Wednesday, May 26, 2010

What Happens If Employer-Based Health Insurance Goes Away?

According to a recent survey of large companies (median size: 5,600 employees) by Towers Watson, 94% of companies expect health reform to increase costs. While most expect to continue offering health insurance, 43% of those offering retiree benefits expect to reduce or eliminate them.

88% plan to pass cost increases on to employees, and 74% anticipate reducing health benefits and programs. 20%, moreover, expect to pass increases on to customers. Read more here.

Writing in the Lyceum newsletter Perspectives, Steve Hyde argues that employer-based health insurance will continue its decline at an accelerating pace, as health reform progresses. He states:

The reform law, with its universally available insurance exchanges and generous middle-class premium subsidies (and free Medicaid for many earning $10-15/hour), effectively removes both barriers to exit. And the $2,000/employee play-or-pay penalty, according to Medicare’s actuary, “would not be a substantial deterrent to dropping or forgoing coverage.”

Read Steve Hyde's article here.

If the pace does in fact accelerate, expect commercial and government health plans to shoulder the extra burden, which will manifest in higher premiums and tax rates. Most impacted could be the state Medicaid programs.

And while Mr. Hyde believes group-based coverage is inherently flawed to begin with, the alternative of a government-sponsored individual market does nothing to rectify the economic misalignment of payers not consuming and consumers not paying—at least not in a direct and transparent fashion.

Access to care is also likely to suffer as hospitals will find it increasingly difficult to offset declining Medicare and Medicaid reimbursement with higher charges to private payers. Hyde argues:

Hospitals must anticipate the risk of losing their ability to shift growing government losses onto private payers. For most, responding will require nothing less than replacing the standard business model that has sustained them for decades. Those that don’t could find themselves in mortal jeopardy.

If costs do rise as employers expect, public and private payers experience worsening budgets, and access to care deteriorates, expect a severe consumer backlash. But this isn't the stuff of years to come.

Depending on how the global economy navigates the current economic recovery, including the challenges Europe now presents, any sustained increase in capital costs will exacerbate these negative trends.

Consumer response would be immediate.

Monday, May 24, 2010

Short Sellers Are Grown Up Goths

Picture this. Instead of inhabiting the grown-up world of financial markets, we're back at high school. What teenage subclasses would investors represent? Quants, no doubt, are the jocks. They are the brash muscle guys, the BMOCs. The huge sums of money their algorithms whirl around move markets and all participants. The geeks have inherited the earth.

Long-term fundamental investors are the new nerds: bookish, no longer conventional, and happy to stay at home. One day, they could be relevant once again.

Momentum investors are the cheerleaders: always looking to chase what's hot, and avoid what's not. The trend is their friend: they wouldn't be caught dead at study hall.

And what about market contrarians? This clique lurks around the dark corners of financial disclosure, hunting for corporate fraud and hated for its efforts. Cynical and shunned, these short-sellers are the goths.

In his new book, "Selling America Short", Richard Sauer chronicles his experience as an SEC attorney and administrator and an analyst for one of the most gothic of short-sellers. Combining legalese and descriptive flair, he details some of the SEC's highest profile cases over the past several years: ACLN, Lernaut & Hauspie, AremisSoft,, NovaStar, and Fairfax Financial Holdings.

He also delivers a hard-punching defense of David Rocker and his colleague Marc Cohodes, who later would lead the short-lived hedge fund Copper River. Sauer advised Rocker as a defense attorney and later worked for Cohodes as an analyst.

The SEC, he writes, has a difficult time finding its regulatory advantage:

Most of what happens in the market in the market is a puzzlement even (or perhaps particularly) to the people who regulate it. From its deep waters, things now and then float to the surface that can be identified as requiring a certain treatment under the law. Other pieces of market flotsam, when seen, are harder to classify. But what lies beneath the surface for the most part remains a mystery.

