Friday, September 18, 2009

Capturing the Employer's Voice: A New Twist in the Health Reform Debate

Every now and then some data point comes along that completely disrupts the flow of a debate. In health care, this occurred in June, when the Congressional Budget Office (CBO) scored the first two health reform bills to emerge from the 111th Congress.

Then, the CBO starkly reminded us that large reductions in spending cannot occur without fundamental changes in the financing and delivery of care. And dollar savings attributed to comparative effectiveness, health IT and other "soft" initiatives vanished, as simple speculation.

With its scoring, the CBO established the ten year/ trillion dollar benchmark as a deciding legislative factor. Immediately, the debate shifted from concepts and theory to economic reality. This drew in the electorate, which arcane medical and insurance language and plain-old inertia had sidelined previously. (Remember, consumerism only factors into the health value chain on a limited basis.)

Now, a just-published survey could similarly disrupt the debate. It reveals just how the biggest payer of health care is thinking. And it's not positive.

This summer, the consultancy Towers Perrin surveyed 433 employers on health reform. Here are excerpts from its press release (published September 17th):

"Employers say they will not absorb any additional costs that result from reform and plan to take actions to avoid doing so, including reducing benefits, raising prices for customers and/or reducing head count"

"Nearly one in four companies (23%) in the survey are currently rethinking benefit changes in light of possible reforms, and nearly all (89%) plan to reexamine their health benefit strategies for active employees in response to the passage of health care reform legislation. And while talent management considerations such as productivity, workforce health, and recruiting and retention remain important even in a tough economy, cost issues will dominate employers’ decision making in a post-reform world, according to the survey."

"In addition, employers do not expect that reform as currently proposed will address some of the fundamental drivers of health care costs. For example, nearly two-thirds of employers (65%) believe that health care reform will have little or no impact on consumer behaviors, an area many leading employers have begun to target as one of their key cost-containment opportunities"

"Towers Perrin’s Health Care Reform Pulse Survey also examined the experience of employers based in Massachusetts, a state that has imposed a pay-or-play mandate on employers and a coverage mandate on individuals similar to those currently proposed in Congress. Among those employers, most are not sure what, if any, impact the three-year-old Massachusetts mandates have had. Most respondents have seen little or no change in employee or employer health care costs or access to or quality of care. Notably, however, more than two-thirds of these employers report that their administrative burdens have increased."

Pretty glum. What's important, though, is that the survey unifies the employer's voice. While different trade associations exist to represent them, politics distort opinion, which too often collides, diminishing what amounts to a potent and relevant stakeholder.

Recently, we've seen political dissonance muffle certain large employers sharing individual experience—Safeway, Walmart and Whole Foods. Rather than focusing on one company, however relevant its message, this survey reflects a cross-section of experience and opinion.

Towers Perrin, a consultancy, grinds no political ax. It makes a living advising employers on managing health benefits, which includes surveys and data collection.

This survey—its timing—provides as clear a window as we're likely to get into how 60% of the health care dollar is thinking.

And if employers are planning for higher capital costs and reduced head counts, then the bill we pay could be much higher than the CBO's current scoring, which measures direct tax revenue and government spending, not indirect economic consequences.

Anyway you cut it, the survey's results present a new twist and a new reality, not likely to disappear anytime soon.

Although it doesn't carry the same headline effect of the CBO suddenly grounding congress in financial responsibility, it does forecast an economic response we could feel for some time to come.

Tuesday, September 15, 2009

The Capital Markets and Common-Sense Rules

Private enterprise is taking a beating. Whether in health care or the financial services industry, policy debates rarely feature the economics of supply and demand—much less self-correcting mechanisms. Instead policymakers have re-conceived market dynamics as a web of casual relationships.

Take, for example, these common lines of argument that advocate government intervention in the capital markets. Big Wall Street bonuses lead to excessive risk taking, which forces "bad behavior" in the capital markets. Likewise, improperly incentivized ratings agencies inflate the quality of securities, which bloats leverage ratios. Or, inconsistent regulation fails to curb market excess, which contributes to a moral hazard.

The fix, then, should be simple, right? Legislate—or mandate—bonus limits, new business models for ratings agencies and more comprehensive regulation.

Okay. Let's say we accomplish this and call it common-sense rules. (Read the text of President Obama's Wall Street speech here.) Will it achieve the desired effect? Well, that depends what we mean by "desired effect" or "common-sense".

