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Economic Insights

The election may be good for pharma and medical devices, bad for hospitals, while the outlook for HMOs is uncertain. Lord Abbett analysts elaborate.

 

In Brief

  • Pharmaceutical companies got the best possible outcome from the election, as major price controls appear unlikely, but a number of secular and regulatory changes could negatively affect the sector going forward.
  • While Republicans are expected to use the budget-reconciliation process to initiate repeal during the first 100 days of President Trump, many parts of the Affordable Care Act (aka “Obamacare”) cannot be addressed under reconciliation (e.g., insurance regulations). 
  • The healthcare sector will likely evolve through a Trump presidency.   
  • Given the midterm congressional election two years from now, it is unlikely that politicians will drop coverage of 20 million individuals in a repeal scenario in the meantime.  

 

As Americans processed the historic upset in the presidential election, Lord Abbett research analysts were quick to notify colleagues and clients about the potential investment implications, especially when it came to the Affordable Care Act (ACA), commonly known as "Obamacare."

According to Iskra Simidchieva, a taxable fixed-income analyst, pharmaceutical companies got the best possible outcome. “After the sweeping Republican win, we believe there is little chance of major drug price control legislation being passed,” she said.  

Simidchieva said the Medicare Part B drug pricing demonstration project is unlikely to go through,1 while a potential repatriation of overseas profits would greatly benefit the large-cap pharmas that have billions of cash accumulated overseas. The likely repeal of the Independent Payment Advisory Board (IPAB)2 is also viewed as a positive for the sector. (Recall that the IPAB mechanism was implemented as a result of the ACA and could be used as early as next year for Medicare cuts in areas such as the Part B and Part D drug programs.)

Elsewhere, the Prop 61 ballot initiative in California, which sought to link state drug prices to the much lower prices paid by the U.S. Department of Veterans Affairs, failed by a big margin. The multimillion-dollar pharmaceutical industry campaign against the initiative led to fairly conclusive results, and the other states are unlikely to follow at this point—another important win for pharma, Simidchieva added. 

The post-election rally in pharma stocks did not surprise Simidchieva. “But not all the clouds are gone from the pharma sky, as there are a number of secular and regulatory changes that could negatively impact the sector going forward,” she said. “Various drug pricing transparency initiatives at the state level, potential changes in Part D pricing as part of a broader Medicare overhaul, and ongoing investigations and hearings targeting excessive price increases will continue to be an overhang.” 

Repealing Obamacare
While Donald Trump and many congressional Republicans have called for repealing the ACA, there has been less consensus on how to replace such healthcare reform. There are roughly 20 million individuals who are now receiving health coverage either through a health exchange or through state Medicaid expansion, so taking away this entitlement is more easily said than done. (See Chart 1.) 

 

Chart 1. Repealing the ACA Could Dump 19.7 Million Insured People 
Impact of Trump’s proposed reforms on the number of people with insurance coverage, 2018; number of insured, in millions

Source: E. Saltzman and C. Eibner, “Donald Trump’s Health Care Reform Proposals: Anticipated Effects on InsuranceCoverage, Out-of-Pocket Costs, and the Federal Deficit,” The Commonwealth Fund, September 2016.
Note: Changes in coverage relative to the ACA scenario are shown above each bar, in red. The estimated distribution of enrollment by source of coverage is based on data from the RAND COMPARE micro simulation model.

 

The Republicans are expected to use the budget-reconciliation process to initiate the repeal of Obamacare during the first 100 days of Trump’s presidency. “However, many parts of the ACA cannot be addressed under reconciliation—such as the insurance regulations,” Simidchieva said. "Further legislative changes will be hard to accomplish in 2017, given the small Republican majority absent an acceptable replacement reform," she said. 

Simidchieva expects the potential replacement of the ACA to be based on the following framework laid out by House Republicans, led by Speaker Paul Ryan (R-WI) and endorsed by the newly nominated HHS Secretary Tom Price.  According to Ryan’s “Better Way” white paper, Republicans are looking to change major components of the ACA, and more specifically to:

  • Eliminate the individual mandate and the employer mandate;
  • Repeal the high-cost insurance plan “Cadillac tax,” the medical device tax, the insurer and the drug industry taxes;
  • Repeal the premium assistance tax credit that funds the healthcare exchange market; 
  • End Medicaid expansion after a two-year phase-in period while adjusting the Medicaid Disproportionate Share (DSH) payments for hospitals to offset the decline in Medicaid reimbursement and enrollment; 
  • Transform Medicaid into a block grant program, which would allow states more flexibility to design the program; and
  • Increase funding for community health centers. 

