S&P Global Ratings' outlook on the U.S. health insurance industry remains stable for 2022.

During 2020-2021, health insurers went through different phases of earnings volatility. Early in the pandemic, shutdown and social distancing measures resulted in an unprecedented drop in national medical utilization, a temporary financial tailwind. However, subsequent COVID-19 case spikes and hospitalizations in late 2020/early 2021, and the second half of 2021, resulted in elevated COVID-19 testing and treatment costs, with each surge providing less financial benefit from deferred non-COVID-19 utilization.

We believe the industry's role as a payor in the health care system, its pricing flexibility, and strong capital levels, are foundational credit strengths that the pandemic has highlighted. The industry's financial strength allowed it to provide monetary relief to its clients, members, and providers, while absorbing COVID-19 medical costs and making long-term investments, including acquisitions. We believe the industry's accelerating push into non-insurance health care services should improve its control over medical costs and create new long-term growth drivers.

For 2022, we expect an improving economy, repriced premiums based on better pandemic claims experience, and growing community immunity (even if partial) through vaccination and infection should support solid industry revenue growth and steady operating performance. So far, the COVID-19 Omicron variant appears to be more transmissive, though less virulent than the Delta variant, which, in an upside scenario, could signal the eventual transition of the pandemic into the endemic phase.

We believe the industry's key risks in 2022 are intensifying competition across all market segments, additional COVID-19 variant surges (beyond Omicron), deferred care in 2020-2021 that could result in disease progression and higher costs in 2022, the return of Medicaid redeterminations, and acquisition-related leverage and integration risks. We also expect that inflationary pressures, stemming from providers with labor cost issues, could gradually translate into higher unit costs for insurers.

We expect limited federal legislative activity on healthcare , unless the Build Back Better reconciliation bill, which we view as a net positive for the industry, becomes law in 2022. In California, state legislators are pursuing a single-payor health care model, though this may be difficult to enact and implement based on other states' experiences. Nationally, we expect this type of healthcare reform will not be likely for the foreseeable future.

We expect more regulatory activity. Federal and state regulators will continue to react to the pandemic. Regulatory mandates on the industry, such as the new requirement that commercial health plans cover at-home COVID-19 testing kits for consumers, will test the industry's ability to react and implement rapidly evolving guidance.

Build Back Better, Back In 2022?

Public policy and regulatory trends during the pandemic have supported maintaining health insurance coverage for Americans, which has been favorable for the industry. Remarkedly, the national uninsured rate held steady at about 11% during the pandemic, according to an Urban Institute study, owing to recent policy actions and the Affordable Care Act's (ACA) Medicaid expansion and individual marketplace programs.

Among key policy actions, the Families First Coronavirus Response Act (enacted in 2020) bolstered Medicaid enrollment by providing states with enhanced Medicaid funding in exchange for states pausing their member redetermination processes. Moreover, the $1.9 trillion American Rescue Plan Act (ARPA) (enacted in 2021) bolstered ACA marketplace enrollment by temporarily increasing premium subsidies for consumers and expanding subsidy eligibility for 2021-2022.

Federal legislators are working on extending these temporary coverage expansions. The social infrastructure-focused Build Back Better (BBB) reconciliation bill, currently stalled in Congress, includes coverage expansion provisions which could further lower the uninsured rate. It will pay for these coverage expansions largely through drug pricing reform initiatives. We are uncertain on which health care provisions will survive in the bill if it gets enacted in some form in 2022.

As proposed, the BBB act would extend the ARPA's ACA marketplace subsidy enhancements beyond 2022 through 2025. Moreover, the BBB Act would attempt to close the Medicaid coverage gap (about 2.2 million low-income people) in the 12 states that have chosen not to pursue ACA Medicaid expansion. It would allow individuals in those states to enroll in subsidized ACA marketplace coverage through 2025. It would also provide enhanced Medicaid funding incentives to the 12 states to pursue permanent Medicaid expansion.

Outside of legislation we expect significant regulatory activity. In January 2022, federal regulators announced that commercial health plans will need to cover at-home COVID-19 tests for consumers in 2022 (limited to 8 per month). Health insurers did not incorporate these costs in their 2022 premiums and benefit designs. However, at-home testing costs are significantly lower cost than physician-administered tests. We view this change, while unexpected, as a manageable development for the industry.

