Handicapping Health Reform

4/30/2012


Owners of health-care stocks have a lot riding on the Supreme Court's review of the Affordable Care Act (ACA), likely to arrive in June or July.

The court has said nothing about the issue since the hearings in March, so investors can do little but prepare for the three most likely outcomes: The Supreme Court leaves the law intact, strikes only the individual mandate, or tosses out the entire thing.

INDUSTRY PERFORMANCE
The median health-care stock lagged the median S&P 1500 Index stock from the start of 2012 through March 23, before the Supreme Court hearings on the Affordable Care Act. Since the hearings ended March 28, the sector has slightly outperformed the index, with managed-care and facilities stocks setting the pace, suggesting investors are optimistic that the law will stand, at least in part.
--- Median Price Change ---
Health-Care Industry
(No. Of Companies)
2012,
Until
Hearings
(%)
2012,
Since
Hearings
(%)
Biotech (12)
10.3
0.1
Distributors (9)
7.6
(3.3)
Equipment (38)
11.3
(2.8)
Facilities (10)
7.4
0.5
Services (22)
7.4
(4.1)
Supplies (9)
11.9
(0.1)
Technology (6)
13.0
(6.9)
Life Sciences (15)
24.1
(6.2)
Managed Care (12)
8.6
0.7
Drugs (21)
7.3
(0.7)
Health Sector (154)
9.6
(2.7)
S&P 1500 Index (1,500)
11.0
(3.3)

A major sticking point is the principle that holds the law together, a requirement that all Americans carry health insurance, also called the individual mandate. The law forces insurers to accept all applicants, even those with pre-existing conditions, at lower premiums. Critics question whether Congress can force individuals to buy a product from private companies, while the Obama administration argues that nearly all Americans will eventually use the medical system, and those without insurance unfairly burden everyone else.

The ACA's insurance mandate won't hit until 2014, but some portions of the sprawling law have already taken effect. In 2011, drug companies such as Abbott Laboratories ($61; ABT) began paying annual fees and offering 50% rebates for branded prescription drugs sold to patients in the Medicare Part D coverage gap, the so-called "donut hole." Also last year, managed-care providers started offering rebates for a portion of the premium if medical loss ratios slipped below certain levels.

On the positive side, the ACA would increase the pool of likely health-care customers. Should health-reform stand, hospitals and insurers look like the biggest winners, while benefits for drug and medical-device companies would be more modest.

Facilities

Health reform should boost the profits of Universal Health Services ($43; UHS) and other facilities stocks for at least two reasons.

Higher margins. Reducing the rate of uncompensated care should increase profitability.

More customers. Last year, Universal Health saw its lowest occupancy rate in more than a decade.

Offsetting those positives, reimbursement rates for Medicaid started falling this year, while Medicare payments will dip starting in 2014. Facilities may be able to make up the difference by raising rates for commercial insurers.

Repeal of the ACA would likely be a net negative for facilities. However, utilization rates will probably rise on their own as the economy improves.

Insurers

Insurers, including UnitedHealth Group ($59; UNH) and Aetna ($49; AET), are already preparing for millions of new customers. The individual mandate would extend coverage to up to 30 million uninsured Americans, with Medicaid getting a bit more than half and commercial plans the rest. Under the law as written, by 2016, an estimated 92% of the U.S. population would carry insurance. A review of both our recommended managed-care stocks appears on page 6.

Insurers could get walloped if the Supreme Court blocks the individual mandate but keeps the rest of the law intact. That would force insurers to accept applicants they currently reject because of pre-existing conditions but not allow them to dilute those higher-cost customers with an influx of new, healthy people.

Drug, medical-device makers

Wider coverage should boost the use of pharmaceuticals and medical devices. St. Jude Medical ($38; STJ) and other device makers could be indirectly affected by changes in reimbursement rates for key customers: hospitals.

A larger proportion of insured Americans could increase the number of elective procedures. But starting in 2013, the U.S. plans to levy a 2.3% excise tax on medical-device sales. The effect of health-care reform on drug and device companies was always uncertain, so it's tough to guess the fallout from a full or partial repeal.

WHO PAYS THE BILLS?
Company
Medicare
(%)
Medicaid
(%)
Commercial
Payers
(%)
Other
Sources
(%)
Universal Health (% of revenue)
22
15
43
20
Aetna (% of premiums)
20
5
75
0
UnitedHealth (% of segment revenue)
38
14
48
0

Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com