Health Care Reform and the Market’s Response: Is Reform Already Baked Into the Cake?

While markets may lack the rational intelligence needed to become the “invisible hand” that guides constructive change, free markets (and the shrewd marketing experts that corporations employ), can be quite astute when it comes to responding to changing trends. This is, after all, a matter of survival.  If they don’t get ahead of the trend, they risk a rendezvous with a moving train.

Although members of the American public may not be at all certain what the Affordable Care Act will mean for them, insurers, hospitals, drug makers and device makers have made it their business to read the legislation carefully. These companies realize that it would be reckless to assume that the legislation will be repealed:  their competitors already are preparing for change. Thus, market-watchers say that in the medical marketplace, reform is becoming a reality as the health care industry implements fundamental changes in insurance coverage, access, payment, and how health care is delivered.

At a recent University of California-Irvine Health Care Forecast Conference, health care economists and market-watchers explained that whatever happens in Washington, health care “reforms are acquiring their own momentum.” The Kaiser Institute for Health Policy’s Jon Stewart explains:  “Quite apart from the status of the reform law itself—whatever happens to the reform law—politically, judicially, or economically” many speakers at the conference agreed that  health care reform, has left the station and is not likely to be turned back.” (For a webcast of the entire 2011 Health Care Forecast Conference at U.C.-Irvine, click here)

Talking about the market’s response to reform, Chris Jennings, a former White House health care analyst and now head of Jennings Policy Strategies, made the case that “continued implementation makes reform part of the fabric of the system and more difficult to roll back.” Moreover, “every time [conservatives] talk about repeal, this gives Democrats a chance to define what people will be losing.” And as reform moves forward, more Americans will experience how they will benefit from the Affordable Care Act. In the end, “even if repeal were somehow successful,” Jennings says, “the market will have changed so much, repeal wouldn’t alter it.”

But, what about the threat that the Supreme Court will strike down the individual mandate? Ted Shannon, a health equity analyst and hedge-fund manager from Arrowpoint Partners, a Denver-based asset management firm, argues that “a Supreme Court ruling won’t come until after the election, probably not until 2013.” By then Shannon predicts, reform will have already “given shape to a new world order in health care financing and delivery, and if industry players are not ready for it, they are going to be in a world of hurt.”

Why would the Supreme Court wait so long before taking the case and handing down a decision?  After having an “‘influence’ on presidential elections in recent years,” Shannon observes, “the Court won’t rule on this until after the 2012 election.” I agree. The Justices care about their place in history. They really don’t want to be accused of “fixing” another presidential election.

At the conference, other speakers offered examples of how parts of the system are moving to adapt to reform: “Providers are joining larger medical groups and the conversion to hospital-led medical group partnerships is well underway,” noted Robert Kocher, director of the McKinsey Center for U.S. Health System Reform.  “That’s a huge change in the way medicine is practiced in this country. as it sets the stage for more integrated and coordinated systems of care through the kind of accountable care organizations (ACOs) promoted by the reform law.”

John Gorman, leader of the Washington, DC-based Gorman Health Group, an organization that provides Medicare regulatory compliance advisory services to health care payers, added that Medicare will serve as the benchmark and driver for ACOs. Medicare “will lead a system-wide, irreversible change in how care is organized, delivered, and paid for,” Gorman declared, becoming “the blueprint for what you see in the rest of the payment system with a fundamental shift from fee-for-service to more risk-based payment systems that reward quality and efficiency.”

Will all of these ACOs, medical homes, and innovations such as nationwide heath information technology be up and running by 2013? Absolutely not.

But, by then, not only the government but the private sector will have invested so much money in moving away from fee-for-service care, redesigning insurance so that it will meet the new standards, offering insurance to the employees of small companies, and changing how care is delivered (as leading  medical centers turn themselves into Accountable Care Organizations and physicians collaborate to create medical homes),  that reform will have become all but inevitable.

A Wall Street Perspective on Why Reform is Baked into the Market’s Cake

Listening to the speeches at the University of California-Irvine conference, I was struck by hedge-fund manager Ted Shannon’s take on why reform cannot be stopped.

According to Shannon, the Affordable Care Act is “the inevitable outcome of the failure of the industry to find a sustainable solution” to providing health care for the United States. We have endured “a long-term unsustainable trajectory of [health care] inflation,” he notes, “in an industry too big now to be driving economic growth in our country.”  Shannon is correct:  typically small, innovative companies spark growth;  mature, risk-adverse corporations that are trying to meet the expectations of investors accustomed to steady, high returns do not.

