Our Diagnosis of the Baucus Health Reform Bill

The health-care proposal from the "bipartisan six" led by Senator Max Baucus (D.-Mont.), chairman of the Senate Finance Committee (SFC), was released in mid-September, and amendments were considered and debated over the following couple of weeks. The Congressional Budget Office (CBO) is expected to release its final opinion on the total cost of the bill shortly, after which the SFC will vote on the bill. Assuming the bill passes in the Finance Committee, it will be combined with the bill from the Senate Health, Education, Labor, and Pensions Committee before being brought before the full Senate.

Ever since this debate began last spring, we have said that Baucus would emerge as the key player on reform, and we are not surprised that he has helped generate what could be the most politically palatable health-care bill we've seen out of Congress yet. Whether it has enough support from either party to actually make it through the legislative gauntlet remains to be seen. While "America's Healthy Future Act of 2009" is quite robust, we've decided to focus on some of its key components to gauge its potential impact on the health-care space.

Guaranteed Issue, Rate Bands, and an Individual Mandate
Original Bill: The bill would require insurance companies to offer coverage on a guaranteed issue basis, forbidding them from rescinding policies or denying coverage for those with pre-existing conditions. The bill would eliminate medical underwriting, allowing premiums to vary based only on the following characteristics: region, tobacco use, age, and family composition. The bill would require the vast majority of citizens and legal residents to carry health insurance or pay an excise tax. We have long held that in order to maintain the viability of the individual insurance market, an individual mandate--in conjunction with regulations requiring guaranteed issue and non-risk-rated premiums--is a must.

Recent Amendments: During the bill markup, the rating bands were tightened, so that premiums are now only allowed to vary at a 4:1 ratio based on age, or a 6:1 composite ratio within a family category. These restrictions will tend to lower or maintain premium levels for older Americans in the individual market, while significantly increasing premium levels for younger people. The maximum tax penalty for families who fail to carry health insurance was also greatly reduced from the original level of $3,800 per year. In the final version of the bill, the maximum tax penalty per uninsured adult is set at $200 in 2014, $400 in 2015, $600 in 2016, and $750 starting in 2017. Failing to carry health insurance carries no civil or criminal penalty, and interest does not accrue on unpaid excise taxes. The only enforcement mechanism for the individual mandate is for the government to withhold the penalty tax from the uninsured person's annual tax refund. In our opinion, the amendments around the individual mandate have made it almost completely ineffective, which will likely mean lower overall insurance coverage and higher insurance premiums as healthy families become even more likely to opt out of the insurance pool.

What It Means: We think the current version of the SFC bill will have the unintended consequence of significantly increasing premiums in the individual market, especially for younger and healthier individuals, while having minimal effect on the number of people without insurance. We think there is a good chance that the CBO report will agree with this assessment, which will require the SFC or the full Congress to once again strengthen the individual mandate in the final legislation.

Without a stronger individual mandate, we think these provisions could result in more people without insurance, which would be a negative for most health-care companies. On the other hand, if the individual mandate is strengthened, it has the potential to substantially increase the demand for health insurance, which would be a big boost to managed-care organizations. A reduction in the number of uninsured Americans would also result in an increase in the demand for drugs, which would largely offset the pricing concessions and fees imposed on the pharmaceutical industry in other parts of the health-care reform bill. Device manufacturers would also see an uptick in volume.

Annual Industry Fees and Excise Taxes
Original Bill: One of the more controversial components of the bill is its attempt to impose annual fees on pharmaceutical manufacturers ($2.3 billion), medical device manufacturers ($4 billion), health insurance providers ($6 billion), and clinical laboratory services ($750 million). The fees would be parceled out by industry market share and already have the attention of industry lobbyists. There are many, particularly those in the device market, who see the fees as a double hit to their profitability, given that the reimbursement environment is also expected to be constrained in certain areas as a result of this bill. The other feature that is getting some attention is the plan to levy taxes on "Cadillac" insurance plans. Essentially, any plan that exceeds the threshold amount of $8,000 for individuals and $21,000 for families would be taxed at a 35% rate for the portion in excess of the threshold.

Recent Amendments: The excise tax on high-cost insurance plans was increased to 40% from 35%, but the adjustment factor for the threshold level at which the tax would take effect (originally $8,000 for individuals and $21,000 for families) was increased by 1 percentage point annually, to CPI inflation plus 1%. This change will mean more plans will remain exempt from the excise tax for longer, making this measure less effective at lowering the rate of health-care cost inflation. Even so, health-care costs generally increase faster than nominal gross domestic product growth, so the threshold is still likely to become increasingly meaningful over time. The annual fee on health insurers was increased by $700 million, to $6.7 billion, while the annual fee on clinical laboratories was eliminated. It should be noted that the pharmaceutical industry scored a victory when a proposal to require drug companies to provide $100 billion in additional rebates to Medicare over 10 years was defeated, essentially upholding the $80 billion deal the pharma lobby had previously negotiated with the White House.

What It Means: We expect the vast majority of fees on pharmaceutical companies, device makers, and health insurers to be passed on to consumers in the form of higher insurance premiums and cost sharing. Managed-care organizations are accustomed to passing on significant annual medical cost increases to customers in the form of higher premiums, and we expect the same to occur with the $6.7 billion in new fees levied against the industry.