Other proposals that have Republican support and can be part of an ACA replacement include:

  • Refundable advance tax credits for individuals to purchase health coverage, especially for those that don't have access to employer-based or public insurance 
  • Promotion of health savings accounts (HSAs) 
  • Federal funding for state innovation grants and state-based high risk pools
  • Association health plans for small businesses 
  • Cap tax exclusion for employer health benefits that have been opposed in the past by employers and unions 
  • Medicare premium support that should allow managed Medicare health plans to compete more directly with Medicare fee for service.  
  • Sale of insurance across state lines, which would allow individuals to purchase health coverage from out-of-state health plans
  • Increase the eligibility age for Medicare to 67
  • Maintaining the dependent coverage up to age 26 on parents' plan
  • Maintaining coverage for preexisting conditions via setting up high-risk pools (see Figure 1), and other targeted subsidies 

 

Figure 1. Traditional State High-Risk Pools, Pre-Obamacare


Source: NASCHIP, Comprehensive Health Insurance for High-Risk Individuals: A State-by-State Analysis, 2011/2012

 

Another proposal under discussion is modification of the health insurance premium rating band to 5:1 versus the current 3:1, to effectively lower insurance rates for younger individuals, while increasing the premium for older or sicker individuals. (Rating bands are part of a regulation that allows health insurers to charge a multiple of the base premium to the sickest population; i.e., if there is a premium of $100 to a healthy individual, then the high rate for the same plan can be only $300. By expanding the rating bands, there could be more affordable coverage on the lowest tier. The complaint from insurance companies has been that healthy individuals are priced out of the market by the sicker population.)  

The range of Medicare reforms proposed by Republicans is definitely noteworthy, but many of those would likely take several years to implement, if at all, in order to avoid major market disruption, according to Simidchieva. In the near term, we expect Republicans to focus on slowing down the pace of some of the recent Medicare “demonstration initiatives,”3 and especially the total joint bundle proposal and the expansion of the bundle into cardiac conditions and hip/femur fractures—a positive outcome for high-cost post-acute providers overall.

The Stock Outlook 
When it became clear that Donald Trump would be the next president, Devesh Karandikar, a Lord Abbett research analyst, jumped on the outlook for HMOs, hospitals, drug suppliers, medical devices, and healthcare information technology. 

Commenting on HMOs, Karandikar said a Trump presidency should mean more uncertainty, as his policies have not been fully vetted. While there may be optimism regarding the completion of two pending megadeals, investors are concerned about the implications for Medicaid, as Trump has discussed block grants to the states, which would mean less dollars. The loss of 20 million individuals in the insurance pools could put pressure on revenues, but most publically traded companies have little exposure. HMO investors are also concerned about which regulations will take hold. 

As for hospitals and post-acute facilities, Karandikar said a Trump presidency would be a clear negative, as coverage expansion will come diminish and the payer mix likely will become worse. “We could see less pressure on post-acute payment changes,” Karandikar said.  “Fewer patients through the system would be the concern pressuring margins in the long run for the facilities sector.” 

On the other hand, companies in the drug supply chain may benefit, since there is likely to be less scrutiny on drug pricing with a Trump presidency. “If drug prices rise in the first quarter of 2017, then the distributors have upside potential,” Karandikar added. “In addition, there could be less pressure on pharmacy benefit managers and retailers as well.”

Turning to the medical devices sector, Karandikar said the main positive is the potential repatriation of profits stashed offshore. If this occurs, there will be tremendous amount of capital that could be brought back. Larger med-tech companies could benefit from deploying capital through mergers and acquisitions. Longer term, the impact of reworking trade deals also may have an impact. 

For the healthcare IT sector, Karandikar saw longer-term risk. Hospitals experiencing margin pressure, from reimbursement compression and volume slowdown, will cause more scrutiny on information technology spending.  

