What Investors Need To Know About Healthcare Reform

by Tony D'Altorio

What Investors Need To Know About Healthcare Reform

Tony Daltorio, Investment U Research

Friday, April 30, 2010

President Obama officially signed Congress' hotly contested healthcare reform into law on March 23, 2010.

When that happened, both sides of the debate filled the newspapers, blogosphere and break rooms with their opinions on the subject... not that they hadn't been doing just that before as well.

But now that the initial furor has died down at least a bit, it seems like a good time to look closely at the facts instead of the hype from either side.

In particular, investors should know what the healthcare reform means for the businesses most closely linked to it, such as hospitals and the pharmaceutical industry.

What Hospitals Get From Healthcare Reform

Let's start out with the United States hospitals, which include big, publicly traded names such as:

  • Universal Health Services (NYSE: UHS)
  • Health Management Associates (NYSE: HMA)
  • Community Health Systems (NYSE: CYH)
  • Tenet Healthcare (NYSE: THC)

By one estimate, the industry generated $740 billion in revenue last year. And at first glance - considering the legally mandated, incoming influx of insured customers - it seems like they'll do even better in the coming years.

Tenet Healthcare CEO Trevor Fetter says that at its core, the new legislation will fix a key problem hospitals face. Since the law requires them to treat emergencies, they have become the "insurers for the uninsured" in effect. He estimates hospitals lose roughly $1.4 million a day helping uninsured patients.

Mr. Fetter also shared that half of Tenet's patients came in through the emergency room before the new law passed. Most doctors send patients there, especially those without health insurance. That then transfers to higher fees for patients with private insurance from employers.

The Downside To The New Healthcare Legislation

But that doesn't mean Fetter fully supports the healthcare legislation.

He points to Massachusetts, where citizens legally have to have health coverage. There, the newly covered insured have stretched doctors' offices to their full capacity, overflowing into the E.R.

This could overwhelm some hospital systems.

Then there's the issue of reimbursement. The amount that hospitals receive for patient care depends on what insurance each has. Naturally, private insurers pay the most while the elderly on Medicare and the poor or disabled on Medicaid contribute much less.

Under the old way of doing things, each state determined who received Medicaid and who didn't. But the new law sets a national standard, which means that more people will receive it and hospitals won't make as much profit.

Pharmaceutical Companies Fared Best From Healthcare Reform

Big pharmaceutical companies seemed to have fared the best from Obama's healthcare reform.

The industry agreed to changes costing it $90 billion over 10 years. But it also won out on issues such as importing cheap drugs from Canada, which won't happen now.

In addition, the initial bill gave generic drug makers a new pathway to get FDA approval for biological medicines. That would have threatened big pharma while aiding its less flashy competition like Teva Pharmaceutical ADR (NASDAQ: TEVA) and Watson Pharmaceuticals (NYSE: WPI).

Made from living cells rather than chemicals, biological drugs are quickly gaining traction. In 2008, that category made up a full quarter of the world's top-selling drugs. Last year, in the U.S. alone, they generated $65 billion. And at last count, they represented 17% of all global drug sales.

Branded biological drugs can cost patients hundreds of thousands of dollars a year and billions for government insurance programs. Data from the Office of Medicare and Medicaid shows that the U.S. government paid more than $2.2 billion over four years for Medicare patients receiving Neulasta. The drug, made by Amgen (NASDAQ: AMGN), is used alongside chemotherapy treatments.

In the end, Big Pharmaceutical companies won out on the issue, thanks to strong lobbying efforts.

But Paul Bisaro, the CEO of Watson Pharmaceuticals, understandably doesn't agree with the changes. He claims that the regulatory pathways for generic drug makers in the final version of the bill don't serve any practical purpose.

The finished healthcare law contains so-called "evergreening" provisions, which gives branded drug makers 12 years to hold onto their existing patents. And if the drugmaker makes changes to the biological drug, it then receives another 12 years to keep all rights.

According to Mr. Bisaro, that also means generic drugs can't cut it in the markets, at least not when it comes to biologicals. Instead, generic drug makers can focus on so-called biosimilar drugs, which cannot be directly substituted for branded drugs.

Of course, that means they lose out in the end, which suits their name-brand competition just fine. So big drug companies win out... generic drug companies fall short... and hospital companies fall somewhere in the middle.

Good investing,

Tony Daltorio

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