Accountable Care Organizations: The Effect on Medical Care and Healthcare-Related Stocks

Includes: DGX, GE, HCA, LH, THC, UHS
by: Ketan Desai

We all know about the healthcare “reform” bill know as the Affordable Care Act that was passed by Congress in 2010. Assuming that the act is not thrown out by federal courts, and Congress does not change its mind and cancel the program, it is going into effect very soon (some aspects have already kicked in).

A little debated or discussed provision in the act is the Accountable Care Organization (ACO) mandate. To put it simplistically, the intent is to convert private physicians into groups that manage patient care (not stated, but implied that the groups belong to hospitals). The ACO will be given a fixed budget per diagnosis per patient by Medicare and Medicaid, and the ACO will have to stick to that budget. If the ACO exceeds the budget, the individual physicians in the ACO will get penalized by having their reimbursement cut. On the flip side, if they stay within the budget, they will get a bonus. This mandate does not apply to private physicians who take cash only.

There are several repercussions of this policy. The first is of course the effect on physicians and patients. A physician will be less likely to order tests, knowing that it is coming out of his fixed budget, which is the intent of the provision. The physician will, in fact, have to rely on good old history and physical examination to try to figure out the problem, and rely on tests only to confirm a hypothesis. This will be hard on younger graduates, who rely heavily on tests in order to manage patients. It is likely that many more diagnoses will be missed, and what the legal and medical consequences of that will be is anyone’s guess. Another possible effect is that the small but significant number of physicians who do not take any insurance, taking only cash, will increase.

Hospitals will benefit from this mandate. As more physicians are forced to join them, hospitals will be in the driver's seat. They will have less outside competition and the increased volume will help their bottom line. As another provision (of universal coverage) also kicks in, hospitals will benefit from having not to write off losses from uninsured patients. Hospitals stocks that could benefit include HCA, Tenet (NYSE:THC), Universal (NYSE:UHS) and Health Management Associates (NYSE:HMA).

Pharmaceutical and biotechnology companies will not be affected by this mandate. During the debate and bargaining that went on, these companies successfully prevented a large scale generic assault. No European-style caps on costs were placed; no UK-style pharmacoeconomic demonstration of benefits (such as with the British NICE) was required. This sector, which faces other challenges and opportunities, at least does not have to worry too much from this mandate. In fact, the mandate for universal coverage will increase its customer base.

The biggest losers from this act are companies that obtain revenue from tests – whether they be laboratory tests or radiology tests. To give an example, a GP had referred a patient to me for arthritis pain. He had never touched the patient or got a good history. When I saw the patient, his legs were swollen to the hips – and he had gained 20 pounds over a month. It was obvious he did not suffer from arthritis but was retaining fluids.

The GP then went on a testing spree, getting an echocardiogram (for congestive heart failure), doppler ultrasound (for deep vein thrombosis), a CT scan of abdomen and pelvis (for other possible compression of veins in the abdomen), and blood tests for every conceivable esoteric disease. This probably cost over $15,000, great for imaging and laboratory testing companies.

Under ACO, such behavior will be very hard to justify. It will be back to getting a good history, undertaking a physical exam, and ordering tests selectively and rarely. As use of tests decrease on a relative basis, companies that make imaging equipment (such as General Electric (NYSE:GE), Toshiba (OTCPK:TOSBF), and Siemens (SI), clinics that run imaging services, and companies that specialize in laboratory testing (such as Quest Diagnostics (NYSE:DGX) and Lab Corp (NYSE:LH)) may see a decrease in revenue.

As of now, the future of healthcare in the US is still uncertain. Demographics in the US point to an aging population, which is why investing in healthcare companies seems like a good bet. But with deficit reduction a Sisyphean goal, healthcare spending will be in the cross hairs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.