We've incorporated the anticipated effects of the ACA in all of our projections, and as a result, the effect of the ruling on our valuations and recommendations across the health-care sector is immaterial.
The U.S. Supreme Court upheld the individual mandate in a narrow ruling Thursday, clearing the main hurdle for health-care reform known as the Patient Protection and Affordable Care Act (PPACA). While it is possible that the battle over the fate of the health-care law will now shift to the legislature, given the low probability of Republicans gaining a filibuster-proof majority in the Senate, we now believe the PPACA isn't likely to be repealed. We've incorporated the anticipated effects of the PPACA in all of our projections, and as a result, the effect of the ruling on our valuations and recommendations across the health-care sector is immaterial.
For the managed-care sector, the ruling is largely a positive, as alternatives were a lot more punitive, particularly for firms operating in the individual marketplace. We factor into our models the more than 30 million individuals that are expected to gain insurance coverage as a result of the law through a combination of expansions to the Medicaid program (although the Court's ruling on this issue may limit the magnitude of this expansion) as well as new subsidies that can be used to buy insurance in the state-based exchanges. Medicaid MCOs like Amerigroup are best positioned to benefit from broader Medicaid eligibility, adding to the already robust growth story from increased outsourcing of Medicaid. We expect most commercial insurers to compete for new individual members in the exchanges, but those with a strong historical position in the individual market and well-known brands, such as WellPoint (WLP), seem particularly well positioned. On the other hand, MCOs will continue to face margin pressure from regulatory scrutiny of premium increases, minimum medical cost ratios, and cuts to Medicare Advantage reimbursements. However, we expected most of these headwinds to remain in place even without the PPACA, and we have incorporated deteriorating margins in our valuations.
The other group most affected by Thursday's ruling is health-service providers, such as hospitals, but our valuations already properly account for the anticipated effects from the law's provisions, particularly the expanded insured population. We consider the law's reduction of uncompensated care combined with an influx of newly insured patients into the health-care system as a positive for the health-services industry, while other components of the law, including lower Medicare payments and greater oversight of insurance premium increases, mostly mitigate such benefits. Overall, hospitals may breathe a sigh of relief as without the mandate, the environment for providers would have been rather dire. Regardless of this ruling, we think reimbursement pressure is here to stay thanks to government incentives to curb health-care spending growth and an industry shift to quality-of-care-based payment methods, and health providers still will face an uphill battle to maintain profitability amid the ongoing uncertainty of reimbursements.
For the Big Pharma group, we expect the increased demand for drugs as a direct result of the mandate largely will offset the increased fees and rebates associated with health-care reform. Our valuations are unchanged. However, since the costs related to health-care reform are front-end loaded (which started in 2010) and the increased demand will not likely begin until 2014 (when the mandate goes into effect), we believe investors' sentiment toward the drug group should improve as the tailwind of increased demand for drugs begins to materialize in 2014.
The generic drug manufacturers are largely unaffected, in our view. Most of the generic manufacturers have broad geographic operations and generic drug pricing was relatively unaffected by the law. We think additional drug volumes from newly insured patients are relatively immaterial to our fair value estimates for the generic firms. The biosimilars approval pathway should remain intact.
The device side was viewed largely as a relative loser when the reform was passed, and the ruling doesn't change much in terms of our assessments of the industry's prospects going forward. We anticipate the additional insureds in 2014 will not significantly contribute to volume because many devices are concentrated among Medicare recipients. For example, an estimated 90%-95% of pacemakers in the U.S. are implanted in Medicare patients. However, there are some particular product lines that do skew somewhat younger, such as spine devices, which are split more evenly between Medicare and non-Medicare patients. Firms that are not highly tied to Medicare reimbursement should see the volume boost in some magnitude, but likely not to the extent of other health-care industries. With the law upheld, it also appears that the 2.3% medical device excise tax will stand. We already baked that tax into our valuations two years ago, and at the time we said it would cut into the long-term earnings power of medical device firms by 4%-10%, hardly a devastating impact. We believe the marketplace already baked this into assumptions as well and thus most device firms are currently trading in line with the market. The effect of the tax is being mitigated by several factors, particularly the sales mix by geography, which has generally been shifting away from the U.S. Medical device companies also have been preparing for this tax and additional pricing pressure (not necessarily only because of the ACA), which led to the restructuring of operations and investments in more manufacturing facilities in tax-advantaged locations outside of the U.S. Overall, we think a number of larger regulatory and customer issues--such as changes in the pathway to market and fiscal budget pressures in the developed world--are changing the competitive landscape for medical device firms, and these changing dynamics should have a more substantial effect on this industry than the ACA in the foreseeable future.
For other sectors, the impact is also fairly muted. With regards to biotech, we are maintaining our view that health reform has an overall net neutral impact on our valuations as expanded coverage offsets new fees and drug rebates. However, within the spectrum of our biotech coverage, some firms have fared better than others under reform. Companies like Gilead (GILD), Amgen (AMGN), and Roche (RHHBY) have seen the largest hits to their businesses due to larger rebates through Medicaid and industry fees from the higher share of drugs reimbursed by Medicare. Conversely, reform has had little impact on companies like Celgene and
BioMarin Pharmaceutical (BMRN) with heavy exposure to orphan drugs that are exempt from the industry fee.
We expect drug supply-chain companies, including retail pharmacies, pharmacy benefit managers, and distributors, to experience a modest revenue boost due to increased consumption of health care by the newly insured population. But any positive impact isn't likely to be material to our valuations.
Morningstar Premium Members gain exclusive access to all of our health-care
Analyst Reports, including fair value estimate, consider buy/sell prices, bull and bear breakdowns, and risk analysis. Not a Premium member? Get these reports immediately when you try Morningstar Premium free for 14 days.