For the health care industry, Shannon explains, the “choices are very simple: either they work together through models like Accountable Care Organizations” that reform legislation proposes, or we are going to see government price regulation.  As he put it, industry players must “accept cost controls with volume offset” (the Affordable Care Act brings the health care industry 32 million new customers while simultaneously forcing many players to rein in their costs) OR the industry will be forced to “accept cost controls, price controls and volume controls—while losing total control.” 

Shannon is correct: The Affordable Care Act does not set prices. But it will put pressure on many health care providers to tighten their belts and reduce how much it costs them to deliver care, in part by trimming annual increases in Medicare’s reimbursements to hospitals, nursing homes and home health care agencies by 1 percent a year, every year, for 10 years. (This provision does not apply to doctors, only to institutions.) These cuts will mean that hospitals and other health care providers will have to become more efficient, reducing waste and medical errors.

If providers are not willing to shave their costs, Ted Shannon suggests, the alternative is that the government will begin to dictate health care prices. Given the threat that health care inflation poses to our economy, he, like some others on Wall Street, believes that if the Affordable Care Act fails, future legislation would impose price controls on the entire industry, not unlike the caps on prices in other developed countries.

Of course, if we opt for the conservative model that Ryan has proposed, we could simply shift the burden of health care inflation to individual Americans, turning  Medicare over to for-profit insurers, and abandoning seniors to figure out how to pay for health care on their own. But I very much doubt that this strategy will succeed.  Conservatives may attack the American Association of Retired Persons (AARP), but seniors represent a formidable lobby.  They have time; they organize; they vote. 

How the Health Care Industry Is Changing

While explaining why the health care industry has no choice but to change, Shannon puts health care in the context of the larger economy. He is not optimistic.  “In ten years, the U.S. could look quite a lot like Japan” he predicts, echoing what some experienced global investors have been saying. “Japan just got downgraded by their rating agencies,” Shannon noted two months ago.  “Now, Wall street is terrified that the agencies will downgrade U.S. debt.”

 Last week, this happened. How could the downgrade affect our economy? “Interest rates go up, on everything from your mortgage to your credit cards,” says Shannon. Growth slows, “and we’re really in a world of trouble.”

I truly hope that he is wrong.

But what is certain is this: the levitating cost of medical care puts the U.S. health care industry in a precarious position. “The Affordable Care Act presents the best chance for the health care industry to survive,” Shannon declares.

If these companies are going to stay afloat, they will have to become leaner. Going forward, says Shannon, “The pharmaceutical and device industries are in for a long period of [profit] margin compression. Charging you $150,000 for chemo is a business model that is dying.” A $100 price tag for a brand-name drug that may (or may not) be a little better that its rivals will also became a thing of the past" he suggests.

“The changes already going on in the industry are pretty much permanent,” Shannon adds. “There is no such thing as a free-market solution. We either end up in a ‘legislated world’” with all prices set by the government, “or in a ‘reformed world’” with the Affordable Care Act.

For too long, we have been paying too much for everything, from a pill to a hospital pillow. As just one example, Shannon lays out how well drug and medical devices companies have done in our extravagant health care system:

“The average S&P company returns 12 cents for every dollar of investment, and that’s good. For companies that spend a lot on R& D the return is  actually closer to 18 percent—and that’s  really good. For pharmaceutical and Medtech, it’s like 35 percent to 40 percent—depending on the company. Is Pfizer really that much more innovative than Boeing?” he asks.

In recent years, “the number of new medical products that have been brought forward for FDA approval has fallen by 2/3” Shannon points out. At the same time, “the number of ‘supplemental products’ has doubled. So basically we’re making incremental little improvements to products that have been around for ten years.” Meanwhile drug-makers and device-makers are “telling Mr. Hospital Executive that they expect a 30% premium, because it’s new.”

“You all have been sold a bill of goods,” Shannon told his audience. “No question, R& D is expensive, and no question it’s time consuming.” But “the returns these companies have enjoyed—largely because of their profitability in the United States—have come out of the hides of the people in this room.”

8 thoughts on “Health Care Reform and the Market’s Response: Is Reform Already Baked Into the Cake?

  1. Your summary is right on track. I regularly interact with leaders of at least 40-50 large health care systems and have no doubt that they are moving–mostly at a fairly rapid pace–to develop new models of care that will fulfill the goals of the triple aim, especialy the part about lowering cost while increasing quality.
    What the government–via PPACA–is required for is to increase access to care, since this is not something the private sector seems capable of. In addition, the government can and should take the lead in creating reimbursement mechanisms that speed the attainment of all of the above goals.
    In essence, we’re talking about a true public-private partnership that I hope is not derailed by the backward looking goals espoused by many conservatives.

