The prospect of the new Trump administration pushing ahead with the repeal and replacement of a range of legislation has sparked fear among investors and cast a shadow over the healthcare investment universe (see Exhibits 1 & 2 below). However, I believe these concerns are overblown as political realities are likely to preclude further significant changes to the US healthcare system.
Exhibit 1: The healthcare investment universe – breakdown (%) of selected US equity market indices by industry (all figures in USD)
Source: Factset, BNP Paribas Investment Partners, as of 28 February 2017
Repealing The Affordable Care Act (ACA) will not be straightforward…
When assessing the outlook, it is important to remember that the biggest beneficiaries of The Affordable Care Act (ACA, aka Obamacare) have been rural voters and the elderly. This is problematic for Republicans since elderly people vote more frequently than the rest of the populous and rural voters were broadly responsible for electing Trump and the Republicans.
The political ramifications of removing or reducing a benefit should not be understated and this complicates any efforts to repeal and replace this legislation. While Republicans are under extreme pressure from their base to enact, repeal and replace legislation, the seniors in the party understand the political repercussions of these efforts. As a result, when everything is said and done, I believe that any repeal and replace legislation which is passed will ultimately involve only minor modifications to existing law. This should create a relatively stable operating environment for healthcare companies.
Exhibit 2: Returns of different sectors within the US healthcare industry during the period since 8 November 2016 until March 2017
Source: MSCI, BNP Paribas Investment Partners, as of March 2017, 100 = 8 November 2016
Republicans would like to have done with repeal and replace legislation by the spring recess to allow legislators to shift their focus back to their core policy goal of tax reform. This is a tight timeline by any metric, but given the inherent politically charged nature of healthcare and the very tight majority in the Senate, creating a bill which can pass both chambers of Congress is no easy task. The process started last week as House Republicans tabled their first proposal, called the American Health Care Act.
Key aspects of the proposal for the American Health Care Act include (but are not limited to):
- Eliminating all taxes and penalties
- Winding down the enhanced Medicaid federal matching payments related to the Medicaid expansion
- Shifting federal Medicaid reimbursement to a per capita system
- Widening the exchange age pricing bands (from 3:1 to 5:1)
- Eliminating healthcare subsidies and replacing them with advanceable tax credits
- Reducing the essential health benefits and
- Eliminating the individual mandate.
When this bill was initially released, the key Republican leadership responsible for drafting it took significant heat from the Freedom Caucus – who complained that this was ‘Obamacare 2.0’ – as well as from Democrats and centrist Republicans, who criticised the likely increased rate of uninsured and other issues. That is why we believe investors should view this policy proposal as simply a starting point in the negotiations.
The estimate of the budgetary effects of the American Health Care Act published on 13/03/17 by the Congressional Budget Office (CBO) scoring provides some insight into the bill’s prospects and the potential means by which legislators might be able to negotiate a more amenable solution. The CBO estimates that the uninsured population would increase by 24 million by 2026 (an unacceptably high number in many legislators’ view); that exchange plan pricing would initially rise before falling; and that the bill would reduce the federal budget by an estimated USD 337 billion over 10 years. The budget scoring could assuage the concerns of the Freedom Caucus, enabling passage of the bill in the House. However, the same financial scoring provides a means by which the Senate could alter the existing bill to reduce the estimated increase in the uninsured population. I could also envision an auto-enrolment provision being included in the final bill to further mitigate the increase in the uninsured population.
Ultimately, we expect a compromise bill to work its way through both the House and Senate.
In the end, the final legislation will replace Obamacare with a policy that will likely lack a coverage mandate, include exchange policies with lower actuarial value, require fewer funding mechanisms and limit federal Medicaid liabilities but in general operate with much of the look and feel of Obamacare. While this bill would likely result in slightly lower Medicaid and exchange enrolment than projected under current law, we believe the changes will be modest.
Furthermore, I expect the head of Health and Human Services (HHS) to make administrative changes to the exchanges such as further softening essential health benefits and narrowing enrolment periods. These moves would reduce the actuarial cost of exchange plans and help improve the beneficiary mix, which would make plans more affordable for beneficiaries, improve enrolment and make them actuarially more predictable. Notably, this legislation does not address drug pricing. While attention to drug pricing won’t go away, we believe the enactment of legislation requiring 60 votes in the Senate would be challenging and likely limit its potential scope. As such, I envision efforts on this issue will largely focus on political pressure and industry self-regulation.
Our net conclusion is that we envision a relatively stable healthcare landscape in the US. The total insured population will be modestly lower under repeal/replace but I would not anticipate a material decline in overall utilisation. After all, the fundamental growth drivers for the sector – population ageing, lifestyle choices and innovation – remain essentially intact. We believe that payers will continue reimbursing for innovative products and that there will be a gradually increasing concentration on value-based reimbursement in the US healthcare sector. We thus remain constructive on the outlook for healthcare investing and are focused on innovative companies in biopharmaceuticals and devices as well as health insurance providers.
Written on 15 March 2017