In the Medicare Advantage (MA) market, the Centers for Medicare & Medicaid Services' (CMS) preliminary release of 2023 reimbursement rates and other program will be a highly anticipated industry event. The industry has benefitted from favorable overall MA rates in recent years. Given strong bi-partisan support of the MA program, we expect stable MA reimbursement rates for 2023, though regulators may make technical rate adjustments, including those related to risk adjustment coding, that dampen net rates from recent levels.

Higher Medical Costs From COVID-19 Costs And Normalizing Commercial Utilization

Coming into 2021, we believed that the industry had generally priced their products conservatively across the different market segments to reflect potential COVID-19 costs and higher utilization. We also expected that health insurers would vary in their pricing strategies based on their own claims experience and growth objectives.

During 2021, as expected, we saw uneven, though generally positive profitability across the industry, with varying experience. Across the industry, medical costs, including COVID-19 costs, rebounded the fastest in the commercial group and individual market segments, followed by the Medicare Advantage and Medicaid segments. During each COVID-19 case spike, the industry saw less deferred utilization, as the health care system improved its COVID-19 treatment and safety protocols. Overall, the industry did not highlight higher health acuity among its members in 2021, though this remains an ongoing risk.

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The pandemic highlighted the importance of business and geographic diversity. In 2021, diversified national health insurers, like UnitedHealth Group Inc. and Anthem Inc. had medical loss ratios, through the first nine months of 2021, consistent with their original expectations.

Conversely, we saw more varied medical loss ratio experience at companies with more focused businesses. Cigna Corp. highlighted medical cost pressure in its fully-insured commercial group and individual segments in 2021 (most of its business is self-funded). Additionally, regional Blue Cross & Blue Shield (BCBS), health plans many of which have large fully-insured commercial businesses, reported medical cost pressure during the Delta surge, particularly in states with lower vaccination rates.

2022 Expectations

We believe the industry's pricing flexibility, which varies by market segment, provides it with some earnings protection, as insurers generally have the ability to reprice their products every 12 months and to do so prospectively, with expected risks incorporated into premiums.

For 2022, the industry's premium rates will reflect better claims experience with the pandemic. We expect that most publicly-traded health insurers will report flat to slightly lower medical loss ratios in 2022, driven by premium rate increases; lower, though elevated COVID-19 costs; and the phase out of 2021 revenue headwinds (Medicare Advantage risk adjustment, retroactive Medicaid risk corridors). We expect COVID-19 treatment costs should lessen, notwithstanding further variant surges, owing to higher vaccination rates and improvements in COVID-19 treatment, including new therapeutics. Similar to 2020-2021, we believe medical utilization spikes will continue to be limited by health care system capacity limits.

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We expect non-COVID-19 medical utilization will broadly continue to normalize, with less deferred care benefit in 2022, compared with 2021. All previously deferred care may not come back in 2022, though some will manifest in the form of disease progression and higher medical costs. We expect providers, which are experiencing labor cost and shortage issues, will push for higher reimbursements rates, which could play out through negotiated rates during 2022-2023. At the same time, health insurers will continue to push for more value-based contracts with providers, which tie reimbursement to medical cost and quality targets.

Regulatory mandates will continue to be the wildcard affecting profitability. New regulatory mandates, reacting to the pandemic, could impose additional costs for the industry. Beyond 2022, we expect more regulatory scrutiny over the industry's medical loss ratios, which are used to calculate customer rebates in most fully-insured market segments.

Recovering Commercial Group Membership Growth

The commercial group segment is the industry's largest based on membership, as close to half of all Americans (about 155 million) receive health coverage from their employer. The commercial group segment consists of the fully-insured subsegment (30%-35% of the market) and the self-funded subsegment (60%-65%), in which health insurers and other non-risk bearing entities provide administrative services to employers in exchange for fee-based revenue.

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Improving employment conditions bode well for the commercial group segment. S&P Global Economics' forecast assumes that nonfarm employment could reach its pre-pandemic level during the second quarter of 2023. We expect job gains will likely contribute to flat to slightly higher commercial membership for the industry in 2022. Health insurers with large commercial books, including UnitedHealth Group Inc., Anthem Inc., and Cigna Corp. all anticipate growth in 2022. Moreover, commercial revenue growth will benefit from premium rate increases that assume higher medical costs in 2022.

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Inflation and labor cost challenges will create growth opportunities and risks. The tight labor market will incentivize employers to maintain or improve their benefits for existing and prospective employees. At the same time, employers' cost pressures will put the onus on health insurers to innovate and provide a broader range of lower premium products, value-based provider networks, and services to help lower medical costs.

