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US Healthcare: From Boom To Bust!

Supply and Demand

Prior to 1965 medical care in the United States followed fairly fundamental principles of economics, supply and demand. If you wanted care, you'd go and buy it. Granted, health insurance companies were around in those days, but they rarely paid for routine health visits to the local primary doctor and usually were used for only catastrophic or unexpected illness. In those days, if you became ill, you went to the doctor and paid for his or her (in those days usually his) diagnostic skill and prescriptive advice out of your own pocket. Costs were low, the medical care, although not nearly as advanced as today, was generally good and progress in the medical field was steadily forward in research, innovation, and development of an evidence base.

1965 Medicare

The Austrians tell us that when the government subsidizes something, costs go up. The business cycle boom started in 1965 when congress passed the Medicare act creating a nationwide insurance pool for the elderly and disabled which was, and still is, funded through mandatory payroll taxes. At that time, there were 4.6 workers paying into the system for each beneficiary and the average life expectancy of a US worker was only 14.7 years beyond the age of 65 making Medicare coffers flush with cash and payouts generous. Physicians and Hospitals, whose income increased with providing higher quantity of care, billed and collected liberally driving up costs. In the late 1960s and ealry1970s physician and hospital income outpaced CPI increases by more than double, a trend that would continue through the mid 1980s. As healthcare prices rose higher and higher, the population became unable to afford doctor's visits and hospitalization and more dependent on purchasing insurance for care. Private insurance companies sprang up at that time, and grew into large pools able to overbid Medicare prices and capture market share. This trend contributed to healthcare cost inflation between 1970 and 2010 averaging 4% above CPI. Thus, the 3rd party payer system, both private and government funded, became fully dominant in the market for all but the most extravagant of elective healthcare costs. Today healthcare costs are virtually prohibitive for the individual purchaser; hospitals and medical practices are completely dependent on 3rd party payment.


Today healthcare in the US costs more than in any other industrialized nation. National healthcare spending per capita per annum has risen from $147 to $8,402, that's an increase from 5.2% to 17.9% of GDP. The 1965 Medicare Act started the boom by introducing 3rd party payer dominance into a fee for service model, but costs have been further exacerbated by litigation, tax-deductible employee based insurance benefits, and the infamous EMTALA of 1986. These forces have made the current system unsustainable. The 3rd party payers, especially Medicare, are restricting payouts by finding clever ways to clamp down on reimbursement, a trend that will accelerate into the future decade.

Enter Obamacare

Obamacare is a 2.8 million-word mind-boggling piece of behemoth legislation whose primary purpose is to reduce healthcare costs by regulating health insurance "exchanges," force the uninsured to buy health insurance, and penalize employers for not providing health insurance to their employees. It's rolls out additional regulations through 2018 including restrictions and excise taxes on pharmaceutical companies, hospitals, and device manufacturers for not meeting certain price and quality benchmarks. This legislation will improve hospital profit margins in the first few years of it's implementation by bringing 30 million newly insured patients into the pool who will have paid for a product and will want to put their dollars to work. Hospital losses will be mitigated as well by decreasing the number of uninsured patients who use the ER and are later unable to pay the bill. This will help the bottom line for a short time, but will lead to consolidation of hospital systems, less competition, and inefficient care. In the long run, a centrally planned large hospital system has less ability to adapt, change, innovate, and expedite their services.

Invest accordingly

In the past 3 decades, large pharmaceutical companies have made their profits by investing heavily in R&D, patenting blockbusters, achieving FDA approval, and making market share through achieving hospital formulary status and marketing to outpatient providers. These days are ending. Going forward, Pfizer (NYSE:PFE), Merck (NYSE:MRK), Elli Lilly (NYSE:LLY), and Novartis (NYSE:NVS) will face powerful 3rd parties refusing reimbursement for designer drugs when generics are available with similar efficacy. Look for the overall profits of these mega pharma companies to be flat as they depend more heavily on their offshore generic drug manufacturing operations to meet global rather than domestic demand. They will have less growth potential, less R&D investment, and a more difficult time making the formularies lists with cash-strapped hospitals that are dependent on meager DRG (Diagnosis Related Group) reimbursement to stay afloat.

Hospitals and medical practices are consolidating to pool costs, resources, and liability. They are beefing up the balance sheets in preparation for Obamacare, as it will take more and more manpower to fight for reimbursement from the insurance exchanges. Look for large hospital systems with deep balance sheets and actively consolidating to do well (HCA Holdings Inc (NYSE:HCA), Universal Health Sciences (NYSE:UHS)) in the next few years, with smaller local and rural privately owned and hospital groups to get a smaller boost. Obamacare should further the consolidation trend by favoring the larger hospitals and practices that can invest in the manpower to provide the massive amount of meticulous documentation needed to meet the so called quality core measures due to roll out in 2014. However, when the Obamacare "stimulus" wears out we will be left with a larger, less competitive, less innovative hospital infrastructure. Be ready to pull your equity and reinvest in other areas when you see "not for profit" hospitals discontinuing investment in new construction products and equipment purchases (more on this in another article).


The US healthcare boom is coming to an end. As the Austrians teach us, government intervention into the supply/demand balance has consequences. We have seen a boom in healthcare starting in 1965 with Medicare dollars being pumped in. Obamacare, another forced subsidy, represents the last gasp of this boom cycle, the last injection of stimulus into US healthcare. We will see consolidation going forward, better hospital profits for the next 5-10 years followed by, I believe, a slow erosion of hospital, pharmaceutical, and device manufacturing company performance going forward.

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