Obamacare is revolutionising healthcare in the United States – the single most important market for healthcare companies in the world. This has profound implications for the outlook for these companies and as a consequence how to identify the best investment opportunities in the sector.
Half of total global healthcare spending takes place in the US, with the country spending 17.4% of its total GDP on healthcare in 2013, almost twice as much as the OECD average of 9%. Yet as judged by the ultimate outcome measure of longevity, the US is actually below average for the developed world. Furthermore, until the current Obama administration introduced the Affordable Care Act (ACA), more than 30 million Americans lacked health insurance.
The three goals of the ACA are to expand access, improve quality and reduce cost in US healthcare. The first of the three aims, expanding coverage, is being achieved with 17 million Americans having gained coverage since ACA provisions, most notably the requirement for citizens to purchase health insurance and the advent of collective government and state-provided schemes.
The quality and cost aims are being addressed by moving from volume-based reimbursement to a value-based approach which, for the first time, aligns the interests of payers and providers. Under the pre-ACA volume-based system, providers made more revenue the more procedures were carried out. It also encouraged the overuse of specialists at the expense of good primary care. In contrast, a value-based approach ultimately sees providers reimbursed for providing agreed clinical outcomes for a population of patients and penalised in terms of lower or no reimbursement for failing to achieve the agreed outcomes. As such, the provider bears some of the financial risk of their decisions.
This change is not happening overnight though. CMS (Centers for Medicare & Medicaid Services), which controls Medicare and Medicaid and therefore almost half of US healthcare spending, intends to have more than 50% payments in value-based approaches by 2018. Health insurers (Managed Care Organisations, MCOs) and large employers are also moving this way. For example, MCOs already have over a third of medical costs under some form of value-based approach and on their own projections will move to two-thirds by 2020. Individuals are taking more of an interest in their healthcare choices already, driven by 9% per annum growth in deductibles – the amount a patient has to pay out of his or her own pocket to access insurance – over the last 10 years such that 12% of US healthcare spending is now ‘out-of-pocket’. In 2015, 81% of employer plans now have a deductible, up from 52% in 2003. As in other areas of insurance, transparency has increased dramatically as websites allow comparison of health insurance plans. In short, value-based plans will predominate within five years and are already becoming widely accepted by citizens as a means of controlling their own burgeoning healthcare costs.
The extent to which Obamacare will be successful in reducing overall costs though is unclear. Healthcare spending has risen at less than 5% per annum since the financial crisis and the CMS only anticipates a modest acceleration to 5.8% growth CAGR from 2014-24, despite covering an additional 30 million people, highlighting the expected savings from focusing on outcomes not volumes.
Obamacare has profound implications for healthcare company prospects. Continued consolidation within healthcare companies is inevitable to help control costs. More profoundly, the move to a value-based approach will reward providers and payers willing and capable of taking on the risk of being judged and paid on the basis of agreed outcomes. This should favour the big health insurers given their scale and expertise in pricing risk.
Manufacturers of drugs and devices will benefit if they can prove to the healthcare provider that their product gives a desired and reimbursed outcome at a meaningfully lower cost than the alternatives. Over time, manufacturers of such drugs and devices may also look to take on risk by being paid for performance rather than by per unit sold or even offering specific services based on their products. In contrast, those providers of relatively undifferentiated service and products unable to deliver a clear value proposition to payers will have to keep consolidating and keep cutting costs as their share of healthcare spending diminishes. Ultimately, they will need to rethink their business models or will be forced to compete on price and accept much lower margins than in the past.
The impact on investors is likely to be almost as profound. The sector has provided consistently excellent returns since the financial crisis with stock selection less important than the absolute weighting in the sector. This appears destined to change with much greater divergence between future winners and losers.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.