We expect client demand will increase for virtual-first health plans, which often come attached with lower premiums, as well as level-funded products, particularly in the small group segment. We also expect client demand will increase for behavioral health services, digital engagement tools, and member concierge services. For the industry and employers, behavioral health, often delivered through telehealth, is growing area of focus because it is often interlinked with other medical conditions and employee wellness and productivity.

We believe the industry's long-term growth prospects in the commercial group segment are modest. Intense competition and the highly mature nature of the segment will continue to constrain segment growth. The proportion of employers offering health coverage has stabilized (coming off a negative long-term trend) but it is unlikely to increase. Moreover, structural workforce changes, including the loss of jobs that may not return, will create additional growth headwinds. Overall, it may be difficult for health insurers to increase commercial membership on a sustained, long-term basis. We believe price competition and the ease of product replication will more likely lead to short-term market share trades between health insurers.

Return Of Medicaid Redeterminations A Key Headwind

The Medicaid program is a federal/state funded, state-operated health insurance program that covers low-income individuals and families and those with certain disabilities. About 70% of Medicaid beneficiaries (53 million as of July 2019) are covered by comprehensive managed care programs according to MACPAC, an independent agency that supports Congress.

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Medicaid enrollment has surged during the pandemic because of job losses, lower incomes, and states' temporary pause on member eligibility redeterminations. According to the Kaiser Family Foundation, Medicaid/CHIP enrollment increased by 12.0 million (16.8%) from February 2020 to June 2021.

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We expect national Medicaid enrollment will likely decline in 2022-2023, though not necessarily to the pre-pandemic level, once the federal government declares that the National Health Emergency (NHE), tied to the pandemic, is over. As part of the Families First Coronavirus Response Act (enacted in 2020), states temporarily stopped disenrolling Medicaid members in exchange for enhanced federal funding for their Medicaid programs. Once the NHE is over, states will lose their enhanced funding and have up to one year to complete their normal redetermination processes.

The timing and pace of redeterminations will vary by state. We expect most states will attempt to ensure soft landings (continuous health coverage) for members losing Medicaid coverage. Centene Corp. and Molina Healthcare Inc., two Medicaid-focused health insurers, predict they will be able to retain about half of their Medicaid members gained during the pandemic. We predict that they should also be able to regain a portion of lost Medicaid members through their ACA marketplace segments.

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Medicaid reimbursement environment

We believe the Medicaid reimbursement environment is stable, which is critical given that this segment typically generates low single-digit margins. Many states implemented retroactive risk corridor or premium refund programs with health insurers in 2020-2021 owing to lower-than-expected medical utilization. We expect this industry headwind will subside in 2022, as these programs phase out. Standard risk corridor-related programs, many of which provide upside/downside profit sharing with states, will remain.

We expect states will continue to set reasonably adequate Medicaid rates based on actuarial soundness rules. However, some states, under budgetary pressure, may decide to set rates at the low end of actuarial soundness ranges. The industry could also face profitability pressures if rates do not risk pool changes. For example, Medicaid redeterminations could result in the outsized dis-enrollment of lower acuity Medicaid members, which could dampen profitability.

Medicaid growth prospects

We believe the industry's long-term growth prospects in Medicaid are modestly favorable. Two states, Oklahoma and Missouri, implemented ACA Medicaid expansion in 2021, though we expect no further state expansions in 2022. Medicaid contracts are large, covering many members, and multi-year in nature. Medicaid contract wins and losses will continue to create periodic revenue and earnings volatility, with new contracts being initial earnings drags.

Medicaid contract awards have also become hotly contested, with protests often resulting in award delays, cancellations, and sometimes award revisions. Contract incumbents typically benefit from some advantage in retaining contracts, though contract awards are generally unpredictable. In 2022, we expect two large states, California and Texas, will likely release their long-awaited Medicaid contract renewal request-for-proposals for implementations starting in 2023-2024.

Robust Growth In Medicare Advantage

The MA program is the privately-operated subset of the broader Medicare program, which covers people over 65, certain younger people with disabilities, and people with end-stage renal disease. About 44% of Medicare beneficiaries (28 million as of December 2021) are enrolled in private MA health plans, according to CMS' data.

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The MA segment is the industry's strongest and most reliable growth area. Baby Boomers are aging into the Medicare program and increasingly choosing MA over government-run fee-for-service (FFS) Medicare. Moreover, strong bi-partisan political support for the MA program should ensure supportive reimbursement rates and policies supportive of MA growth. For example, federal legislators notably did not pursue MA program funding cuts in the Build Back Better reconciliation bill.