  2. A note: the Standard and Poor downgrade did not have any real effect, so far, on the market and price for Japanese bonds in the time since the downgrade. For the US, the stock market had the usual brief Chicken Little effect, but that was followed by a rally that gave back the drop with change. The ratings can badly hurt smaller (and less well observed) countries, but so far the only major economy to be hurt by a downgrade has been Britain, and that was not because of the downgrade itself but because of the self-inflicted wound the government gave the country in response, with huge cuts in the budget that (so far) have led to a beginning of a double dip in the British recession and an associated injury to British bond prices resulting not from the downgrade but from the attempted “cure.” Of course they did get their ratings raised, much good it did them.
    The basic fact seems to be that S&P and Moody have little to say for the sophisticated traders who actually set bond prices, who have already been well aware of anything that the rating services know. It is also possible that the very poor performance of the rating agencies in the run-up to the great recession convinced sophisticated observers that the people who work for the ratings agencies are actually less well informed and talented than major league financial market players (salaries would certainly suggest that conclusion.)
    Yet another example of the disconnect between “rational” economic theory and “empirical” economic observation. Plato’s Cave is a poor spot to observe the universe.

  3. Meanwhile, congressional leaders are moving to try to kill the Independent Medicare Price Advisory Commission, on the extremely dubious grounds that congress is better positioned to make important decisions about specifics of medical care than trained specialists in the field of health care effectiveness. Both parties are involved, suggesting to me that the long arms and deep pockets of vested interests are having their usual effect.
    As the last 2 years — and the last few weeks especially — have shown, congress is probably only worse than your corner bar as a place to make economic policy. Your corner bar may actually be better if you are near a major university.

  4. Pat:
    You write that, as a place to make economic policy, “Your corner bar may actually be better [than Congress} if you ]are near a major university.”
    Thanks for making me smile out loud! And I’m afraid that you are entirely right.
    On the S&P downgrade of U.S. debt:
    I agree that very sophisticated investors a) knew this was coming and b) don’t wait for the rating agencies to tell them what to think. These rating agences lost some of their credibility in the 1990s.
    Nevertheless, the fact that the S&P–which is part of the “establishment”–is publicly saying that other countries really cannot count on the full faith and credit of the U.S. as “AAA” has created a ripple around the world.
    This is as if the New York Times (also part of the establishment) ran a front-page headline: “U.S., Headed Toward Becoming a Second-Tier Financial Power.”
    I can only imagine the debate that went on within Standard & Poors about this . . .
    Those in the U.S. media who understand what the down grade means are underplaying it because they don’t want to be accused of “panicking readers”. (This is why they largely ignored the warnings about the bubble of the 1990s and the real estate bubble of this decade.)
    The best indicator of the world’s response to the S&P downgrade is the price of gold versus the price of the dollar.
    Gold has become the alternative to the U.S. dollar and U.S. debt. (The Euro is shaky and Asia doesn’t yet have a pan-Asian currency that we can invest in, though eventually it will.)
    Today, Bloomberg reported that “Gold for June delivery rallied as much as 0.8 percent to a record $1,506.50 an ounce.
    “The Dollar Index, which tracks the currency against six major peers, tumbled 0.9 percent to 74.351, the lowest since November 2009.”
    Gold has broken $1500 an ounce. This is Huge. The experienced global investors I follow say it will go to $2000 –no one knows when — but in a bull market (and this is a bull market for gold as well as other commodities,) these things tend to happen sooner than one expects.
    Recently Bill Gross (founder of Pimco, the largest bond fund, very intelligent and honest) said that U.S. Treasuries are now essentially worthless.
    Yields will go up– they have to, in order to attract international investors– but prices will go down. (As you no doubt know, when rates rise, bond prices fall.)
    I’m not licensed to give investment advice, but I would urge friends (and readers) to read Bloomberg and the Financial Times. And pay attention to the fact that commodities–almost all commodities– are rising, which is usually not a good sign for stocks. (When corporations have to pay more for materials, and consumers have to pay more for food, gas, and heating oil, this is not good for corporate profits.)
    I

