Taking On Healthcare Costs via the Private Sector

by: Michael Filighera


Recent unrest in the Middle East and higher oil prices have overtaken much of the financial media attention since the beginning of 2011 and masked what could become the Achilles' Heel of the U.S. economy – potential bankruptcy of states due to double-digit budget shortfall in fiscal year 2012. According to the CBPP (Center on Budget and Policy Priorities), 44 states and the District of Columbia are projecting budget shortfalls in 2012 totaling more than $110 billion, or about 18% of the states’ fiscal spending. To begin to close budget deficits many states have raised taxes and cut discretionary spending. However, to achieve meaningful reduction, healthcare and pension costs, which account for more than 30% of most states' annual expenditure, will need to be addressed and reformed.


In reducing healthcare spending, states have been focusing on three primary areas: demand management, administrative waste and care delivery. With demand management, the emphasis remains on disease prevention and early diagnosis. Although some additional upfront payments would be required, ultimately over the longer term new programs would cut expensive treatments by decreasing the prevalence of serious illnesses.

Second, the U.S. has the highest healthcare administrative costs among most developed countries at around $400 billion per year. Numerous academic studies have estimated that between 15% to 17% of these costs lie in administrative costs (wastes). By using a combination of software technology and administrative outsourcing, states could achieve further savings by eliminating some of the waste.

Third, the setting (facility) where care is delivered makes a difference in costs, with inpatient care bringing the overall cost much higher. Many institutions are adopting outpatient services that include many surgical procedures that previously required several days in the hospital. With outpatient surgery and ambulatory care centers reducing in hospital stays there has been a major shift towards ambulatory and home care, which have reduced costs and enabled further savings.


Diagnostic Services & Test Kits

Much of today’s healthcare expenditures have been spent on disease treatments, ranging from high-end heart valve replacement to cutting-edge biologic therapeutics, costing more than tens of thousands of dollars per procedure or regimen. Treating diseases in more advanced stages has become one of the major cost contributors to state healthcare costs, where the shift towards early disease detection should begin to bring significant budget savings.

Recent returns of diagnostic businesses have outpaced the market, revealing that investors may be expecting the demand to pick up materially. We took a look at two In particular, the Revere Outpatient Diagnostic Services sector and the Revere Disease Diagnostic Test Kits sector which have YTD returned 13.14% and 15.50%, outperforming the S&P 500.

Companies in the Outpatient Diagnostic Services sector are mainly clinical and imaging laboratories, such as Quest Diagnostics Inc. (NYSE:DGX) and RadNet Inc. (NASDAQ:RDNT). Companies in the Disease Diagnostic Test Kits sector include Gen-Probe Inc. (NASDAQ:GPRO) and Genomic Health (NASDAQ:GHDX).

Managed Care Medicaid & Healthcare Software

A large cost component of states’ healthcare expenditures remains the Medicaid program. This healthcare insurance program covers more than 60 million people and spends close to $370 billion annually.

When compared to health insurance companies, state governments lack much of the disease management and quality assurance expertise and are more prone to administrative inefficiency. In the past decade, states have gradually outsourced Medicaid administration to Managed Care Medicaid companies, as the percentage of Managed Care Medicaid enrollees has climbed from 50% to 70%. This trend is expected to continue as states face rising Medicaid enrollment while the baby boomer generation begins to retire.

Increased software adoption has streamlined the movement of healthcare paperwork and helped to reduce costs, particularly in the area of electronic health records and claims verification and reimbursement.

The Revere Managed Care Medicaid sector and the Revere Healthcare Business Software sector have returned 24% and 19% YTD, outperforming the S&P 500 by 22% and 17% respectively.

  1. Companies in the Managed Care Medicaid sector include AMERIGROUP Corp. (AGP) and Centene Corp. (NYSE:CNC).
  2. Companies in the Healthcare Business Software sector include Allscripts Healthcare Solutions (NASDAQ:MDRX) and Cerner Corp. (NASDAQ:CERN).

There are two potential long plays:

  • AMERIGROUP Corp., one of the largest Managed Care Medicaid insurance companies in the U.S., with more than 1.9 million members. It has one of the lowest health benefits ratios (HBR) at 81.6%, which means for every health premium dollar it receives, it is able to keep more than 18 cents as profits. HBR for the whole Managed Care Medicaid sector stands at 83.3%, which is 1.7% greater than AMERIGROUP. Management has also indicated that further reduction in HBR is possible in 2011 through improved disease management protocols and information system upgrades.
  • Gentiva Health Services, Inc. (NASDAQ:GTIV), a home healthcare company that provides a range of services such as respiratory support, nursing, rehabilitation and hospice. Revenues grew 26% in FY 2010 primarily due to its acquisition of Odyssey Healthcare, one of the largest home hospice companies in the U.S. with a presence in 29 states. Home hospice services has one of the most attractive reimbursement rates among all home care services and before this acquisition, Gentiva had minimal hospice operations. We believe this merger has filled a long overdue business gap of Gentiva and enabled it to become one of the most diversified and competitive home healthcare companies in the country.


  • States across the U.S. will continue to be under economic stress and must find ways to reduce their spending or face potential bankruptcy.
  • As one of their major and growing expenses, healthcare will take center stage for costs cutting through promoting disease prevention & early diagnosis, streamlining administrative process and improving care delivery.
  • Sectors such as Outpatient Diagnostic, Healthcare Software, Managed Care Medicaid and Home Healthcare will be major beneficiaries of this trend towards state government austerity.

Jeremy Zhou contributed research & analysis for this report.

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

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