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The U.S. Supreme Court ruling came as welcome news for some, and not quite so for others. In layman terms, according to the Supreme Court, "Obamacare" did not violate the constitution by legislating that people buy healthcare insurance, or else pay a penalty. Starting in 2016, this penalty will be up to $695 or 2.5 percent of income, whichever is greater. In case of employers with more than 50 full-time employees, the employers must provide health insurance or pay a penalty ($2,000 per employee).

What the ruling means for different company stocks is that a lot of uncertainty has been removed. Although the Healthcare Sector showed mixed outcomes, the stocks of hospital chains were the clear winners. This is because the law broadens the pool of paying patients coming to the hospitals, which were often left to cover the high medical bills of the sick with no coverage. On the other hand, stocks of large health insurers fell slightly. The effect on healthcare REITs and ETFs was nominal.

Healthcare Law and System

The healthcare law, known formally as the Patient Protection and Affordable Care Act, is the biggest revamping of the $2.6 trillion healthcare system (18% of the U.S. economy) in about 50 years. President Obama signed it in March 2010, and it was straightaway put to the test in the courts by 26 of the 50 states, and a trade group for small businesses. The court's decision largely vindicates Obama to reform a system that previously left 16 percent of Americans uninsured. This is unlike other leading economies of the world.

The U.S. healthcare system is a mixture of private insurance and government programs. The United States pays more for healthcare than any other country, but about 50 million of the roughly 310 million Americans are still deprived of insurance. The law in question is meant to bring insurance coverage to more than 30 million of the uninsured and gradually mounting medical costs. In 2010, the Congressional Budget Office estimated that more than 20 million people would remain uninsured, despite the mandates and subsidies enacted. Some people think that these healthcare reforms would increase healthcare costs for insured patients too, because according to a 2004 editorial in USA Today, the Department of Health and Human Services data shows that the uninsured pay more than the insured, and therefore subsidize the insured.

Mike Shea, Managing Partner and Trader at Direct Access Partners LLC in New York, was right when he said that the ruling had already been priced into the stocks so the market would only show a minimal impact. If the law had been overturned, a lot of companies would have fallen.

Hospitals - The Winners:

Hospitals have been the clear winners from this ruling. Hospital Corp. of America (NYSE:HCA) was the biggest winner. It saw an appreciation of 10.7% on June 28 followed by Health Management Associates Inc. (NYSE:HMA) up by 8.8% and Community Health Systems, Inc. (NYSE:CYH) up by 8%. Quest Diagnostics (NYSE:DGX), which runs laboratories, gained about 3 percent.

HCA is trading at a slight premium to its closes competitors with a forward P/E of 7.84 as compared to HMA's 7.57 and CYH's 6.9. HMA also has the highest expected EPS of 3.76, free cash flow of $1.24 billion (as compared to CYH's $229 million) and profit margin of 8.2% (HMA's is 2.65%) among the three.

Profit margins

Forward P/E

EPS estimates 2012

EPS estimates 2013

Qtrly Growth in revenues (yoy)

Free cash

PEG ratio

Enterprise Value/ EBITDA (TTM)

HCA

8.22%

7.97

3.69

3.76

14.2%

1.24 b

0.75

6.62

HMA

2.65%

7.83

0.86

0.99

18.2%

43.22 m

0.71

6.45

CYH

1.54%

6.97

3.65

3.99

12.8%

229 m

0.64

6.36

A possible risk for the hospitals in future is that some people might still not buy insurance, and would prefer to pay a penalty, like in the case of Japan, where 10% of the population still have no insurance, even though it is mandatory (though there is no penalty in Japan). The penalty is not that high relative to what people would have to pay to get the insurance. The average cost of a family health insurance premium will equal 50% of the household income by the year 2021, and surpass the average household income by the year 2033. The typical coverage for a family of four in 2016, for example, will average about $5,800 (individual) and $15,000 (for a family of four), according to the Congressional Budget Office.

Insurance Companies - The Losers:

The ruling was bad news for insurers. UnitedHealth Group (NYSE:UNH), the biggest insurer, was up by half of a percentage point, but during the day it had come down as much as 7% after the ruling. WellPoint (WLP) plunged 5 percent, Aetna (NYSE:AET) and Cigna (NYSE:CL) nearly 3 percent.


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UnitedHealth evaded the fate of other insurers because it does not depend as much on individual and small-group policies for its revenue. UnitedHealth also has an information technology business and a pharmacy benefits business, and is the biggest provider of Medicare Advantage plans for the elderly. WellPoint, on the other hand, draws more of its revenue from insurance on individuals and small groups.

Some analysts expressed surprise at the quick selling of insurance stocks because despite the downside of covering riskier people, insurance companies will also gain millions of premium-paying customers from the law. Analysts with Jefferies, an investment bank, said in a note to clients that "after the dust settles, we are generally bullish" on big insurance companies because they will benefit from about 18 million new customers in 2014 and more after that.

Below is a list of points of the healthcare law that do not favor insurance companies:

  • Insurers would be required to provide coverage for non-dependent children up to the age of 26.
  • Insurance companies cannot deny coverage based on pre-existing health conditions. A person will be able to buy insurance for the same premium as that paid by people in good health.
  • Health insurers will have to raise premiums for everyone in order to charge people with pre-existing conditions less than the expected cost of their care. Young people, for example, could see a doubling or tripling of their premiums, according to industry estimates. This might lead to lost customers who would prefer to pay the penalty.
  • Loss of profits is also likely if only high risk customers come to get the coverage, while the low risk ones simply wait until they get sick to apply for insurance and then drop the coverage when they get well.
  • If a person has a very expensive and continuing health problem, there will be no annual limit and no lifetime limits on their health insurance coverage.
  • By 2014, health insurance exchanges are to be set up. They will be state-based and state-administered. Only government-approved insurance can be sold within the exchange. A person will be required to buy insurance from the exchange if he is not covered by any other plan. This will lead to high competition among insurers to offer the government-mandated health insurance benefit package. Smaller insurance companies will be at a disadvantage.
  • A 40 percent tax would be imposed on insurance companies providing "Cadillac" health plans valued at more than $10,200 for individuals and $27,500 for families. The tax would kick in starting in 2018.

Medical Devices Makers:

The ruling also has a negative impact on companies that sell medical devices because the healthcare law intends to utilize the lowest-cost treatment. In such a scenario, medical-device makers who begin investing in new cheaper or cost saving products should be favored in future. Boston Scientific (NYSE:BSX) is a specific stock in this sector that was as much as 3% down after the ruling, but recovered slightly.

The market may see a selling trend for these stocks.

Healthcare REIT and ETF:

The Healthcare Select Sectors SPDR (NYSEARCA:XLV), a healthcare ETF, fell only slightly by 1% right in line with the S&P 500's decline. The XLV is a benchmark exchange-traded fund for the healthcare sector, as its holdings include Pfizer (PFE) , Merck & Company (MRK) and Eli Lilly (LLY) , among other large-cap healthcare stocks.


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Health Care REIT, Inc. (NYSE:HCN), similarly showed a slight increase of 1% and is now almost at its 52-week high value of $52.95

Investment Strategy:

We recommend buying hospital stocks. We do not advise shorting insurance companies' stocks because we do not expect their prices to decline any further. The market has already incorporated the ruling in the respective prices, and the stocks have begun to recover.

Source: Winners And Losers Of The Supreme Court's Affordable Care Act Ruling