  5. Keith–
    I hope that many in HealthBeat’s audience read what you wrote:
    “I regularly interact with leaders of at least 40-50 large health care systems and have no doubt that they are moving–mostly at a fairly rapid pace–to develop new models of care that will fulfill the goals of the triple aim, especialy the part about lowering cost while increasing quality.
    “What the government–via PPACA–is required for is to increase access to care, since this is not something the private sector seems capable of. In addition, the government can and should take the lead in creating reimbursement mechanisms that speed the attainment of all of the above goals.
    In essence, we’re talking about a true public-private partnership that I hope is not derailed by the backward looking goals espoused by many conservatives.”
    Yes, only the government can increase access to care by providing the subsidies that low-income and middle-income families need in order to have access to health care.
    And only the government can insist that insurance companies can no longer refuse to insure the sick–or gouge them, charging more in premiums than they can possibly afford.
    I hope this public/private partnership works. As I have indicated in the past, I’m more hopeful about non-profit health plans in the private sector than I am about for-profit plans. But we’ll see.
    In any case, I think that a public/private partnership between the best of the non-profit insurers (who will almost certainly expand), Medicare, a public option for those under 65, and any for-profit insurer willing and able to add value to the system would be ideal.

  6. Maggie:
    Thanks for your reporting on the UC-I Health Care Forecast Conference. Most interesting was hedge-fund manager Ted Shannon’s insight that the health care players are going to either “work together through models like Accountable Care Organizations” or “see government price regulation.” I want to see whether some of them try to water down the draft ACO regulations so that they can get bonuses without too much accountability (Medicare Advantage-lite?). If they do try, I hope the established ACOs — the ones that already prepared to meet higher standards — fight back.
    When the ACO draft regulations were announced, Kaiser Health News reported that “[i]nitially, regulators estimated, between 75 and 150 ACOs would be formed and approved by CMS. They would care for anywhere between 1.5 million and 4 million Medicare beneficiaries. (http://www.kaiserhealthnews.org/stories/2011/march/31/aco-rules.aspx?)
    That must have been a low-ball estimate. According to a 2010 report by Robinson and Dolan, Accountable Care Organizations in California: Lessons for the National Debate on Delivery System Reform (http://www.iha.org/pdfs_documents/home/ACO_whitepaper_final.pdf), there are 62 large ACOs already in California, each of which has more than 50,000 total enrollees. (Table 3, pg. 10) With Medicare enrollees accounting for at least 10 percent of total enrollees (see Table 2, p. 7), these are the ACOs that would meet the minimum size under the draft regulations. These 62 ACOs are currently caring for 1.3 million Medicare beneficiaries. Maybe a reporter should ask Medicare for a current estimate.
    The report also points out that California “vigorously enforces benefit mandates for the health plans (mostly HMOs) under its purview, whereas the regulatory authority of the California Department of Insurance (CDI) authorizes less rigorous oversight for the high-deductible PPO products under its purview.” (p. 22) I wonder what affect the ACO regulations will have on this unlevel regulatory playing field in California, or what affect the disparate regulatory climate will have on the number of ACO that qualify under the new Medicare regulations. Those who have been subject to vigorous oversight should be better positioned to meet the accountability challenge. I also wonder what the lobbyists for the less regulated have been up to. Watch the comments to the draft regulations.

  7. Gary O.–
    Welcome to HeatlhBeat, and thanks for your comment.
    On the number of ACOs– for some reason, the link to the Robinson & Dloan report didn’t work, so I could read what they had to say.
    (If you could re-send, that would be great. I’m
    v. interested in topic)
    But I would say this:
    1) I’m not sure that all of the ACO’s in California that claim to be accountable will be legit ACOs (Cal. heath plans tend to be either very good, or very bad
    This fits with waht you say about the difference in regulation of HMOs vs. PPOs in Cal.
    2) I expect we’ll see many more ACO’s in the West than in the East (particularly the corridor from Boston to D.C.) where doctors are pretty committed to solo practice and small practices.
    Many also are absolutely oppposed to working on salary.
    (I would predict that the very last place to see health care reform will be Manhattan.)
    Finally, you quote the report as saying that “California vigorously enforces benefit mandates for the health plans (mostly HMOs) under its purview, whereas the regulatory authority of the California Department of Insurance (CDI) authorizes less rigorous oversight for the high-deductible PPO products under its purview.” (p. 22) You addd: ” I wonder what affect the ACO regulations will have on this unlevel regulatory playing field in California, or what affect the disparate regulatory climate will have on the number of ACO that qualify under the new Medicare regulations. Those who have been subject to vigorous oversight should be better positioned to meet the accountability challenge. I also wonder what the lobbyists for the less regulated have been up to. Watch the comments to the draft regulations.”
    Very good points. The comments to draft regulations will be interesting.