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Guy
Can Alignment Healthcare disrupt the Medicare Advantage market?
Introduction
Alignment Healthcare (Alignment) is a small med-tech start-up that is attempting to disrupt the Medicare Advantage market with advanced technology, including AI models. You can find more information about their technology at the following link to related Alignment presentations.
Within this essay, I am not so concerned about Alignment of technological edge. I am more concerned about understanding the economics of Medicare and whether Alignment can make it.
Alignment is of special interest to any Marin resident who qualifies for Medicare. Alignment entered the Marin County Medicare Advantage market for the first time in 2023, as it was selected by the Meritage Network to replace Aetna they had kicked out. In 2024, Alignment is still within the Meritage Network and Aetna is still out of it. Also, Alignment is the most competitive of the 4 Medicare Advantage plans offered in Marin County through the Meritage Network. I covered this topic a little bit earlier this year in my Letter Selecting a 2024 Medicare Advantage plan
Background information
First, I‘ll provide a bit of information on Medicare. When one turns 65, you become eligible for Medicare health insurance coverage.
When choosing a Medicare plan you have two options
The first option
The first option is to use the Government-sponsored original Medicare insurance that covers 80% of your costs at hospitals (Part A) and doctors’ offices (Part B). You will also purchase a private policy to cover the remaining 20% not covered by original Medicare. This is called a Medi Gap or supplemental policy. You will have to purchase drug coverage (Medicare Part D) that is private but partly funded by the Government. You may consider purchasing private insurance for dental and vision. When combining all policies, you will pay $174.70 per month (in 2024) for original Medicare, nearly as much or more for Medi Gap, about $30 for drug coverage, $50 for dental, and $10 for vision. Except for the original Medicare premium, the figures are not exact, but representative. Depending on your selection, the combined costs of those policies will range from $400 to over $1,000 per month.
The second option
The second option is to go with a private Medicare Advantage plan. Here, the Government Medicare program redirects its funding sources toward a private insurer offering insurance coverage that meets Medicare specifications. Medicare Advantage covers all the mentioned insurance coverages at no extra costs. Individuals just pay the monthly $174.70 Medicare premium and that’s it.
The basic trade-off is access vs. price. With a Medicare & Medi Gap policy, you have greater access to doctors of your choosing, but the aggregate of your monthly premiums will be a lot more expensive. With Medicare Advantage, you will be limited to doctors “in network.” But, you will save a ton in premiums.
The diagram below summarizes the two different options:
- Medicare with Medi Gap policy (in blue on the left)
- Medicare Advantage (in green on the right)
Next, I will cover several building-block topics to further our understanding of this market:
- Medicare
- Medicare Advantage
- Alignment Healthcare, Inc
Medicare
A dire fiscal situation
Medicare is in fiscal trouble. Medicare’s main trust fund to support hospital insurance (Part A), is projected to be depleted by 2031.
The graph above shows that as recently as 2005, this trust fund level covered 1.5 times or 150% of the related Medicare annual expenditure. By, 2022, this multiple decreased to only 0.5 times. And, it is projected to drop to 0 by 2031.
Why is Medicare in such fiscal trouble?
It is about demographics aging. The graph below shows the multiple of the working age cohort (25 to 64) to the retiree age cohort (65 +). I leveraged two scenarios (from 2022 to 2100) from the UN Population Division to construct this multiple out to 2100.
The graph above shows that in 1950 there were 6 workers to support one single retiree (through payroll and income taxes). By, 2000 this multiple dropped to 4. By 2021, it dropped to 3. By, 2075 regardless of scenarios, it is expected to drop below 1.64. That is the current level for Japan. I consider the 1.64 multiple the “Japanese test.” Japan is uniquely equipped to withstand such an adverse demography to still sustain their social entitlements. This is because Japan has:
- one of the highest savings rates. Japan’s Government borrows from Japanese (not foreigners) to finance their large Budget Deficits;
- The Bank of Japan has sustained a humongous quantitative easing program (buying far more Government Debt than the Federal Reserve ever has); and
- Japan has one of the lowest inflation rates and interest rates. The latter translates into a low cost of financing Government debt.