And here's the rub. The capital markets work as they do exactly because countless thousands (millions) of people interact with them daily, a few directly and many more indirectly, for many different purposes: investing, funding, speculation, arbitrage, price information, short-term needs, long-term needs, and more. Like Facebook or MySpace, the markets are a social network, except much bigger, much broader and much more unifying.

If it's control lawmakers want, then whatever they establish today risks obsolescence tomorrow—or, worse, some significant unintended consequence. Just look at the fallout from the short sale ban last fall. Market volatility elevated and the price discovery process deteriorated: the exact opposite of what the SEC and market participants intended, and needed, to take place.

Rules and regulation designed for control can never keep pace with market innovation. Nor would we necessarily ever want them to keep pace. Because if they ever were to match innovation, innovation could never occur, by definition.

Rules and regulation should, instead, support market innovation. Consider this in terms of Lehman's demise. Whether the Feds were correct in allowing the bank to shutter is secondary to the fact that the business model—Wall Street's business model—failed.

And let's not confuse the markets with Wall Street. The markets themselves didn't err. They got it right, punishing those who got it wrong. And we know government and regulators were far behind, having little clue that the Wall Street business model was failing as badly as it was.

Fast forward one year, and we're at the same place we were before the crisis. Nothing has really changed in terms of a new model taking root. The bulge bracket features new name plates, and one or two old ones. But if we view the landscape as a continuum of capital flows, then money is just as—or more—concentrated among these big guys as it was in September 2008.

In the name of 'Too Big to Fail', taxpayer money is effectively buttressing a broken model, and postponing its inevitable replacement.

The question should be: What's the opportunity cost of not allowing this transition process to take place? Weak economic growth, high unemployment, a diminished dollar, market uncertainty? Likely all four and more, as Wall Street fails to expand money flows between corporations and institutions.

Here are four expectations for the next Wall Street business model, in sequence.

A return to the partnership model. It should be no surprise that Goldman emerged on top because it embraces a model closest to a partnership than any of its competitors. In contrast to a shareholder controlled firm, a partnership ties the firm's capital directly to its manager, so that risk capital is their money, not other people's money.

A breakdown of concentrated capital. Empire building may be instinctive, but emperors will always define themselves by personal gain. It would be naive to expect that market participants would ever curtail their pursuit of personal fortune. That pursuit, though, could be much more lucrative in a different business model, even if the ultimate scale of the business is much smaller than, for example, Sandy Weill's Citigroup at its peak.

A greater sense of firm identity. An important byproduct of the partnership model is less employee turnover. The compensation format ties individuals to a firm. Wall Street had become a battlefield of mercenaries: analysts and bankers, for example, benchmarking themselves against external polls, instead of their own contribution to the firm's bottom line. Firms became faceless and amorphous, as employees sold themselves to the highest bidder.

A shift to longer-term planning. Goldman demonstrates that a partnership-like model can function within a publicly traded company. Other firms, however, may opt to proceed as private businesses. Either way, this shift will allow managers to plan longer-term and respond less to "best practices", which can often standardize quality. Firms may become more cautious, but they will likely become more specialized.

So, who's to say what's right and what's wrong? Definitely not government or regulators, or really anyone but the market itself. That's not to say there is no place for oversight or rules, just not the kind that impose control.

Capital is finite. It's an economic good. If there's one lesson we should take from the health care reform debate it's that we should never depend completely on the expectation that somebody will do something for us. The sooner that policymakers can trust markets, the better off we become, and the faster our economy will recover.

After all, the last thing we can afford is the restriction by non-market forces of a natural market transition.

Monday, September 7, 2009

The Missing Stakeholder in Health Reform

Pop quiz: who's missing at the health care reform discussion table? Is it: (a) government (b) patients (c) doctors (d) employers or (e) owners of health care companies?

Guess what? Of all the stakeholders in the health care universe, it's the corporate shareholders—the very owners of those health care companies, large and small—who are left out in the cold.

Why is this? Like every other industry, health care depends on Wall Street for much of its capital needs. Growth requires investment, investment requires capital, and the financial markets are the spigot from which capital flows. So why don't shareholders have a voice in the reform debate?

