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Three Things Investors Really Need to Know About Healthcare Reform

Companies / Healthcare Sector Mar 28, 2010 - 12:46 PM GMT

By: Q1_Publishing


Best Financial Markets Analysis ArticleHealthcare reform is now law.

Over the next decade the government will reach further into the private sector than it ever has before.

Despite the year of debate and non-stop selling of the program, there’s still a lot of uncertainty over the impact of the law.

All politics aside, we know a few things already.

First, it will not be nearly as good as proponents said it will be.

Second, it will not be as bad as opponents said it will be.

Third, over the long-run though, we know it will cost far more than projected. The expected tax revenues and savings will not materialize and spending will be greater than forecast.

Finally, as with all other government interventions, it will create opportunities and pitfalls for investors.

As a result, we see lots of opinions based on the “buy healthcare stocks” rationale.

It’s a very popular thesis.  Health insurers are some of the best performing stocks in the market. Shares of Cigna (NYSE:CI), UnitedHealth Group (NYSE:UNH), and WellPoint (NYSE:WLP) are up an average of 120% since the healthcare debate began a year ago.

We, however, expect the thesis will go down as all the other over-simplified and seriously flawed theses that have pervaded the markets over the years. It’ll turn out as well as the “buy infrastructure stocks” after the stimulus bill.

That’s why at the Prosperity Dispatch, we’ve been putting together a more in-depth approach.

As a result, we see a few opportunities and many more dangers due to healthcare reform.

Here’s where see as the best of the bunch and the more popular ones that are just plain wrong.

Buy Health Insurance Stocks – They’re Getting 32 Million More Customers

On the surface, the reform looks great for health insurers.

According to government estimates, the mandated purchase of health insurance will add 32 million new customers to the health insurance industry.

A breakdown of the economics reveals a much different story.

The current fines for not having health insurance are too small. They are well below market rates for health insurance. And they will result in fewer insured people.

Consider this. A business will have to pay $2,000 for every employee who doesn’t have health insurance. The employee would have to pay a few hundred dollars or up to 2.5% of gross income, whichever is greater. For someone making a $50,000 a year, that puts the total fine at $3,250. That’s about one-fourth the national average for a family of four.

Of course, if you get sick, you don’t have to worry about not having health insurance. The health insurers won’t be able to turn you away for a preexisting condition when the law is in full effect.

Basically, this is a perverse form of price controls. We don’t see the big employers passing up health insurance. It’s just bad public relations. But small employers will drop the insurance very quickly and just pay the fine. The way the reform is laid out, it’s the only economical thing to do for both employees and the employer.

Considering the that small business account for more than half of all jobs in the country, we foresee a situation where there will be more uninsured people in 10 years than there are now. Not 32 to million more as the popular thesis is based on.

The entire reform will create a situation where most people have health insurance are sick and healthy people will go without it. This means premiums are going much, much higher as the healthy folks forgo paying into the system until they need to.

On top of that, health insurers are about to get handed stacks of new regulations and the costs to meet them will only go up.

There’s no way the current rally in health insurance stocks is justified over the long run.

Hospital Stocks – A Temporary Lifeline

Another popular thesis is that this bill is good news for hospital stocks.

In the short run it is.

Shares of hospital owners have been reflecting that reality too. The day after the House of Representatives passed healthcare reform shares of Health Management Associates (NYSE:HMA), Tenet Healthcare (NYSE:THC), and Community Health Systems (NYSE:CYH) jumped 11%, 9%, and 6% respectively.

The reform offers all kinds of subsidies and goodies to help keep hospitals running.

It also ensures that almost every patient that ever goes to a hospital will be insured. The basic rationale is they won’t have to give out free care to the uninsured because there won’t be any.

The reform also insulates them from competition.

A recent Investor’s Business Daily article found showed how the new law will “effectively bar new physician-owned hospitals” from ever being constructed. The physician-owned hospitals, which are usually smaller and much more able to innovate, are a serious competitor for big general hospitals.

The thing about hospitals though is that innovation is destroying their century-old and outdated business model.

Clayton Christenson, who coined the term “disruptive technology” and is founder of leading consulting firm Innosight, describes the problems facing general hospitals in The Innovator’s Prescription (a must read book for anyone looking to do well in the healthcare sector):

"We will do everything for everybody” has never been a viable value proposition for any successful business model that we know of--and yet that's the value proposition managers and directors of general hospitals feel they are obligated to put forth…

Were it not for today's tangled web of subsidies, administered prices and regulations that constrain competition, today's general hospitals would not be economically or competitively viable.