Despite the best efforts of the device manufacturers' lobbyists, we expect the firms will be hit with some fees to help pay for the reform package. The proposed fee of $4 billion annually seems disproportionately high given the size of the industry, from our perspective. However, with the $750 million annual fee originally slated for laboratory service companies now eliminated, we think this whip-sawing means there is room to whittle the device fees down. Also, manufacturers may use this fee as a counterargument to hospitals seeking lower device prices, should reimbursement rate cuts ensue. Device manufacturers may even choose to pass on the extra costs to customers, which will ultimately raise the cost of health insurance. As for the pharma industry, the annual pharmaceutical fees of $2.3 billion are a drop in the bucket compared with the $80 billion in other concessions already offered by the industry over the next 10 years.

Because the tax on "Cadillac" plans does not kick in until a relatively high threshold, we don't expect it to have a material effect in the near term. However, since the thresholds are indexed to CPI inflation plus 1%, this tax provision will become increasingly important over time and could be one of the most effective components of the reform package at "bending the health-care cost curve" over the long run. This provision would be the first step toward meaningfully undermining the tax-favored status of employer-sponsored health insurance, which was long considered politically untouchable. It is possible that the thresholds could be lowered in the future as concerns continue to mount about ever-rising health-care costs. In any case, while we think any tax on employer-sponsored benefits makes good economic sense, we consider this provision a negative for most health-care companies.

 

Consumer Oriented and Operated Plan (CO-OP)
Original Bill: Senator Baucus and the "bipartisan six" seem to have realized early on that for many, particularly Republicans, the government-run insurance option is a non-starter. Instead, they are recommending health-care co-ops that would attempt to foster competition with private insurers. These entities would be funded initially by the U.S. government through loans and grants in the amount of $6 billion.

Recent Amendments: The Senate Finance Committee voted down an amendment proposed by Sen. John Rockefeller (D.-W.Va.) that would have created a government-run insurance option. The plan, referred to as the Community Choice Health Plan, would have set provider rates based on Medicare's fee schedule and was rejected by a 15-to-8 committee vote. Sen. Charles Schumer (D.-N.Y.) proposed an amendment that would have added a government-run plan that negotiates its provider rates, similar to a provision in the bill produced by the House Energy and Commerce Committee. Schumer's amendment was voted down 13-to-10. These efforts appear to be the beginning of a full-fledged debate in the Senate over the next few weeks on the merits and weaknesses of the government-run plan. We continue to think there is not enough support for a public option, particularly among certain key moderate Democrats in the Senate.

What It Means: We remain skeptical that co-ops would be able to achieve the scale necessary to compete with large private insurers. The absence of a government-run insurance plan from the SFC bill--especially one using Medicare's below-market provider fee schedule--is a major victory for the health insurance industry. We think co-ops would have limited effects on the device industry, making them more palatable to industry players than a public option. As for pharma, the lack of a public plan and the associated strong pricing power means a major risk overshadowing the drug group will likely recede.

While we don't expect the co-ops to have a meaningful impact on the health-care sector, some Republicans remain opposed to this proposal because they are concerned that the co-ops will still enjoy an unfair competitive advantage as a result of the government's involvement. This advantage might come from explicit subsidies or merely because of a lower cost of capital owing to the co-op's implicit backing from the government.

Employer Roles and Responsibilities
Original Bill: Currently, the U.S. government does not require employers to provide coverage for their employees, and this will not change under the new bill. However, if an employer does not currently offer coverage and has 50 or more employees, it would pay a fee for each employee who receives a tax credit for insurance through one of the new state exchanges. Essentially, the employer would be refunding the government for that employee. The maximum amount of payment would be limited to $400 per employee multiplied by the total number of employees.

What It Means: The exclusion of an employer mandate from the SFC bill means that employers' role as the principal purchasers of health insurance may be somewhat diminished, as new regulations could potentially improve the functioning of the individual market. However, we expect employer-sponsored insurance plans to remain the foundation of our health insurance system, due to their tax advantages and lower administrative costs. If the individual mandate is not strengthened in the final legislation, the individual market is likely to continue to be plagued by adverse selection, which could cement the role of employer-sponsored plans.

Health-Care Tax Credits
Original Bill: Refundable tax credits would be available on a sliding scale for individuals and families with adjusted incomes of up to 400% of the Federal poverty level who purchase insurance through the state exchanges.

Recent Amendments: Recent amendments tweaked the eligibility levels for the Health Care Affordability tax credits, which are based on the cost of insurance premiums as a percentage of income. Tax credits would cap an individual's responsibility for premiums for a basic policy at 2% of income for those at 100% of the federal poverty level, increasing to 12% of income for those with incomes between 300% and 400% of the poverty level.

What It Means: New tax credits will enable more low-income people to purchase insurance, increasing revenue and profits for the MCOs. Expansions to Medicaid will be similarly beneficial, as many state Medicaid programs are administered by private MCOs. Tax credits should increase the demand for drugs and devices as people who couldn't afford insurance previously will likely enter the market. Increasing the number of insured people is the major offsetting factor to the fees and pricing concessions offered by the pharmaceutical industry.

With the bill now in the public domain, it's up to Congress and the president to bring it across the finish line. This will be no small feat, as members of both parties are already lining up against it, including, ironically, a few of the members of the "bipartisan six" who helped author the bill. While many Democrats, particularly in the House, continue to say that any bill without the public plan is a non-starter, there are many Republicans who think the bill is too expensive, especially coming on the heels of the bailout and stimulus packages from earlier this year. We think that this bill will be the basis for any reform, and if the House and Senate end up rejecting it or its revised forms, health-care reform is unlikely to be accomplished in 2009.

Morningstar analysts Matthew Coffina, Debbie Wang, Damien Conover, and Alex Morozov also contributed to this article.