Motley Fool Inside Value recommendation

UnitedHealth Group
Its vast network, with more than 70 million insured, makes it a must for doctors and hospitals.
Sheer size puts it in a strong bargaining position, which reduces costs.
Headquarters: Minnetonka, Minn.
Recent Price: $20.52
No one likes the big managed healthcare providers these days. Rising medical costs, lawsuits, shaky Medicare and Medicaid reimbursement, and the uncertainty of healthcare reform have all weighed on the industry. But the valuation of UnitedHealth Group (NYSE: UNH) reflects these prospects and then some. The future of health insurance is anything but declining, and with 73 million members, UnitedHealth is one of the dominant companies in the industry.

The health insurance game boils down to size. Large insurers can negotiate lower rates on behalf of their customers, be they governments, companies, or individuals, and this leads to a virtuous circle. Doctors and hospitals rely on a network of tens of millions of patients, which affords UnitedHealth tremendous pricing power, allowing it to pass savings on to its paying members. In turn, the variety of healthcare providers and lower negotiated rates attract more people to the network. And the circle is complete.

UnitedHealth's database is also a huge asset -- it includes comprehensive clinical data covering 85 million people and pharmaceutical histories for 250 million -- that enables the company to smartly underwrite risks. Plus, according to government data, UnitedHealth is getting the biggest slice of the new Medicare drug plans and Medicare Advantage plans. Its share was also boosted by a marketing arrangement with AARP and the PacifiCare acquisition. This is one of the key growth drivers for the company.

The Risks
The rising costs of healthcare are a top concern. Reimbursement rates from the government on Medicare and Medicaid are constantly at risk of being cut. Large companies are increasingly moving toward service contracts in which they take on the risk of healthcare costs and have companies like UnitedHealth manage their programs, which lowers revenue but reduces risk.

Lawsuits are also part of the health insurance business. The latest: The New York State Attorney General's Office announced its intent to sue UnitedHealth, which could lead to a cash payout but shouldn't affect the stock's valuation.

The Foolish Bottom Line
Occasionally an entire industry falls out of favor with Wall Street for reasons that are unclear -- and temporary. It is in times like these that investors can hardly go wrong in picking up the strongest companies in the sector, including UnitedHealth. Over the next five to 10 years, UnitedHealth should thrive.

The Motley Fool owns shares of UnitedHealth.