Here's why NIB Holdings Limited offers healthy returns 

Strong management and industry tailwinds bode well for NIB Holdings Limited (ASX:NHF). 

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NIB Holdings Limited (ASX: NHF) is the fifth largest private health insurer in Australia with an 8% market share and provides cover for more than 1 million people living in Australia and New Zealand. In addition to health insurance, the company also sells life and travel insurance, although these are not underwriting businesses.

Strategy

The acquisition of New Zealand-based TOWER Medical Insurance in 2013 was NIB Holdings' first move into overseas markets. Management intends to leverage its Australian health insurance expertise to grow the newly acquired business and harness efficiencies.

Management have also used NIB Holdings' existing strong brand and asset base in innovative ways to create extra revenue streams. For example, in March 2014 the NIB Options product was launched, which offers bundled cosmetic and dental surgery services for a single fee. The hope is to exploit the recent boom in medical tourism whereby people travel abroad to have treatment. There are also plans to launch products for Australians who live abroad.

The company has enjoyed significant success through targeting niche market segments such as young people. It has done this through effective marketing and smartly designed insurance packages. Management is now attempting the same thing with those over the age of 55, and in May 2014, a partnership was announced with Apia, an insurance company specifically catering for older people. Under the terms of the deal, Apia will sell NIB Holding's insurance to their existing and new customers.

Environment

Demographics are in the company's favour with the health insurance industry as a whole expected to grow at around 3% per year as the population ages. Companies in other industries are also likely to benefit from this trend including Challenger Ltd (ASX: CGF), which specialises in investment products for retirees.

The fortunes of NIB Holdings are subject to a range of regulatory matters. The National Commission of Audit Report published in February 2014 was largely positive for health insurers. It recommended deregulation of the health insurance industry as well as requiring higher-income earners to take out private health insurance. This may lead to the removal of the current risk equalisation charge, a mechanism where the industry as a whole shares hospital costs of high-risk groups.

However, the report also advised income testing for the Australian government rebate for health insurance. Along with the recent increase in the Medicare Levy Surplus income threshold, this has caused a fall in demand for NIB Holdings' policies. Overall, given the growing pressure demographics and rising costs are placing on the public health system, future regulatory changes are likely to be positive for the medical insurance industry.

There are also strict requirements on the amount of cash medical insurance companies have to hold. Consequently NIB Holdings has in excess of $450 million, which it cannot return to shareholders or invest into the business. Current low interest rates further compound the issue, inhibiting the returns that can be made on this unused money.

Financials

Group profits grew 4.3% to $72.3 million in 2014. Return on equity was an impressive 20.8%. This is important because it shows that management is using shareholders' capital wisely.

There was a 3.5% fall in earnings of the core Australian health insurance business due to higher claims. This remains an ongoing challenge to the business that management is looking to address, in part through higher premiums. All other businesses performed strongly and non-core business grew from 24% to 25.4% of group profits.

The current market capitalisation of the company is around 18 times the midpoint of guidance provided for 2015 of $78.5 million. This appears a good value when compared to Medibank Private Ltd (ASX: MPL), which is currently trading at around 23 times its 2015 pro forma profit forecast of $282 million.

Should you buy?

Since listing in 2007, NIB Holdings has provided returns including dividends of more than 475% compared to just 9% for the ASX 200 over the same period. It currently has a 3.5% dividend yield and special dividends are regularly paid on top of this. The threat of claims inflation is more than offset by demographic and regulatory tailwinds and a strong management team pursuing an innovative growth strategy.

Motley Fool contributor Matt Brazier does not own shares in any of the companies mentioned in this article.

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