We have seen how $UnitedHealth(UNH)$ had reported missing their quarterly estimates last week, they had also lowered their guidance. The reason cited is because of higher medical costs.
Based on recent reports surrounding UnitedHealth Group's (UHG) Q1 2025 earnings released on 17 April, they have significantly revised its 2025 financial outlook, which includes expectations for higher medical costs than previously anticipated. This led to a reduction in their earnings per share guidance for the year. Shares of UnitedHealth plummeted 22.4% after the insurance giant reported lower-than-expected sales and profits for the first quarter.
This was the heaviest decline in the Dow and the S&P 500. Having caused other health insurance stocks to lose ground as well, with shares of $Humana(HUM)$ falling 7.4%.
What Is The Reason For UnitedHealth Guidance Revision?
Higher-than-Expected Medicare Advantage (MA) Utilization: Care activity, particularly for physician visits and outpatient services (including wellness, elective, and preventative care), surged among MA members in the first quarter of 2025.
This increase was reportedly twice the rate the company had planned for, far exceeding the elevated levels already seen in 2024.
This higher utilization directly translates to increased medical costs for the insurer.
Changes in Optum Health Member Profile & Reimbursement: Optum Health (UHG's care delivery segment) saw an influx of new patients, some migrating from MA plans that exited the market in 2025.
These former plans had minimal engagement with these beneficiaries in 2024, meaning their health conditions (risk scores) may not have been accurately captured.
This resulted in lower-than-expected reimbursement levels from Medicare for these members in 2025, which likely don't reflect their actual, potentially higher, healthcare needs and costs.
Ongoing Medicare funding reductions (like the V28 risk adjustment model changes) also had a greater-than-expected impact on costs for complex patients.
So in this article, I would like to examine how combination of unexpectedly high use of outpatient and physician services by Medicare Advantage members and reimbursement pressures related to the health profile of new members in Optum Health led UnitedHealth to anticipate higher overall medical spending for 2025 than previously forecast.
This is significant because UNH is one of the largest health insurance provider, with UNH lowering its earnings guidance for the year. What would happen to other similar size or even smaller health insurance provider.
If you looked at UNH overall revenue and cost, to earnings and expenses, we can see that there is a significant increase in its cost of sales and expenses, hence this would further impact its earnings.
Pharmacy Costs Continue To Rise, Driven By Higher-Cost Pharmaceuticals
Pharmacy costs continue to rise, driven by higher-cost pharmaceuticals, including biosimilars and gene therapies. The rapid increase in the number of individuals taking glucagon-like peptide-1 (GLP-1) drugs has also contributed to escalating costs.
From the PwC analysis, we can see that the hospital and related services index have increased significantly compared to Health Expenditure index by end of 2023, and in 2024, the rate of increase in pharmacy claims was in the double digits and accounted for over 13% of total medical claims. In addition to GLP-1 drugs, gene and cell therapies, as well as high-cost injectable drugs, have contributed to the rising overall cost trend.
Insurers have tried to manage these costs by directing patients’ sites of care to lower cost options, such as at-home administration, but the growing pipeline of drugs for 2025 will likely make pharmaceuticals an ongoing concern.
Health Insurers Earnings Affected By Higher Medical Costs
Higher medical costs significantly impact health insurers' earnings and long-term outlook by affecting profitability, pricing strategies, and competitive dynamics. Here’s a detailed breakdown:
Direct Impact on Earnings
Increased Loss Ratios
Loss ratio (claims paid ÷ premiums earned) rises as insurers pay more for medical services, drugs, and hospitalizations. For example, if medical costs spike 10% but premiums stay flat, loss ratios could exceed 90% (vs. a typical 80–85% target), squeezing margins.
Underwriting Profitability: Insurers rely on the spread between premiums and claims. Higher costs erode underwriting profits, a key earnings driver for companies like UnitedHealth or Anthem.
Investment Income Pressure
Insurers hold reserves to cover future claims. If reserves are depleted faster due to rising costs, they may need to liquidate investments prematurely, reducing returns from bonds or equities.
Strategic Responses and Challenges
Premium Increases
Insurers may raise premiums to offset costs, but this risks losing price-sensitive customers to competitors or public options (e.g., ACA exchanges). Regulators in some markets (e.g., Medicaid, Medicare Advantage) limit rate hikes, complicating adjustments.