In fact, he argues that the agency suffers a distinct disadvantage, not just because it's poorly staffed, but that it's underresourced. Rogue targets, especially if located overseas, often use complex legal maneuvering to thwart the agency's challenges, and force it to burn through its limited case budgets.

According to Sauer, the SEC is constantly reconciling its own economic reality:

In deciding to litigate a run-of-the-mill case, a government agency will do a cost-benefit analysis, however informal, balancing the importance of the matter against its potential cost, and the likelihood of losing at trial. But in high-profile cases in which the agency will be criticized for inaction, the analysis shifts to one of weighing how much grief it will get should it bring the case lose compared to the amount to be expected should it forego bringing the case at all. And, of course, the pain from a eventual loss at trial will not occur for a few years, so it is given a sort of psychological discounting to present value.

Perhaps its biggest disadvantage is that it's a government agency, run by politicos with staffers doing the actual investigative work, often at odds with each other. Sauer cites the example of the insider trading case against John Mack, soon to be CEO of Morgan Stanley. Despite some significant evidence, the politicos killed the case before it could be more thoroughly investigated.

High-octane mouthiness
Cohodes, who possessed "disarming candor and high-octane mouthiness", had once shown up at a shareholder meeting dressed as a referee. Whenever he deemed that management was misleading, he blew his whistle and threw a red penalty flag.

Unlike trading firms, Cohodes and other contrarians typically manage concentrated portfolios of companies carefully scrutinized for fraudulent practices, such as falsified revenues, money laundering, and phantom asset valuations.

Pay-offs, though substantial, might not occur for several months, or years in some cases, as Sauer notes:

Short investments often follow a path of long-term pain followed by sudden jubilation when the short-seller at last "gets paid" for his trouble and patience. Timing, as in stand-up comedy, is everything, and hard to get right. Warren Buffet has said it's easier to pick bad companies than to predict when they will come to grief. They can blow up without warning or their faults can escape notice for longer than anyone who believes in efficient markets would think possible.

Copper River, which Cohodes formed after Rocker retired in 2006, fought a long, costly war against Patrick Byrne, CEO of The several pages Sauer devotes to the various fronts and battles portray Byrne as borderline psychopathic. The reader almost feels embarrassed at having walking into a bitter family feud.

Lehman's collapse, the SEC ban on short-selling and rough-treatment by Goldman Sachs sank Copper River almost instantaneously. The SEC ban, hypocritical for executing the same market manipulation it prosecuted, did nothing to ease volatility, and Goldman's actions, attacking a bleeding hedge fund—and also a prime-brokerage account—in shark-like fashion, strongly suggested front-running and total disregard for Chinese Walls.

So, what of financial reform? For someone like Sauer, he's seen it all, and is decidedly pessimistic:

When the government imposes rules that come down to telling economic actors to "tell the world what you're really up to" some will regard this as more a challenge than a directive. Something to finesse when the stakes are high. And experience teaches that they will succeed in getting around the new rules and the government sloggers who enforce them—until they become altogether too good at it and bring on the next crisis. A cycle of creative destruction that creates less than it destroys.

Goths see dark while the rest of us see light. As in high school, many different actors make up the financial markets. The balance among these cliques can shift, but they are each important to each other.

Short-sellers expose the dark side of company management, which most of us want to believe is doing the right thing. And with regulators usually steps behind, they represent an important self-correcting mechanism.

Lawmakers, not realizing this balance, could overshift market equilibrium. Imagine, for example, a world of just jocks and cheerleaders. Not a pretty thought.

Thursday, May 13, 2010

Health Care Costs Continue to Rise

Just published: the 2010 Milliman Medical Index. This closely monitored index reports total annual medical spending for a typical American family of four covered by an employer-sponsored program. It examines key components of medical costs, and charts changes over time for both employees and employers.

