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When investors think of the Affordable Care Act they think about the potential of 30 million previously uninsured individuals gaining insurance by 2022. They think about the opportunity for insurers to gain new customers. They think about the growth in prescriptions and the impact on the pharmaceutical industry. They think about the increase in patients and procedures for healthcare providers. They don't usually think about the impact of Value Based Purchasing.

Value Based Purchasing (VBP) is an approach to healthcare reimbursement that seeks to reduce costs and improve the quality of care. In a VBP payment model, when providers deliver quality care below a "reasonable" benchmark cost, they can earn a share of the savings. Providers may have to pay a penalty if the cost exceeds the benchmark. In some cases, providers receive a fixed payment for the benchmark cost amount. They get to keep all savings below the benchmark and are responsible for any costs above the benchmark.

VBP is a completely different approach than the fee for service model that prevails today. Under the fee for service model providers tend to "overtreat" patients so they can earn higher fees. If you have ever looked closely at your medical bills, you'll see this in practice. You look at your bill in disbelief - lots of consultations, lots of procedures, all billed separately and resulting in an astronomical amount. VBP seeks to eliminate this by rewarding physicians that provide cost effective treatment. VBP seeks to do more than just eliminate redundant or unnecessary procedures. It wants to incentivize providers to reduce costs by delivering better patient outcomes - e.g. using preventative care to avoid or minimize illnesses, reducing medication errors, improving quality of care and follow up to drive down re-admissions. Post-acute care is a good example of an area where inefficiencies drive up cost. Home health care is the lowest cost and most effective (fewest re-admissions) option for post-surgery recovery. Despite this fact, 60% of Medicare patients are sent to nursing Homes or rehabilitation hospitals. Hospitals have no incentive to optimize the cost or quality of patient recovery. Since the home based option requires more paperwork, hospitals often take the easy way out and refer patients to nursing homes. These issues are outlined in detail in the NY Times Magazine article - "Who is Betting on Obamacare?" (11/3/2013).

Below are the key VBP initiatives of the Affordable Care Act:

  1. Hospital Value-Based Purchasing Program - a pay for performance program for hospitals with incentives and penalties that went into effect in October 2012
  2. Medicare Shared Savings Program (MSSP) - a shared savings payment program for accountable care organizations (ACOs) that deliver quality care are rewarded when their treatment costs are below the benchmark. An ACO consists of primary care physicians, nurses, and specialists responsible for providing care to at least 5,000 beneficiaries. The Affordable Care Act also establishes pioneer ACOs. Pioneer ACOs can earn a higher reward for savings below the benchmark, but they are exposed to a penalty if they come in above the benchmark.
  3. Bundled Payments Initiative - A bundled payment is a fixed payment for a comprehensive set of treatments / services that goes across providers and care settings. The bundled approach incentivizes more cost effective (fewer duplicate and unnecessary procedures) and higher quality care (fewer medication errors and reduced re-admissions).

Below are 4 investment ideas that will benefit from the trend towards Value Based Purchasing:

#1: IPC- The Hospitalist Company (IPCM) - IPC's physicians act as the primary care physician for hospitalized patients - providing, managing, and coordinating care. They are a key player for hospitals that are trying to succeed under value based purchasing. "No physician group is more essential to this partnership than Hospitalists. As the primary admitters and managers of patients, Hospitalists can have a major impact on all aspects of the VBP formula."

Price - $56.44 on 10/8 Market Cap - $954 MM P/E (TTM) - 24 EPS Growth (next year) - 36%

#2 - Addus HomeCare Corporation (ADUS) - Addus provides home and community based services to elderly and disabled individuals. They are benefiting from the shift away from nursing homes - "While Medicaid still spends more total dollars on nursing homes than home care, states have been making a concerted effort to shift spending to home and community-based settings that seniors favor and that tend to save significant money over the long run."

Price - $25.63 on 10/8 Market Cap - $276 MM P/E - 12.8 EPS Growth (next year) - 19%

Additional Ideas - Almost Family (AFAM), LHC Group (LHCG), Amedisys (AMED), Gentiva (GTIV)

#3 - UnitedHealth Group (UNH) - UnitedHealth is a leading health insurance provider that has embraced Value Based Purchasing as a way to boost their margins and differentiate their business. They are seeking to more than double their pay-for-performance spend by 2017 - from $20B to $50B. "We are improving health outcomes for patients at lower costs by moving even more broadly to value-based payment models and integrating those with our care provider network, product and clinical strategies," said Austin Pittman, president, UnitedHealthcare Networks. "Our unparalleled experience with accountable care models - and there are many - demonstrates that they can work better for everyone in health care, from patients to payers to care providers."

Price - $70.50 on 10/8 Market Cap - $72 B P/E - 13.3 EPS Growth (next year) - 3%

Additional Ideas - WellPoint (WLP), Aetna (AET), Humana (HUM), Cigna (CI)

#4 - Cerner (CERN) - Cerner sells software that healthcare providers use to collect, analyze, and manage patient data. The global market for healthcare IT is expected to grow rapidly. Analysts say the market, valued at $40.4 billion in 2012, will swell to $56.7 billion by 2017 for a compound annual growth rate of 7%. A key driver of this growth in the U.S. will be IT spending by healthcare providers to comply with the Meaningful Use Standards - a VBP initiative of the Centers for Medicare & Medicaid Services (CMS) Incentive Programs that governs the use of electronic health records. Cerner has a competitive edge over McKesson and Allscripts with large institutions and is well positioned to take advantage of this growth trend.

Price - $57.04 on 10/8 Market Cap - $20 B P/E - 44.6 EPS Growth (next year) - 16%

Additional Ideas - McKesson (MCK), AllScripts Healthcare Solutions (MDRX)

Source: Value Based Purchasing - An Under-Publicized, Compelling Obamacare Investment Theme