Personal Wealth Management / Market Analysis

A Discussion of Health Care Reform’s Impact on Health Care Stocks

Love or hate the Affordable Care Act, it may influence Health Care stocks less than you think.

The often heavily debated health care reform bill (officially known as the Patient Protection and Affordable Care Act of 2010) is headed for the Supreme Court—which will decide sometime this spring or early summer whether certain aspects (like the personal mandate to buy coverage) are constitutional. Some argue even if the Supreme Court finds the personal mandate unconstitutional, the bill still stands, while others say the lack of a severability clause will make the whole thing moot.

Love or hate the bill, my view (which attempts to be free of political ideology) is it doesn’t address the real reasons health care costs are rising. Therefore, the bill’s enactment or reversal likely has a limited impact on health expenditures or investment opportunities within the Health Care sector overall.

At roughly $3 trillion, US health care spending is approaching 20% of the country’s GDP, and PricewaterhouseCoopers estimates about half of that spending is waste. Capitalism and greedy health insurance companies are favorite political scapegoats. However, many health insurance companies are nonprofit, and net profit margins of publicly traded health insurers are in the mid-single digits. Health insurers were already paying 80% or more of premiums received in health benefits prior to reform discussions. So what’s really driving costs?

In reality, most everyone contributes to the problem—patients, doctors and even the third-party payment system (i.e., insurers). (Politicians won’t say this because it’s likely not a great way to score political points.) Patients are estimated to cost nearly $500 billion per year in wasted expenses—preventable diseases, risky lifestyles and not following doctors’ orders are often to blame. There are often low-cost (or free) ways for patients to make a dent here—like simply following doctors’ orders, quitting smoking, exercising, following a healthier diet, etc.

Then there’s doctors’ practice of “defensive medicine”—estimated to cost over $200 billion per year. People can be sued for anything, and doctors are especially vulnerable. As a result, many doctors may schedule excessive tests or procedures to limit liability.

Although unquantified, the third-party payment system is probably the largest cost driver. In most industries, businesses and customers are equipped with roughly the same information about a product or service. This symmetric information helps lead to efficient price discovery. However, in health care, information is often asymmetric—hospitals/doctors have far more knowledge than patients, which gives them pricing power and the ability to sell more products and services.

Add the fact many patients don’t know—or even care—about cost because someone else (like the insurance firm) pays the bill, and it’s easy to see why costs escalate. Consider your own behavior: If you have health insurance, do you shop doctors/hospitals to find the best service at the lowest price for heart surgery . . . or even a routine teeth cleaning? Doctors and hospitals account for over 50% of total health expenditures, and there’s little competition among them—doesn’t need to be when most customers don’t inquire about cost. But what happens when there’s even a bit of competition? Evidence shows prices tend to fall—like the average 80% drop in the price of branded drugs when generics enter the market. We need more capitalism and competition in the system, not less.

Few want health care costs to keep rising. But from an investment standpoint, it’s not necessarily a negative, particularly when we look out over the next 12 months. It will, however, likely create winners and losers as parts of the bill are implemented in 2013 and beyond. It’s unlikely the fundamentals of the drug and medical equipment industries, which account for roughly 85% of the investable Health Care universe, will be materially impacted. They will likely pass along any new regulatory costs to patients and payers. We should focus on other operational drivers like innovation and competition.

Health care is a polarizing subject and bound to frustrate many. But try not to let that influence your view of the macro world. We believe 2012 will be a good year for global stocks in general as economic activity and investor sentiment continue improving. Most Health Care companies are efficient and innovative—it’s just the system they operate is inefficient. That said, the sector is poised to do well over the next year as utilization rates improve, pipelines continue to evolve and fears of patent expiration fade.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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