At $2.4 trillion, the total annual spend on health care is well-publicized. Few of us, however, realize that this expenditure translates into a market capitalization just under $2 trillion. Within the S&P 500, only information technology and financials boast higher total values. The 52 companies that comprise health care equal 13.5% of the index's total value.

S&P 500 Health Care Constituents
And while docs, drugmakers and drugstores may come first to mind when we think of health care, shareholders represent a critical stakeholder. Without their money and collective judgment, there is no research and development, no new plant facilities and no incentive for clever business strategies.

Individually, a shareholder might be any other stakeholder: a physician, corporate executive or consumer. No lawmaker, though, is weighing the sum total of these individuals.

Out of sync
Despite the stock market size of the health care industry, it lacks breadth, and does not adequately represent the entire universe. Drugmakers, for example, make up 60% of the listed market capitalization. Hospitals, on the other hand, constitute less than 1%. (Of 5,000 hospitals across the country, just eleven hospital groups are publicly listed.) In terms of total spend, prescription drugs and hospital care represent 12% and 37%, respectively.

National Health Care Expenditures
Source: Centers for Medicare and Medicaid Services


Health Care Industries
Source: Yahoo! Finance

The market, moreover, values commercial health plans—36% of the source of funds spent on health care—at just 4% of the total health care universe. (We wonder: How much does head-to-head competition with government programs contribute to this under-representation?)

If we break down spend between private and public money, majority public- (Medicare/Medicaid-) funded services feature substantially less in the investment universe, and private-funded services substantially more. Of course, the two questions that naturally follow this are: one, what's the impact of market forces? And, two, to what extent do these forces drive efficiency?

While most folks would probably argue that drug manufacturers underachieve in operating efficiency, no one would dispute the fact that the pharmacy "value chain" (the dollar flow from manufacturer to consumer) is inherently more efficient than the public spending-led medical side. The best example for this is claims processing—a major source of administrative inefficiency across health care (more than a half according to one study). Pharmacy systems adjudicate claims instantaneously, whereas the medical system can take several weeks or months.

The table below breaks down types of service by funding source.

Source: Centers for Medicare and Medicaid Services

We can only speculate, unfortunately, whether market forces would drive efficiency the same way in hospital care.

The disconnect between the market and the industry extends to the way Wall Street pros analyze health care. Sell-siders and buy-siders, for instance, still segment drugmakers into biotechnology and non-biotechnology companies, even though all manufacturers—even the generics—now target biological products.

Rarely do these same "drug analysts" also cover pharmacy benefit managers ("PBMs"), even though these companies directly affect pricing and market share. In fact, Standard & Poors doesn't even categorize CVS Caremark and Walgreen as health care stocks, despite their obvious focus, which includes major PBM franchises. Broader indices also don't include the smaller capitalized health information service companies such as Allscripts-Misys Healthcare and Cerner Corp., and instead add them to the technology sector.

As a result, information does not flow as seamlessly as it could across the marketplace. Compounding this problem, coverage teams on either side of the Street don't normally exist across health care, as, for example, they do in technology between software and hardware.

And what about employers? The employer-based insurance market provides coverage to two-thirds of the US population under the age of 65. A large company with 50,000 employees, for example, likely exceeds $500 million per year in total health care spend, including dependents and retirees. As with Starbucks, this level often surpasses investment in core products and services.

Assuming $500 million of spend on average for the largest 100 companies, we can estimate a total annual budget of $50 billion. How management allocates this money directly affects a company's cash flow. Are shareholders prepared to ask the right questions? Are they asking questions at all?

Still relevant
What if lawmakers did include shareholders as a stakeholder? At a minimum, shareholders would urge more efficiency. They would also articulate viewpoints based on return on investment, and frame health care as an economic good—rather than as a right or privilege.

In a recent Wall Street Journal opinion piece, Greg Karpel describes health care as a value-creating industry: "The $2.4 trillion Americans spend each year for health care doesn't go up in smoke. It's paid to other Americans." Mr. Karpel refers to job growth and medical innovation as two examples, and addresses health care as a "significant, perhaps a principal, driver of the economy".

Shareholders could be advocating this uncommon position in precise fashion—except for dislocations across market participants. Still, the market can provide critical and dispassionate information and assessment, which the health reform debate desperately needs.

Even though the shareholder stakeholder may have far to go in developing his own voice, what he can contribute to the reform discussion would be relevant enough.