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We expect industry-level MA membership, including the individual and group MA subsegments, will grow by 8%-10% in 2022, in line with the CMS' estimates, following growth of about 10% in 2021. MA is a significant revenue growth driver for the industry, as MA premiums per member can be twice as large as those for commercial members. From a profitability perspective, health insurers can generate low-to-mid single digit pretax margins in the MA business.

We expect the industry's risk adjustment revenue headwinds will subside in 2022. In 2021, the industry received lower-than-normal risk adjustment MA revenue because health plans struggled to collect data on the health conditions of their members in the prior year. We believe most MA health plans were more successful on this in 2021, which should result in improved risk adjustment revenue in 2022.

MA reimbursement environment

We believe the MA reimbursement environment is stable given that rates are largely tied to FFS Medicare costs. In recent years, the industry has benefitted from favorable rate increases. CMS increased average MA rates by 1.66% for 2021, and 4.08% for 2022. CMS will release preliminary MA rates for 2023 in February 2022, before finalizing rates in April 2022. We expect MA rate increases will continue to be in the low-single digits, which should be manageable for the industry in terms of growth and profitability. If CMS introduces significant changes affecting rates, we note that it historically incorporates some industry feedback and typically phases in such changes.

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Key MA risks

Intensifying MA competition, risk adjustment issues, and potential reimbursement changes loom as potential industry risks.

National health insurers, including UnitedHealth Group Inc., Humana Inc., and Aetna (part of CVS Health Corp.), currently lead the MA market. We believe there should be enough MA growth for most players in the coming years. However, competition from BCBS health plans and tech-enabled startups could start to chip away at the current leaders' market share. For example, Humana expects to generate lower-than-market average growth in 2022 because of intense price competition and its efforts to improve profitability in 2022 and plan for 2023. For the industry, increased membership churn due to price competition could present profitability issues since new members are typically less profitable than longer-tenured members.

MA health plans face high regulatory and compliance risks. Federal regulators continue to scrutinize the industry's risk adjustment practices through risk adjustment data validation (RADV) audits and related reviews. Separately, the Department of Justice continues to file lawsuits relating to risk adjustment against MA health plans, which have typically led to monetary settlements.

We believe the MA program's reimbursement methodology could also change in future years. In recent years, MedPAC, an independent agency that supports Congress, has recommended that CMS should change the way MA benchmark rates are set, replace the current Star quality bonus program, and lower risk adjustment payments. These changes, if implemented by CMS, could to lead to net reimbursement cuts for MA health plans.

Competition & Profitability Concerns In The ACA Marketplace

The ACA marketplace is largest part of the commercial individual market, where nonelderly individuals directly purchase health insurance. The ACA marketplace segment receives a lot of headlines but is relatively modest in size based on membership. As of January 2022, 14.2 million consumers signed up for ACA marketplace coverage for 2022.

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The ACA marketplace has matured since its rough start in 2014-2016. In recent years, a growing number of health insurers have expanded their market presence or re-entered this segment owing to its improved growth and earnings prospects.

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The ACA marketplace is experiencing record growth because of the pandemic's economic impact and favorable public policy and regulatory trends. In 2021, the federal government implemented a special enrollment period (SEP) from Feb. 15 to Aug. 15 for consumers to enroll in coverage. Moreover, the $1.9 trillion federal stimulus package (ARPA) temporarily increased premium subsidies for consumers and expanded the eligibility for these subsidies for 2021-2022. The Build Back Better reconciliation bill proposes to extend these changes through 2025.

In 2021, price competition, higher-than-expected medical costs (including COVID-19), and possible adverse selection (from the SEP) dampened industry profitability in the ACA marketplace. We expect these factors, other than the SEP, are risks that will continue into 2022, and could lead to continued earnings pressure. We believe the industry's long-term growth prospects in the ACA marketplace are neutral to favorable, with potential pretax profit margins in the mid-single digits.

Steady M&A Activity With A Healthy Dose of Divestitures

The industry continues to be very active in mergers and acquisitions (M&A). Health insurers are using acquisitions to diversify within the industry, and increasingly to diversify into non-insurance health care services industries. Each insurer has its own growth angle, but common M&A objectives appear to be 1) growing in Medicare and Medicaid; 2) diversifying into health care services like care delivery and pharmacy services; and 3) building technology and data analytics infrastructure.

