Managed Care: How Likely Is a Worst-Case Scenario?

Alex Morozov: Hi, I'm Alex Morozov, associate director of the health-care team here at Morningstar. With health-care costs steadily increasing as a percentage of GDP, calls for a comprehensive health-care reform have become increasingly prominent. Managed care, as the center in a system of financing health care, is in the center of all these discussions. With me is our managed-care analyst, Matthew Coffina. Welcome, Matt.

Matthew Coffina: Thanks, Alex. Good to be here.

Morozov: Well, Matt, let's talk about the worst-case scenario for managed care. There has been a lot of calls for a public health-care plan. In your opinion, what would that plan do to a managed-care system?

Coffina: Sure. Well, we don't think that the government is going to explicitly move to a single-payer system. Most people nowadays get their insurance through their employer, through an employer-sponsored plan. We think that what is on the table, and is definitely being discussed, is the creation of a new public-insurance option that would compete with the private plans.

The problem with creating a new public plan is that if it was linked to Medicare, Medicare is already a very large program. It controls over $400 billion of health-care spending. By comparison, the largest private companies control about $100 billion of total spending. So Medicare is about four times as big as the largest private companies.

What we think this would mean is that Medicare would pay much lower provider rates than any of the private companies, you would have much lower administrative costs because of the additional scale, and that, basically, Medicare would have much lower costs than the private plans, allowing it to charge lower premiums.

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Morozov: OK. Well, let's talk about less-drastic proposals that have been on the table or currently are on the table. Let's talk about the Medicare Advantage. That's one of the areas that we're going to see significant cuts to managed care, is that correct?

Coffina: Sure. The managed-care organizations have done very well with Medicare Advantage over the last five or so years. Total enrollments have about doubled in the last five years. This is a program that's a private alternative to traditional, fee-for-service Medicare. And there are about 10 million people in the country currently enrolled in Medicare Advantage.

The thing is that Medicare Advantage is currently reimbursed at a premium: about 12%-13% more than original Medicare. And we think that that's going to be cut down to parity levels with original Medicare, that they're going to make beneficiaries in Medicare Advantage cost the same as beneficiaries in regular Medicare.

The net effect of that will be, probably, lower members, certainly lower revenue for the managed-care organizations, such as Humana, United Health, that are involved in Medicare Advantage. But on the other hand, we think that's already incorporated in stock prices, and it's certainly incorporated in our valuations.

Morozov: OK. Well, let's talk about another potential threat. The Obama administration, one of the key proposals is to increase uninsured coverage, to expand it to all presently uninsured people. If we have some kind of individual mandate on the table, and it comes with a requirement that managed care cannot underwrite pre-existing conditions, what do you think are the chances of this proposal to pass, and what do you think it would do to a managed-care system?

Coffina: Well, that's actually a really good question. I think if you really want to get the 46 million uninsured down to something closer to zero so that everyone has insurance, you really have to force people to buy insurance. Because, no matter what, there's going to be some healthy people that are not going to want to buy insurance; they're just not going to think it's worth it. So they're going to opt out of the pool.

That's especially the case if you're not going to allow managed-care organizations to medically underwrite their policies. If they have to take people with pre-existing conditions, then you have to make people without pre-existing conditions buy insurance anyway, even though it's more expensive than they really think it is to be worthwhile, because you need those healthy people to subsidize the unhealthy people.

From managed care's perspective, that kind of regulation actually doesn't really matter at all, as long as the healthy people are forced to stay in the pool. Where it becomes a concern is if you have to charge the same premium to everyone, and the healthy people are able to opt out, then premiums for everyone can go up, the total number of people with insurance can go down, and that hurts managed care. And it hurts everyone else, too: consumers.

Morozov: One of the proposals that's been gaining steam, even though President Obama initially opposed it, is potentially taxing employer tax benefits. If that's going to be the case, it is a very great likelihood that the managed-care plans would probably see a contraction in the scope of the plans being offered. What would that do you your estimates, then?

Coffina: Well, that's actually a really good question, and it's something we're watching closely. It's a proposal that's out there. Employer-sponsored benefits are currently tax-deductible to the employer, but they're tax-free to the employee, unlike other forms of compensation. If they went that route, we think that it would lower overall health-care spending growth. It could be a very effective cost-control mechanism. But on the other hand, it would be a very large tax increase on the middle class, which is something that President Obama promised wouldn't happen during the election.

Something that's sort of a middle ground that they're considering is just taxing employer-sponsored benefits above a certain value. So, if you have one of these Cadillac health plans, those would be taxed, but a basic plan would not be taxed. In any case, we think that any kind of tax on employer-sponsored benefit, by increasing the after-tax cost of having more generous benefits, is going to lower the total amount of insurance that people carry, and it would negatively affect our fair value estimates.

I think that it's very unlikely that they would put an across-the-board tax on employer-sponsored benefits. It's very unpopular in polls. Most of the Democrats are opposed to it. What is possible is maybe they'll tax the Cadillac-type plans. And that would have a marginal effect on the fair-value estimates, but probably not anything too remarkable.

Morozov: So, to summarize: none of the proposals that you think are passable would drastically alter the managed-care space.

Coffina: Yeah, I would agree with that. Certainly, the proposal that's out that concerns us the most is the creation of the new public plan. There are a lot of reasons that we don't think that that's actually going to happen. It's opposed by Republicans. But more importantly, it's opposed by doctor groups, hospitals, pharmaceutical lobby, the device-makers. Pretty much everyone is against this.

So managed care has a lot of allies throughout the health-care space in opposing the creation of a new public plan. If that did happen, that would have a pretty drastic effect on our fair-value estimates. But of the things that we think are likely to happen, we think that we're comfortable with where we are.

Morozov: Thank you for your time, Matt.

Coffina: Thank you.