Privatization of Medicare?
Karandikar also was quick to take issue with certain parts of a New York Magazine article that quoted House Speaker Paul Ryan’s assertion that privatization of Medicare was on.

But first, a quick overview on the current state of Medicare, which covers 55.5 million beneficiaries. According to the Social Security Administration (SSA), the Medicare program has two separate trust funds: the Hospital Insurance Trust Fund (HI) and the Supplementary Medical Insurance Trust Fund (SMI). HI, otherwise known as Medicare Part A, helps pay for hospital, home health services following hospital stays, skilled nursing facility, and hospice care for the aged and disabled. SMI consists of Medicare Part B and Part D. Part B helps pay for physician, outpatient hospital, home health, and other services for the aged and disabled who have voluntarily enrolled. Part D provides subsidized access to drug insurance coverage on a voluntary basis for all beneficiaries and premium and cost-sharing subsidies for low-income enrollees.

While the New York Magazine article suggested Obamacare has lengthened the viability of the fund, the SSA refutes that on its website: 

“The Trustees project that the Medicare Hospital Insurance (HI) Trust Fund will be depleted in 2028, two years earlier than projected in last year's report.

“For Supplementary Medical Insurance (SMI), the Trustees project that both Part B (which pays doctors' bills and other outpatient expenses) and Part D (which pays for prescription drug coverage) will remain adequately financed into the indefinite future because current law provides financing from general revenues and beneficiary premiums each year to meet the next year's expected costs.”

“As for privatization of Medicare, Paul Ryan will try to push for more Medicare beneficiaries to opt in for Medicare Advantage [MA] rather than the higher cost Medicare Fee for Service [FFS],” Karandikar said. “MA is an HMO version of Medicare, which is offered by HMO companies. About 35% of Medicare beneficiaries have elected MA plans over FFS. Ryan and the Republicans view MA as a success at lowering costs and providing broader benefits for beneficiaries. This has been accomplished by companies competing for members through price, network, and benefit design. The companies receive roughly a 14% premium to traditional Medicare, but companies typically have included extra benefits and drug coverage.  If and when the Republicans begin to privatize Medicare, they are likely to steer beneficiaries to MA, but then potentially cut the 14% premium closer to traditional payments.”

The bottom line is that the healthcare sector will evolve through a Trump presidency. Meanwhile, the “repeal and replace” rhetoric has softened. Given the midterm congressional election two years from now, it is unlikely that politicians will allow 20 million individuals to lose coverage in a repeal scenario. 

 

Chart 2. Distribution of Enrollment in Medicare Private Plans, by Plan Type, 2016

Source: Kaiser Family Foundation analysis of the Centers for Medicare and Medicaid Services (CMS) Medicare Advantage enrollment files, 2016.
Note: PFFS is Private Fee-for-Service plans.  PPOs are preferred provider organizations, and HMOs are Health Maintenance Organizations.  Other includes MSAs, cost plans, and demonstration plans.  Includes enrollees in Special Needs Plans as well as other Medicare Advantage plans.  Excludes beneficiaries with unknown county addresses and in territories other than Puerto Rico.  

 

1 CMS has announced a proposed rule to test a new model to improve how Medicare Part B pays for prescription drugs and supports physicians and other clinicians in delivering higher quality care. The proposed Medicare Part B Model would test new ways to support physicians and other clinicians as they choose the drug that is right for their patients. It is designed to test different physician and patient incentives to do two things: drive the prescribing of the most effective drugs, and test new payment approaches to reward positive patient outcomes.

2 The Independent Payment Advisory Board, or IPAB, is a 15-member government created by the Affordable Care Act which has the explicit task of achieving specified savings in Medicare without affecting coverage or quality.  IPAB was given the authority to make changes to the Medicare program with the Congress being given the power to overrule the agency's decisions through supermajority vote.

3 The Centers for Medicare & Medicaid Services (CMS) conducts and sponsors a number of innovative demonstration projects to test and measure the effect of potential program changes. Our demonstrations study the likely impact of new methods of service delivery, coverage of new types of service, and new payment approaches on beneficiaries, providers, health plans, states, and the Medicare Trust Funds. Evaluation projects validate our research and demonstration findings and help us monitor the effectiveness of Medicare, Medicaid, and the Children's Health Insurance Program (CHIP).

 

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