Key findings include:
  • 7.8% total increase in costs, from $16,771 in 2009 to $18,074 in 2010 (remember that CPI declined 0.4% in 2009)
  • $10,744 employer's share of costs (59% of total)—the first time above $10,000
  • 48% inpatient and outpatient share of total spending, the largest component
  • $22,098 cost for Miami, the most expensive city, and $16,071 for Phoenix, the least expensive city
  • 59% total increase in costs for employers since 2004, and 65% for employees
Read report here.

As to the near-term impact of health care reform, the report expects costs to shift from employees to employers, and provider/payer negotiations to intensify, as regulators put more pressure on the premium rate-setting process.

Factors that will raise costs for employers include:
  • expanded dependent coverage for adult children up to age 26
  • no lifetime and annual limits
  • restricted cost sharing for preventive care
  • prohibition of preexisting condition exclusions for children's coverage
Long-term impact is less certain, according to the authors:

Debate continues on the extent to which the changes from healthcare reform have potential to bend the long-term cost curve; however, for the near-term, the underlying drivers of increasing healthcare costs are not expected to immediately change...

For now, the onus of control remains with insurers, who will attempt to put pressure on providers to lower costs to a level that approved premium rate can support. There may be more extensive shifts in market dynamics in 2014, when the government takes on an even larger proportion of payment responsibility due to expansion in Medicaid, the creation of exchanges, and the availability of subsidies for certain lower-income individuals.

As the report suggests, we can expect lots of strategic challenges for employers and insurers over the next few years.

And while costs may ease somewhat for employees, payers will bear an extra burden, which they will look to offset with reimbursement cuts to providers (hospitals, docs) or, in the case of employers, higher price points for their end products.

Adding to these challenges would be a stagnating economy, structurally high unemployment, or rising inflation—or, worse, any combination of the three.

Monday, May 10, 2010

Wall Street Succumbs to Short-term Trading

We depend on computers for just about everything. Has this become an over-dependence on Wall Street, and a direct threat to how capital markets should function? Yes, according to the latest article in the Lyceum newsletter Perspectives.

The article highlights the May 6 market collapse as another signal of a perilous shift from fundamental investing to short-term trading:

The May 6 market crack glaringly exposed the fundamental flaw of quantitative trading: machines have advanced faster than man’s ability to control them, or for regulators to understand them. The actual cause—a “fat finger”, an algorithmic trade gone astray, an errant high-frequency trading program, or a rogue quant—is less important than the culture that has not only permitted, but encouraged, such activity. In today's capital markets, speed has overtaken deliberation, action has replaced thinking, and irrationality has swamped reason.

At risk is a total loss of confidence in the capital markets' ability to support economic growth.

Quantitative traders have devised a quick means of making exorbitant profits, and converted capital markets into a casino. Their actions risk lost confidence among millions of small investors, which would make us all losers. Businesses will find it difficult and more expensive to raise capital, jobs will be lost, and retirees and shareholders will see their savings dwindle.

Read article here.

Government needs to take action, and point financial market reform to investing—not trading.

Friday, May 7, 2010

Hospitals Face Uncertain Future

Over the past year, share prices in hospital operators have made impressive gains. Community Health Systems and Health Management Associates, as illustrated below, have outperformed the S&P 500 (bottom, brown line) by a nearly two-to-one margin, and Tenet Healthcare by more than three times.

Investor enthusiasm also extends into the private markets. In the days after President Obama signed health reform into law, Cerberus Capital Management announced a $830 million investment in Boston's second largest hospital network, Caritas Christi. According to reports, Cerberus may also target additional investments in hospital operators.

And just today (May 7th), HCA, the nation's largest hospital operator, has filed for a $4.6 billion IPO to pay off debt incurred by its private equity owners, KKR and Bain Capital.

While prospects might seem good, big questions remain, especially in two of hospitals' primary revenue sources: state governments and commercial health plans. Noted health care entrepreneur and pundit, Stephen Hyde, is cautious:

While [32 million newly insured users] may mean an end to the era of chronic unreimbursed care, it also brings on a new age of chronic under-reimbursed care. Without fundamental changes in how hospitals operate, increased losses will make it difficult for many of them to survive.