Cost-Shifting to Members
Higher deductibles, copays, or narrower networks shift costs to consumers. However, this can reduce plan attractiveness and enrollment, especially in competitive markets.
Provider Negotiations
Insurers may pressure hospitals and pharmacies for lower rates, but consolidation among providers (e.g., hospital systems) weakens insurers’ bargaining power.
Sector-Specific Risks
Medicare Advantage (MA)
MA plans are tied to government funding benchmarks. If medical costs outpace federal reimbursement rate adjustments (e.g., due to aging populations or chronic disease spikes), margins compress.
Star ratings (tied to bonuses) may suffer if cost-cutting reduces care quality.
Medicaid Managed Care
State budgets constrain premium adjustments. Insurers like Centene face margin risks if states delay rate approvals during cost surges.
Commercial/Employer Plans
Employers may self-insure to avoid premium hikes, reducing insurers’ revenue from administrative fees.
Long-Term Outlook Pressures
Regulatory Scrutiny
Medical Loss Ratio (MLR) Rules: Under the ACA, insurers must spend 80–85% of premiums on care. Rising costs make hitting MLR thresholds harder, forcing rebates to customers or margin sacrifices.
The MLR minimum for spending on medical care and quality improvement activities is 80% for insurers in the individual and small group markets and 85% for insurers in the large group market.
Drug Price Reforms: Policies like Medicare drug price negotiation (Inflation Reduction Act) could lower costs long-term but create near-term uncertainty.
Shift to Value-Based Care
Insurers investing in value-based models (e.g., UnitedHealth’s Optum) may better control costs by tying provider payments to outcomes rather than volume. However, transitioning from fee-for-service is slow and capital-intensive.
Competition and Innovation
Tech Disruption: Startups using AI for claims processing or telehealth may undercut traditional insurers on cost efficiency.
Vertical Integration: Insurers acquiring providers (e.g., CVS-Aetna) aim to control costs but face execution risks.
Investor Implications
Earnings Volatility: Stocks like Humana or $THE CIGNA GROUP(CI)$ may see pressure if quarterly margins miss expectations due to unexpected cost surges (e.g., GLP-1 drug demand).
We could be seeing CI suffer from higher drug cost, and we might see an earnings miss and also a weaker guidance. Things could be make worse if the tariffs on the drugs came in and hit CI, then we could be seeing a huge downside.
So I am prepared to take a short position maybe by doing puts in options, I will see how tariff on pharma goes.
Dividend Sustainability: Insurers with high payout ratios (e.g. $Molina Healthcare(MOH)$ ) could struggle to maintain dividends if earnings decline.
If we looked at the current share price of MOH, we can see that it is struggling to keep up with the 200-day period and there was a huge decline after its Q4 2024 earnings in Feb 2025, so if MOH suffer the same high medical cost like UNH, then we might see a huge decline and they might not be able to maintain dividends.
So it is not a good time to consider MOH despite its price discount.
Valuation Multiples: Persistent cost inflation may lead investors to assign lower price-to-earnings ratios, reflecting uncertainty about future profitability.
Mitigation Strategies for Insurers
Data Analytics: Predict high-cost patients early and intervene with preventive care.
Formulary Management: Restrict coverage of expensive drugs (e.g., requiring step therapy for GLP-1s).
Telehealth Expansion: Reduce costs by shifting routine care to virtual platforms.
Diversification: Expand into higher-margin services (e.g., pharmacy benefit management, wellness programs).
Summary
Higher medical costs compress insurer earnings in the short term and challenge long-term sustainability. Companies that proactively manage costs through innovation, provider partnerships, and regulatory agility are better positioned to maintain profitability.
As investors we should continue to monitor if you are going into the healthcare sector for defensive.
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Medical cost trend reports (quarterly guidance vs. actuals),
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Policy developments (e.g., drug pricing, Medicare rates),
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Enrollment trends (ability to pass costs to consumers without losing members).
The sector remains defensive due to essential healthcare demand, but margin resilience will separate winners from losers.
Appreciate if you could share your thoughts in the comment section whether you think healthcare sector can still be used as part of one’s defensive strategy despite the challenges faced by health insurer due to high medical cost.
@TigerStars @Daily_Discussion @Tiger_Earnings @TigerWire appreciate if you could feature this article so that fellow tiger would benefit from my investing and trading thoughts.
Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.
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