Recent deals have been neutral to the ratings. Long-term competitive position benefits from acquisitions have been balanced by reasonable manageable leverage reduction plans and integration risks. Most publicly traded health insurers have a debt-to-capital ratio target of 35%-40% and temporarily go above 40% for certain acquisitions, with the intention of reducing leverage to 35%-40% within 12-24 months. These companies generate significant free cash flows, with a sizable amount of deployable capital that can be utilized for debt repayment if needed. Usually debt reduction plans are based on a combination of short-term debt repayment and earnings growth. For large transactions, some companies will pull back on share repurchases. Most publicly traded health insurers have solid debt repayment and coverage metrics.

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Publicly traded health insurers have been the most active in M&A

UnitedHealth Group's (UNH) pending acquisition of Change Healthcare, a healthcare technology-focused company (announced in January 2021), will be its largest since its 2015 acquisition of Catamaran Corp. UNH originally expected this deal to close in the second half of 2021, but updated this to 2022.

Outside of this transaction, acquisitions have been small-to-midsize in nature (relative to the acquirer). In December 2021, Centene Corp. completed its acquisition of Magellan Health, a behavioral health and pharmacy services company. Additonally, in 2021, Anthem acquired MMM Holdings Inc., a Puerto-Rico based Medicare/Medicare health plan; Cigna Corp. acquired MDLive, a telehealth provider; and Humana Inc. acquired full ownership of Kindred at Home, a home health provider, from its private-equity partner.

CVS Health Corp., which owns Aetna, has been noticeably quiet in terms of M&A because of its leverage reduction priorities. However, we expect it could become more active in M&A based on its progress in reducing leverage and strategic pivot towards building a scaled primary care-focused delivery system.

Privately-owned health insurers have become increasingly active in M&A as well

Privately-owned health insurers, such as BCBS health plans, are also pursuing M&A to expand their government-sponsored business and broaden their geographic footprint.

In 2021, GuideWell, the parent of BCBS Florida, announced its pending acquisition of Triple-S Management Corp., a Puerto-Rico-based diversified health insurer that it expects to complete in 2022. Moreover, Highmark Inc., another BCBS health plan, acquired full ownership of Gateway Health Plan, a Medicare/Medicaid health plan, and completed its affiliation with HealthNow New York, also a BCBS health plan.

Among rated non-Anthem BCBS health plans, we view Health Care Service Corp., GuideWell, and Highmark, as the most likely to pursue M&A within the BCBS system and outside of it based on their scale, strategic aspirations, and balance sheets (with moderate financial leverage of less than 20%). Recent BCBS Association rule changes will provide all BCBS health plans with more flexibility to acquire and operate non-BCBS branded business.

Divestitures

Health insurers are also pruning their businesses through divestitures. In 2021, Cigna announced the pending sale of its international supplemental business to Chubb Limited. Moreover, Centene announced that it is considering the sale of its international health business as part of a broader strategy . We expect Cigna and Centene will use sales proceeds from their pending and potential sales to fund business growth or shareholder returns.

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What Could Weaken The Industry Outlook?

The following are potential downside scenarios.

Lower run-rate profitability

The health insurance industry generates single-digit pretax margins off large revenue bases primarily consisting of premiums. Industry margins could deteriorate owing to sustained price competition, higher than expected medical costs, integration issues, and/or policy and regulatory actions.

Debt-funded acquisitions

Increased competition for acquisition assets may cause more companies to overpay for acquisitions or enter businesses where they lack expertise. Overextended financial commitments and integration failures would likely lead to downgrades on a case-by-case basis and affect the industry outlook if prevalent.

Weakened capitalization

Rated health insurers generally maintain a good level of capital cushion in terms of their regulatory risk-based capital requirements, as well as those based on our capital model. Weakened capitalization because of lower profitability, lower quality of capital (reflecting higher debt and intangibles), and financial policy changes could lead to downgrades.

Public policy and regulatory changes

The industry has weathered transformative health care legislation like the ACA (2010) relatively well. However, policy proposals calling for greater government involvement in the industry, including variations of "Medicare-for-All" or the "public option", will likely resurface in future election cycles. We also expect the industry will contend with greater regulatory and compliance risks as it pursues growth in government-sponsored business.

Ratings Distribution & Trends

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Related Research

• Economic Research: U.S. Economic Roundup: Tight Job Market Allows For More Fed Tightening, Jan. 10, 2022