Any other country will be hard-pressed to sustain their social entitlements with a mentioned multiple of only 1.64. And, the US is no exception.
Medicare Income Statement
On a relative basis, 2022 was an excellent year for Medicare. Its total revenues of $988.7 billion far exceeded its total expenses of $905.3 billion. Thus, it was able to shore up its trust funds by $83.4 billion. However, this will do little to resolve the mentioned long-term Medicare fiscal crisis.
The table below shows the revenues and expenses mix for the three different parts of Medicare.
The table below discloses how much Medicare relies on Government funding that includes both taxes and borrowings (Budget Deficit financing). Overall premiums charged to Medicare beneficiaries cover only 15.5% of Medicare’s actual medical claims reimbursements.
The table below shows a much more detailed Medicare funding mix.
Medicare Advantage
The table below shows how much Medicare incurs in direct expenses by reimbursing original Medicare claims; and, how much it pays private Medicare Advantage plans to cover similar medical claims.
The graph below shows the rapid growth of Medicare Advantage enrollees from 19% of Medicare beneficiaries in 2007 to 51% in 2023. Over the next 10 years, Medicare Advantage enrollment may well reach 65% or more of total Medicare beneficiaries.
Source: Kaiser Foundation
Why is Medicare Advantage growing so fast?
It is because Medi Gap (the alternative) is very expensive. The table and graph below show the range in annual premiums for a supplemental Medi Gap policy — Plan G (in addition to the original Medicare premium of $174.70 a month). Medi Gap Plan G is the most popular Medi Gap policy and the most similar in coverage of hospital and doctors’ office visits to a Medicare Advantage policy.
Source: Medicare.gov
As shown above, a supplemental Medi Gap policy — Plan G, will cost you at a minimum $1,584 a year if you are 65 and healthy. This premium rises as you age. And, it is sensitive to your health status. So, you can’t always count on getting the minimum premium available given your age. As shown, premiums at any age can be way over the minimum level. This Plan G, by definition, does not cover dental, vision, and drugs. So, you will have to pay much more in yearly premiums to get fully covered. Meanwhile, all of that is fully covered by Medicare Advantage at no extra cost besides the monthly original Medicare premium.
How can Medicare Advantage offer all the peripheral coverages for free?
It is about the Rebate business.
Private insurers submit Medicare Advantage contract bids to Medicare. The latter sets a baseline benchmark price for such contracts. If a private insurer submits a bid below such benchmarks, it receives a large rebate that is dependent on its Medicare Star rating, reflecting its quality of care. The table below shows that if a private insurer has a low rating (< 3.5), its rebate will be 50% of the difference between the Medicare benchmark and its bid. If the private insurer has a high rating (> 4.5), its rebate will be 70%.
The mentioned rebates result in enormous funding from the Medicare Government program towards private insurers’ Medicate Advantage plans.
The table below shows the history of Medicare Advantage plans funding including the bid component + rebate.
As shown above, the rebate component has risen from 8.5% of total funding in 2013 to 11.7% in 2022, and is expected to reach 15.2% of funding by 2032.
Even after the rebates, the Medicare program saves a lot of money as it keeps 30% to 50% of the actual savings between its benchmark and the private insurer’s bid for Medicare Advantage contracts.
The table and graph below details the bid as % of total Medicare payments to Medicare Advantage plans out to 2032.
Medicare Advantage plans use these large rebate funds to offer coverage for dental, vision, and drugs. They often offer additional benefits including several hundred dollars in flexible accounts, etc.
The Medicare Advantage marketplace
It is very highly concentrated.
As shown above, the top 3 Medicare Advantage insurers control 56% of the market. Of the top 3, 2 of them (UnitedHealthcare, CVS) are giant diversified healthcare conglomerates with divisions engaged in insurance, pharmacy, hospital chains, etc. For information on the emerging healthcare landscape, please read the article below.
Who profits most from America's baffling healthcare system?
