowed to charge their customers (for example, older members as opposed to younger members).
I’m not disputing the social merits of these policies here, but it can’t be argued they’re good for these companies’ bottom lines.
So why are Medibank and NIB in the buy zone then?
Well, firstly the share prices of Medibank and NIB have taken a hit today. Medibank reported its half-year earnings this morning and it wasn’t a pretty picture. Earnings per share were down 14.3%. The company kept its dividend steady but is now paying out 88% of earnings to cover it – up from 67% last year. That’s not a good sign. In response, the Medibank share price is under $3 at the time of writing – down 1.85% to $2.92.
But here’s why this might be a buying opportunity.
In my opinion, the government isn’t going to let the private health insurance business model collapse. Private health takes a lot of pressure off the publicly-funded Medicare program. With our ageing population only going to get worse in the next decade or two, the government can’t afford to take up the slack and would much rather the private sector do the heavy lifting.
So, I would expect some reforms coming down the road that will increase the viability of the current private health model – which in turn should increase the value of the businesses that run it.
This is just my opinion, but I don’t see it going any other way.
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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has recommended NIB Holdings 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.