He argues that a combination of different factors could severely challenge profitability as costs outpace revenues on rising volume, including:

  1. no credible source of higher Medicaid payments, especially if state budgets remain stressed
  2. increasing demand for non-ER services and strains on capacity, as providers continue dropping Medicaid coverage
  3. an escalating inability of commercial health plans to subsidize shortfalls through cost shifting

As would be true with any 3,000 page law, health reform will, no doubt, showcase an expanding list of unintended consequences in the years to come. Mr. Hyde points to the perils of badly conceived health insurance exchanges, as one example:

[T]he federal rules for the new state insurance exchanges contain some nasty landmines that are actually more likely to force insurers to be seeking subsidies rather than providing them. These rules include overly rich mandated benefits, excessively restrictive patient cost-sharing limits, uneconomic medical-loss-ratio mandates, unrealistic premium controls, continued medical inflation, and the probability of serious adverse selection... (Read more here.)

So, one, the bill mandates state insurance exchanges, a distinctly different target than the care delivery system; two, the rules laid out governing the exchanges severely restrict private carrier pricing and profitability; and three, hospitals, the recipient of the unintended consequence, will no longer be able to rely on private sector payments to offset below-cost Medicaid reimbursement.

At the same time, we're now witness to the consequences of severe government indebtedness, which we may soon experience in the quality of our health care system.

Monday, May 3, 2010

Will Biosimilars Alter Biotech Landscape?

Though flawed, the pathway for follow-on biologics establishes a new dialogue between the FDA and manufacturers, according to Steve Grossman of FDA Matters. It encourages different strategies for best-possible routes to market for follow-on, or biosimilar, products:

The new law “protects” the reference product from competitors, by denying competitors the benefits of the new approval pathway for 12 years. This isn't market exclusivity, because there are other ways to get a biosimilar approved. Also, this isn't data exclusivity, because the competitive product can have its own data and still not be able to use the new abbreviated pathway for approval. What, in fact, the new law has granted to the reference product is 12 years of “pathway exclusivity”...

For drugs approved more than 12 years ago, companies that wish to market biosimilars will choose between the abbreviated pathway and filing a full Biologic License Application ("BLA"). For drugs approved less than 12 years ago, companies will either wait, or go the full BLA route.

Many companies—even those with the opportunity to take the abbreviated pathway—will decide that the full BLA exceeds the cost of collecting additional data. Some will take the data from their biosimilars already approved in Europe, and discuss with the FDA which pathway is likely to work best.

Other companies will work towards approval of BLAs for so-called “bio-betters”—new products that are similar to an existing product, but which are safer, more effective or easier to use.

What comes next depends in part on the FDA. The new law clearly empowers the FDA to find ways to get more biosimilar products on the market. Since this can only be partially achieved through the abbreviated pathway, we believe the agency will be looking for ways to make the BLA process friendlier for biosimilar and bio-better products.

Any change in the ability of manufacturers to approach the FDA—or any change, for that matter, in the FDA's confidence in approving biosimilars—could unleash powerful market forces, and upset innovators', such as Amgen, Genzyme and Genentech, longstanding balance and legal maneuvering.

Although overly restrictive patent law hamstrings the pathway itself, Grossman's argument suggests that investors can still expect manufacturers to pursue biosimilar products, even if via a traditional BLA process.

As the pathway stands now, for example, applicants must hand over the full application dossier to the reference product manufacturer 20 days after filing, in effect risking, upfront, privileged information on patents and corporate strategy.

Expect basic economics to dominate the drug supply chain over the coming months and years. Payers such as health plans and employers will demand a more competitive marketplace to drive down prices, and manufacturers will supply a larger number of competitive products.

A new dialogue with the FDA—or just regulatory confidence in biosimilars—provides a valuable opportunity for competitors to help payers improve affordability and access.