Did Health-Care Reform Die in Massachusetts?

Pat Dorsey: Hi. I'm Pat Dorsey, director of equity research at Morningstar. Well, the Democrats have lost a crucial Senate seat, Massachusetts, throwing all of the best laid plans of mice and men for healthcare reform completely up in the air. I'm lucky to have with me Matt Coffina from our health-care team, who's been following every twist and turn of the package through the Senate and the House over the past several months. So thanks for joining me, Matt.

Matt Coffina: Thanks for having me, Pat.

Dorsey: So, my goodness. Now what?

Coffina: Sure. Well, this is really a stunning turn of events. As recently as two weeks ago, there seemed to be a very clear march towards health reform for the Democrats. Now they've lost their 60th seat. The latest indications are that neither the president nor the House really wants to go ahead with one of the sort of plan B "rush this through before the guy gets seated" options. So it looks like they're going to have to do some kind of bipartisan compromise or it's just going to die on the table.

Dorsey: Yeah, so assuming that the plan B--which would of course, I think, not really foster inter-party cooperation in the future--of ramming it through before the new guy gets seated, assuming that doesn't happen, what are the most likely scenarios in your opinion?

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Coffina: Really, Obama and the Democrats really only have one option at this point, which is they have to go after Olympia Snow, who is the only Republican, really, to show any interest at all in the health reform legislation. And possibly, if they can get her, maybe then can get Susan Collins from Maine. There is some talk that the new senator from Massachusetts, Brown, might even be interested in coming up with some sort of compromised solution.

But we think it's actually going to be very hard for them to reach any kind of agreement that can bring Republicans on board and also keep enough Democrats that they could actually get to 60 votes in the Senate. And we can't forget that it was a pretty slim majority that passed the bill in the House. So really, they don't have much room for error in either chamber.

Dorsey: So there are sort of three possibilities here. Maybe I'm getting this wrong and you can correct me. But you've got they could pass something that looks like the House version, pass something that looks like the current Senate version, or the whole kit and caboodle could just die on the vine.

Coffina: I think if we get a bipartisan compromise, it's probably going to look like the very toned-down version of the Senate bill.

Dorsey: Which is already toned down from the House version.

Coffina: It was already quite toned down, especially compared to what the liberals were hoping for going into this process. The problem, I think, also is that there are a lot of provisions that follow one another. So it's not really clear how you tone this down without it completely falling apart.

The Republicans would like to take out a lot of the Medicare cuts that are in the bill, and I'm sure they would not like to tax the rich to pay for the bill. They're in favor of the Cadillac tax, but if you put too strong of a Cadillac tax in there, the unions are going to fall away from the bill.

So once you take away most of the funding mechanisms for the bill, then you can't really afford the subsidies. If you can't afford the subsidies, you can't impose an individual mandate to force people to buy insurance. And without the individual mandate, you can't have a pre-existing condition exclusion. So really, it is all or nothing...

Dorsey: The thighbone is connected to the hipbone...

Coffina: [laughs] Exactly.

Dorsey: What would you handicap the odds of nothing getting passed? It seems like that is actually a material possibility now.

Coffina: Two weeks ago I would have said, I think, 80%, 90% chance this bill gets passed. Looking at it today, I would say it's less than 50%.

Dorsey: So you think there's a 50% chance that nothing gets passed, and it is just status quo, as we were before this whole thing started?

Coffina: Pretty much. I think the Massachusetts election has that result. If they do pass something that's going to be a really watered down, compromised-type version, it's probably not really going to be appropriately termed health-care reform, it's just going to be little tweaks on the edges. But certainly nothing that's going to get the huge population of uninsured down to something closer to zero, which is what they were hoping for originally.

Dorsey: And so, thinking about this from an investment perspective, your thesis and our thesis at Morningstar for the past year has been that the reform package would not be as bad as was priced into the stocks. Health-care stocks have been one of our most undervalued sectors for quite some time.

Would you say now, with the prospect of getting even more watered down or nothing gets passed at all, does that have the prospect for some of those fair values even coming up more?

Coffina: Sure. I think so. We weren't too scared of any health-care reform bill. I think the market was a lot more scared than we were. I think that the bill failing is a marginal positive for the managed care sector. It's more of a mixed bag for pharma and devices, because on the one hand, if the bill fails altogether, that should be good for those sectors. If nothing else, it reduces the uncertainty surrounding them.

If we get a more watered-down version, one concern that we have is that some of the funding that's coming out of those sectors, the contributions that pharma and devices have given to the bill, could remain. Those might be the last sources of funding to get cut. But they might lose that offset of getting a whole group of new people with insurance, which we were originally thinking it would offset those losses.

Some other potential losers, obviously, are the ones that we were pointing to before as potential winners. Companies focused on Medicaid, the distributors that would have benefited from increased volumes, some of these benefactors may not turn out to be benefactors in the end.

Dorsey: A lot of these changes sound like they're sort of more at the margin, as you mentioned. It's not going to be kind of a sea change in our viewpoint on health care no matter what gets passed, whether it's sort of a watered-down version or nothing at all.

Coffina: Well, looking at the managed care sector, for example, we had these companies, most of them have been deeply undervalued, a lot of them for the last year and a half. A lot of them have run up to more like fair value, but I think there's some room to raise some fair value estimates a little bit. But because we didn't think the bill was such a big deal to begin with, the removing of the bill doesn't really make that much of a difference either.

Dorsey: Fair enough. Thanks for joining me, Matt.

Coffina: Thanks, Pat.

Dorsey: I'm Pat Dorsey, and thanks for watching.