Hospitals are an aging relic. They will always have a place in the world, but they are too inefficient to meet the increased demands on the healthcare system of an aging population.

Just take a look at the Shouldice Hernia Center in Ontario, featured in the Innovator’s Prescription, to see why.

The center has developed a specialty in treating hernias. The specialized experience and knowledge of its staff allows it to repair a hernia for $2,300 that would cost $7,000 at a U.S. general hospital. It allows for three days of recovery while in a U.S. general hospital a hernia usually requires outpatient surgery and you’re on your own for care. It also has a recidivism rate as much as 10 times lower than U.S. general hospitals.

There was a time when the general hospital had to be “everything for everybody.” That is no longer the case. The savings offered by specialized treatment centers more than offset the cost of plane tickets and other travel costs.

Over the long run, we expect hospital stocks, as a group, to do very poorly. They will always have their place in the world. They’re actually great at addressing complex and new diseases.

In the end though, healthcare reform and its regulatory burden will only provide a temporary reprieve from the natural forces of innovation.

Stick to Politically-Favored Healthcare Sectors

Although the “hot” healthcare sectors are insurers and hospitals, the best opportunity will be in politically-favored industries.

They are biotech and diagnostics.

In the post-healthcare reform world though where the government is more involved than ever, we have to realize that some biotech sectors will be much more lucrative than others. Here’s how to tell the right ones.

One of the best examples of politically-favored biotech sectors is breast cancer. Groups like the National Organization for Women have played a big role in how the government doles out healthcare research money.

For proof, consider this. Breast and prostate cancers have similar mortality rates. But that has nothing to do with the funding.

Over the past decade the U.S. government has spent almost twice as much on breast cancer research than prostate cancer research.

According to Zero Cancer, federal research funding for breast cancer totaled about $6 billion. Meanwhile, funding for prostate cancer research came in at about $3.1 billion.

And the gap is only getting wider. Between 2003 and 2009, prostate cancer funding declined 13% while breast cancer funding increase.

At this point we can safely assume the only reason for the difference in funding is politically-motivated. Women have organized well. Men have not. To the better organizer goes the subsidy.

That’s why when it comes to looking at biotech stocks; you have to look at the companies developing drugs that will be bought regardless of price.

The best of the group is probably Alzheimer’s disease treatments.

Not only is the opportunity the biggest prize in the biotech industry as we noted when we sat down with one of the world’s top Alzheimer’s disease experts, it’s also focused at a politically powerful group of customers who consistently vote – old people.

No politician could possibly vote against buying Alzheimer’s disease treatments – whatever the cost – or funding more research and expect to be reelected.

The other big politically-favored opportunity is in diagnostics.

Throughout this debate we heard from both sides of the aisle about the importance of preventive care.

Although anyone who looks at studies which analyze the actual cost savings of preventive care would easily see there’s no evidence to support increased spending on it, you can’t deny it’s politically popular. After all, it “makes sense on paper.” And that’s all politicians really need as an excuse to spend money.

That’s why we expect the diagnostics sector, which makes all the tests and equipment to support preventive care, to be the biggest winners in the long run from the healthcare reform law.

In the end, the lasting impact of health reform will make the entire system even more efficient than it already is.

It will be more expensive than even the most honest forecasts are anticipating.

It will seriously stunt innovation. The tremendous high-potential medical fields like stem cells and personalized medicine will be hampered. They won’t be stopped completely, but development in these areas will just be slower.

Above all, from an investment perspective, healthcare reform will likely have a tremendous impact on the stock market and the economy as a whole.

The increased taxes on “unearned income” and capital gains realized from investments in businesses and stocks will hamper the recovery.

At no point in history has decreasing the rewards of investment and risk-taking ever created led to more of it.

Although there’s a lot to not like about the reform (and more skeletons will emerge from the reform closet in the weeks and month ahead) and we’ll continue to hold out hope for the realization that less government is the solution to better, cheaper healthcare, we have to play the cards we were dealt.

That means steering clear of the popular investment theses taking over the market and looking a few steps beyond the mainstream point of view. Because as history has proven many times over, that will go a long way to making you a more successful investor whether you’re looking into healthcare or any other sector.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2010 Copyright Q1 Publishing - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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