Among the top 3, Humana is not so diversified. It earns over 80% of its overall revenues from healthcare contracts with the Government, mainly Medicare Advantage plan. As such, Humana serves as an informative benchmark for Alignment Healthcare.
Alignment Healthcare, Inc (Alignment)
Alignment is a very small player within the Medicare Advantage market, with only a 0.30% market share. It is active in only 6 States: Arizona, California, Florida, Nevada, North Carolina, and Texas. It positions itself as a med-tech specializing in Medicare Advantage plans. It was founded in 2013, and it went public in 2021.
As shown in the Income Statement below, Alignment is still very far from breaking even, after 10 years of operations.
Even though revenues have more than doubled between 2019 and 2023, general and administrative expenses have actually increased from 14.5% of revenues to 16.5% of revenues in 2023. For a Medicare Advantage plan administrator, it is critical to control G & A expenses to below 15%, because per Medicare regulations, a Medicare Advantage insurer has to spend 85% of its revenues on medical claims. Thus, if Alignment spends more than 15% of revenues on G & A expenses, it will inevitably incur operating losses.
Below see Alignment’s main balance sheet items.
Alignment’s balance sheet is strong as it raised a boatload of capital that is supporting its chronic operating losses. As of September 2023, cash balances are sufficient to cover current losses for nearly 3 years (34.9 months); working capital can cover losses for 23 months, and equity for 17 months.
Below, I explore several scenarios so that Alignment would maintain a Market/Book value ratio of 1.00. The scenarios highlighted in green represent the more feasible scenarios. Such scenarios combine a pre-tax profit margin of less than 2.50% with a G & A expense cap as % of revenues of greater than 12.5%. The combination of both would add up to 15%. This in turn would allow Alignment to still pay out 85% of revenues on medical claims as mandated by Medicare.
To construct the scenarios, I fixed Alignment asset turnover and leverage at levels that represented Humana's long-term averages for such metrics. I then sensitized ROE targets from 6.0% to 14.0%; and the federal tax rate from 10% to 30% (as I noticed that Humana paid far less than the customary corporate income tax rate of 35%).
Extending the capabilities of this model, I explored given an ROE level what would be the resulting P/E, growth rate, and PEG ratio (P/E divided by growth rate) of Alignment, so it could maintain its Market/Book value of 1.00 and a PEG ratio of 1.00.
A company with a Market/Book value of less than 1.00 is destroying equity capital. A company with a PEG ratio greater than 1.00 is deemed overvalued and vice versa.
Growth rate is a critical factor for Alignment prospects to survive and raise additional equity capital. The tables below show Alignment’s growth rates in Medicare Advantage members and revenues.
The growth rates above show that they may align with an ROE target of at least 8.00% or more for Alignment to meet its targets of a Market/Book of 1.00 and a PEG ratio of 1.00.
The table below shows how small Alignment is relative to Humana in terms of Medicare Advantage plan members.
Company market valuation: Alignment vs. Humana
As shown in the table below, the market valuation of Alignment is converging with Humana’s as of September 30, 2023. Both companies' Market cap./Revenues and Market cap./Book value multiples are reasonably close. This is surprising given that the two companies operate on a different scale. Humana is among the industry leaders. The other one is a med-tech start-up, which after a decade of operations is still far away from reaching break-even.
What the future holds for Alignment?
What will it take for Alignment to survive? To ponder this topic, let’s revisit how many months of losses can its balance sheet resources cover.
In view of the above, Alignment will have to raise about $400 million in equity over the next 12 months. That would extend its equity base coverage of chronic losses by another 36 months. This should give Alignment enough time to grow revenues to an adequate size to reach breakeven. I suspect this calls for at least doubling if not tripling revenues within three years. This corresponds to annual growth rates of 26% and 44%, respectively. Historical growth rate trend over the past three years is in line with the mentioned 26% level. Tripling revenues would call for a substantial revenues acceleration much above growth trend over the past three years.
If they are unable to raise equity on a timely basis, Alignment will be forced into a sale to a larger player such as Humana.
THE END