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By Matthew Coffina, CFA | 11-19-2013 11:00 AM

How Investors Should Approach Health-Care Stocks After ACA

Despite the rollout complications, the Affordable Care Act will affect health-care subsectors differently but won't have much of an impact on stocks overall, says StockInvestor editor Matt Coffina.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. How should investors think about investing in health care against the backdrop of the rollout of the Affordable Care Act? I'm here today with Matt Coffina. He's editor of Morningstar StockInvestor to take a look at this question.

Matt, thanks for joining me today.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start with a big-picture look at what the Affordable Care Act is trying to accomplish and how it's been going so far. What were some of the big goals of this law?

Coffina: The two big goals, I think, are slowing the growth in health-care spending and increasing the number of people with health insurance. Currently, the U.S. has about 15% of the population that's uninsured, and health-care spending growth has exceeded nominal gross domestic product growth by about 270 basis points a year for the last 50 years with few exceptions.

In terms of how well the law is going to do in actually solving these problems, I think the law tends to do much more to increase the number of people with insurance than it does to slow the growth in health-care spending. The way it accomplishes that first goal is through expansions of the Medicaid program. This is the program that historically has been only for low-income families, and now they are expanding coverage to all low-income people. Of course, some states are participating or not participating--it's a joint federal-state program. In the states that are participating, the CBO, Congressional Budget Office, expects about 12 million people to gain health insurance coverage by 2016.

Then the other major way that insurance coverage is being increased is through these insurance exchanges, both state and federal insurance exchanges, and the CBO estimates that about 22 million people gain insurance through that source by 2016. Of course that's assuming that the current implementation issues get sorted out. Then all of that is going to be offset by about 10 million people expected to lose coverage from existing employer-sponsored individual policies. It translates into about 9% net increase in the insured population, again in 2016.

Glaser: How about on the health-care spending side, how does the law expect to slow spending there?

Coffina: That's a good question. There are explicit cuts to Medicare spending as part of the funding of the law, and then there's also direct fees and taxes on health companies, the insurance sector, the device manufacturers, and pharmaceutical companies are all contributing directly to the cost through increased taxes and fees. Other than that the law includes a lot of demonstration programs and pilots and things like that. Probably the most prominent would be accountable care organizations, the idea being to incentivize health-care providers to slow the growth in health-care spending by providing them a share of the savings.

Another way that the law attempts to slow health-care spending growth would be by taxing very high-benefit plans, so-called Cadillac plans, the idea being to encourage employers from not offering such generous coverage to begin with. And then one more way would be by pressuring premium rates at insurers.

The federal government has higher oversight over premium increases, which is making it harder for the insurance sector to raise their prices over time, which in turn is causing them to push back more on price increases at the provider level. So, we are seeing more heated negotiations between health-care providers like pharmaceutical firms and hospitals and insurance companies or pharmacy benefit managers on the payor side.

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