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By Jeremy Glaser and Matthew Coffina, CFA | 06-28-2012 10:00 AM

Health-Care Ruling Net Positive for Managed-Care Firms

The market is undervaluing how the boost in new customers will offset new regulations for managed-care companies, says Morningstar's Matt Coffina.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Supreme Court handed down its long-awaited ruling on the Affordable Care Act today. I'm here today with Matt Coffina, senior equity analyst, to get the implications for health-care companies and if there's any best ideas in this sector right now.

Matt, thanks for joining me.

Matthew Coffina: Thanks for having me, Jeremy.

Glaser: Can you give us kind of the brief summary of what the Supreme Court held and if that was different from what you were expecting?

Coffina: Sure. I'm not sure that we had a specific expectation coming in. The Supreme Court upheld the entire law on a 5-4 vote. The most controversial provision, the individual mandate, perhaps surprisingly was actually voted for by Chief Justice John Roberts. And Justice [Anthony] Kennedy, who many had expected to be the swing vote and the deciding vote, actually voted against that provision. But once the individual mandate was upheld, the rest of the law stands.

One thing that was a little bit unexpected is that there was a limitation placed on the expansion to the Medicaid program. Basically the court said that the Federal government can't withhold funds from states' regular Medicaid programs, if those states choose not to participate in the expansion of Medicaid. That could mean that Medicaid won't be expanded in some states like it otherwise would have been.

On the other hand, because the individual mandate is still in place, states are really going to need to find a way to help their residents meet the individual mandate, particularly low-income residents. I would expect the vast majority of states still to take the federal money and expand Medicaid as the law had indicated.

Glaser: Now that we know that the law is going to stand and essentially has passed, can you review a little bit of what your thesis says and what impact that's going to have on the health-care industry?

Coffina: Sure. There's a lot of ins and outs in the law, but the big take-away is that about 32 million people are expected to gain insurance--about half of them in Medicaid and about half of them in the individual market--helped by subsidies from the federal government. And then all of this is going to be paid for by some new taxes and fees on certain sectors and cuts to reimbursements on other sectors. So, in general, I would say, looking at the entire health-care universe, we expect the increased patient volumes to largely offset the increased fees, such that it should be a fairly neutral event to most companies involved. That's not necessarily true in every specific sector, for example, devices. A lot of people that use devices are already covered by Medicare, so [device manufacturers] have relatively little to gain from increased patient volumes, which means that the legislation is probably a small net negative for them. They're still going to be paying the fees, but not that many new patients.

For pharma, it's more neutral. Then for managed care, we actually think that this is a positive outcome, which is really contrary to the way the stocks are moving today and what I think a lot of people think about this sector. It's been our view that a lot of the negative aspects of the law for Managed Care--things like cuts to Medicare Advantage reimbursements, minimum medical cost ratios, meaning that health insurers have to spend at least a certain percentage of their premiums on health-care costs, as well as state scrutiny of premium increases--we think that almost all of these things would have been resurrected or would have come back in some form even if the health reform law has been thrown out. But since the law was upheld, these companies get to maintain the benefit of the increased patient volumes, both through the subsidies and the Medicaid expansion. Those things were very unlikely to be resurrected, given the current political environment.

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