The healthcare space as a whole has been in the eye of a storm over the past year, with the divergent policy platforms of the two presidential campaigns offering different paths for the sector going forward. Some of the industries in the broader healthcare space like pharmaceuticals have remained under a cloud even after the election, but the overall uncertain outlook for Obamacare and final regulatory shape of this space continues to be a headwind for the sector as a whole.

The health insurance industry, however, has done reasonably well despite these issues. The Zacks health maintenance organization (HMO) industry, part of the Zacks Medical sector, was up +7.7% since the start of 2016 through November 7th. During that same time period, the Zacks Medical sector was down -13.1% (the S&P 500 index was up +4.1% in that time period). Since November 8th, the industry is up +12.5% while the Zacks Medical sector is up only +4.7% (the S&P 500 index is up +8.1%).    

The outperformance suggests that market participants don’t see the emerging policy landscape to be unfavorable for the HMO industry. Market participants likely expect the underperforming public exchange business to get fixed and regulatory constraints on the two proposed mega mergers of Anthem Inc. (ANTM - Free Report) with Cigna Corp. (CI - Free Report) and that of Aetna Inc. (AET - Free Report) with Humana Inc. (HUM - Free Report) to get eased.  

The industry witnessed a massive overhaul following the Health Care Reform Act which came into effect in Mar 2010. The reform changed the face of the industry, so much so that the once-successful strategies and business practices of the players were no longer sustainable.

The players enjoyed no interference from government entities from the early 1980s until 2010. The health insurers were fully autonomous in conducting their business, many times refusing to grant coverage to people with pre-existing diseases and rejecting genuine claims. But with the implementation of Obamacare, things changed substantially.

Did the Reform Really Affect Health Insurance Stocks?

The reform, along with its numerous provisions, put a number of restrictions on insurers. Some of the clauses of the law related to the provision of insurance coverage for people with preexisting diseases, a bar on rejecting claims, restrictions on increases in premium and many more have changed the operating environment of the industry. These players were now faced with increased competition, regulatory compliance costs, changing patient mix, pricing pressure, rising consumerism, higher taxes and fees, rising medical costs and a general marketplace uncertainty.

The sea change that occurred in the industry got the players on their toes to remodel their business with innovative, consumer-centric products and services. They have since then aggressively been hunting for new avenues of growth both at home and abroad.

The players, after initially protesting the law, eventually came to grips and realigned their businesses within the new mandates. This is evident from increasing profitability year after year since 2010 for almost all the players. This is also evident from the U.S. Healthcare Providers iShares ETF (IHF - Free Report) 150% gain and the Zacks classified Medical - Health Maintenance Organization industry’s growth of 175.32% since the passage of the reform in Mar 2010 versus 95.3% growth of the S&P 500.

Why Insurance Stocks Still Have Some Upside Left

While the industry outperformed the broader market over the last six years, valuations are far from nose-bleed expensive. The Zacks HMO industry is currently trading at 15.8X forward 12-month consensus EPS estimates. This isn’t cheap, but it remains below the 10-year high forward 12-month P/E of 18X.

The industry is also trading favorably relative to the S&P 500 index, which is currently trading at a 10-year high forward P/E multiple of 17.9X.