Tue, 27 Mar 2012
Regardless of when and how the justices rule on the Affordable Care Act as well as the best- and worst-case scenarios, company valuations should see little change, says Morningstar's Matt Coffina.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As the Supreme Court hears oral arguments about the constitutionality of the Affordable Care Act, I'm joined today by Matt Coffina. He is a senior health-care analyst, and we'll take a look at what impact the Supreme Court's ruling could have on health-care companies and what investors should do?
Matt, thanks so much for joining me, today.
Matthew Coffina: Thanks for having me, Jeremy.
Glaser: So, let's talk a little bit about what the Supreme Court has decided. They are having a few days' worth of arguments here. We probably won't get decision until June. What are the Justices looking at? What are some of the really the key issues that they're focused on?
Coffina: So the Justices have a few things that they need to decide. The first question is whether or not they can even rule on the constitutionality of the Affordable Care Act. If people don't carry insurance under the individual mandate, then the taxes won't be collected until 2015. So there is something called the Anti-Injunction Act, which might mean that the court is unable to rule on the constitutionality of this provision until after the tax is collected.
The second issue they need to decide is really whether the individual mandate, which is a requirement that all Americans carry health insurance, is constitutional. They'll look at whether the mandate is permissible under the Commerce Clause of the constitution, whether Congress has that ability to require individuals to purchase health insurance. Assuming that they were to decide that the individual mandate is not constitutional, the next question would be whether or not the rest of the law can stand without that provision, or whether the entire law would have to be considered unconstitutional and therefore thrown out.
Then finally, sort of a side act to all of that would be the Medicaid expansion, where some of the states have argued that the expansion of Medicaid is overly coercive to the states, even though they have the ability to opt out of the Medicaid program entirely. Even though the federal government is going to be picking up the tab for most of the expansion and eligibility that will begin to take effect in 2014, some states have ruled that that was an overreach of congressional power, as well.
Glaser: So let's take a look at some scenario analysis here. I think it's probably difficult to read the tea leaves to see exactly what the Supreme Court is going to rule. But what are some of the possibilities? What do we think are some possible outcomes, and what impact are they going to have on some of the health-care firms?
Coffina: So I think the most important takeaway for investors is that, when the Affordable Care Act passed originally, we didn't really change any of our fair value estimates for health-care companies, even for managed-care companies, which tend to be the most affected by legislation like this. So therefore, almost regardless of what the Supreme Court does, it's relatively unlikely that you'd see material changes to our fair value estimates one way or another.
Now in terms of thinking of the best- and worst-case scenarios, I cover managed-care companies, and as far as that sector is concerned, I actually think at this point that they want the legislation to stay in place or that they should want for the legislation to stay in place in its entirety. That's because of the wheels of reform have already sort of been set in motion at this point.
We think of the provisions in terms of some negatives and some positives for the managed-care sector, and on the negative side, there are things like increased state scrutiny of premium rates, increased consolidation among health-care providers, and probably a move to state-based insurance exchanges in the individual and small group market. Those kinds of provisions are probably here to stay, and even if the law were thrown out entirely, a lot of those provisions would persist or they'd be resurrected in one form or another, whether at the state level or the federal level.
Some of the positive aspects for managed-care on the other hand, such as the Medicaid expansion and subsidies for people to purchase individual insurance, are much less likely to be resurrected in the current political environment, where the focus has really turned to government deficits, much more so than health-care access. So in other words, you might end up staying with the bad and throwing out the good which would really be the worst-case scenario for managed-care organizations.
Looking at some other industries, the pharmaceuticals sector was asked to make some contributions in the form of helping to close the doughnut hole for Medicare, for example, and some industry fees. Medical devices are also going to be subject to some fees under the law, and again, if the entire law were thrown out, that could be OK for those sectors in that they wouldn't have to pay those fees. But it's also entirely possible those fees could be resurrected in one form or another just to close the deficit. On the other hand, the offset, which came from more people with insurance and more people buying health care, that's unlikely to make a comeback if the law were thrown out.
Glaser: Now, if you look at these individual companies that are also obviously watching these proceedings, do you think regarding their investment decisions, are they not investing and instead waiting for the outcome? Or do you think that most companies in the health-care industry are going about their business as usual and are just keeping an eye on this from the side of their heads?
Coffina: I think there is no doubt that health-care companies in general have been spending a lot of money to bring themselves into compliance and to prepare for the major changes that are happening as a result of the law. A lot of those changes come on in 2014. Certainly if the Supreme Court decided it couldn't yet rule on the constitutionality of the law, I would view that as very negative: It would both prolong the current state of uncertainty, and it will also extend some of the increase in compliance spending that's going on and make that drag out even more so. It's quite possible that these companies would be spending on initiatives that would be all-for-naught if the law were thrown out eventually. So I think so far most health-care companies have been proceeding, assuming this is the law of the land and that it's going to stay in place. It would certainly throw a wrench into things if the Supreme Court decided now that it was unconstitutional, and it would be sort of back to square one from both the legislative and just a health-care system perspective of what should we do next.
Glaser: Finally, for investors then, does it not make sense then to try to front-run the decision anyway? It sounds like there aren't going to be big changes to fair value estimates. Does it make sense for health-care investors to kind of stay the course, or should they be looking making some more strategic moves ahead of any potential changes to the law?
Coffina: Well, again, I think because we don't necessarily see the Supreme Court's decision as having a huge impact on our valuations, I would say that valuation would be the name of the game and just trying to find companies that we think are undervalued. A few names that come to mind would be WellPoint in the managed-care space which is trading for about a 35% discount to our fair value estimate or Novartis in the pharmaceutical space. I think if you buy a company that's trading at a reasonable discount to fair value, you'll probably do all right over the long run almost regardless of what the Supreme Court does.
Glaser: Matt, thanks for sharing your thoughts with me today.
Coffina: Thank you, Jeremy.
Glaser: From Morningstar, I'm Jeremy Glaser.