Argument: The overall outcome of the 2016 US elections was highly meaningful for companies impacted by federal legislation concerning healthcare. Both presidential candidates proposed to handle the issue in very different ways. Accordingly, the future business prospects of various companies within the sector could virtually change overnight. With the prospective repeal of the Affordable Care Act and replacement with the American Health Care Act, I offer which main segment of the healthcare industry will benefit.
The Patient Protection and Affordable Care Act (typically known as the ACA or Obamacare) had a notable impact on the market by influencing returns in certain sub-sectors of the medical industry. No piece of legislation will uniformly appease all contingents and interest groups. There is practically always winners and losers.
The ideal solution is such that collective societal utility is maximized, though how this is done is very open to debate through various ideological interpretations.
With the two-party system within the US, there are generally two camps - a "Democrat way to do it" and a "Republican way to do it." Naturally there is plenty of infighting both within and between parties on how to best accomplish the matter.
One way to do healthcare is to provide coverage for all citizens through a nationalized program with funding derived from taxing the base most fit to provide the budget requirements for the program. The other way is to leave matters mostly in the hands of the private sector in order to increase competition and ideally drive down costs for consumers, while giving the individual the opportunity to choose among the various market options that come out of it. The ACA model was closer to the former while the American Health Care Act (to be called AHCA henceforth) is closer to the latter model.
First the differences between the two (full text of each piece of legislation is hyperlinked with each header):
- Individual mandate
- Those with pre-existing conditions were enrolled in Medicaid or the ACA exchanges
- Medicaid expansion in perpetuity
- Required coverage in 10 essential health categories
- Health savings accounts had very limited focus
- Coverage for young US adults on parents' plan until age 26
- Low-income assistance relied on subsidies based on income and Medicaid expansion
- Medicaid financed through cost sharing with the states - the federal government pays for 90% of Medicaid's expansion and 50% for standard Medicaid costs
- Old-to-young premium spread: 3-to-1
- No individual mandate
- Pre-existing conditions handled by the states, but incentivized through direct federal grants; insurance for those with pre-existing conditions will be permissible if coverage is continuously maintained
- Medicaid expansion through 2020; uncertain beyond that
- No required health coverage in 10 essential health categories
- Health savings accounts encouraged
- Coverage for young US adults on parents' plan until age 26
- Low-income assistance is available with tax credits provided on the basis of both age and income
- Medicaid financed through per capita grants
- Old-to-young premium spread: 5-to-1
Key Beneficiaries of Replacing the ACA with the AHCA?
The AHCA would expect to boost earnings for most healthcare insurers by providing a more favorable risk pool relative to the ACA. Under current legislation, participants on the exchanges are older and less healthy, leading to extra cost burdens. Under the AHCA it is anticipated that the risk pool will become younger and less sick by incentivizing younger, healthier individuals to enroll.
Older, sicker individuals are likely to be increasingly passed into risk pools that are taken care of through federal funding. The high-risk pool passed onto insurers under the ACA has provided a more challenging operating environment. Younger, healthier individuals have lacked the incentive to enroll on the ACA exchanges due to cost, which has disproportionately slanted the pool toward an unbalanced high-risk demographic.
Over the past 2-3 years, health insurers have lost billions through participation on the ACA exchanges, perhaps somewhere in the vicinity of $3.0-$3.5 billion through year-end 2015. Some of these losses were mitigated as premiums were hiked in 2016 in addition to greater free rein among insurers on whether or not they choose to participate.
Those enrolled on the ACA exchanges are on average older and less healthy and numbered somewhere above 10 million as of December 31, 2016. Another 11 million were eligible to enroll on the exchanges but did not participate, even as 5 out of every 6 eligible participants would have qualified for government-sponsored subsidies.
The AHCA contains the somewhat surprising element of a Medicaid expansion through 2020. As a proposal that would emphasize cost efficiency, it was expected that this provision would be axed outright. Nonetheless, it appears as though Medicaid will be expanded over the next 3-4 years to ease the transition over to the new law. The proposed way in which Medicaid will be financed - through per capita grants - could benefit insurers that specialize in Medicaid insurance through a basic expansion in the program's membership.
The ACA limited the young-to-old cost premium to 3-to-1, meaning that older enrollees could not be charged more than three times the cost of younger enrollees. Loosening this regulation will also save insurers costs, as the equilibrium young-to-old spread is somewhere above this and has historically trended around 5-to-1, meaning healthier individuals would need to fund less healthy individuals in order to make the requirement work. The AHCA proposes a 5-to-1 spread, which puts matters back toward equilibrium while also preserving some of the framework that goes into making healthcare expenses more equitable among all individuals.
Lowering the range back to 5-to-1 will help improve the risk pool for insurers allowing for more profitable policy underwriting. Relaxing the spread should also help bring down costs for younger individuals through lower subsidization requirements. Moreover, younger individuals will have the opportunity to qualify for a tax credit in accordance with age and income while having the option to enroll in a lower-cost plan.
The heavily debated topic of pre-existing conditions will be handled through the continuous coverage provision. This is always a sticky point for insurers due to the risk inherent in people signing up for coverage after getting sick. Those who maintain continuous coverage will avoid the insurance costs of those who sign up only after being incentivized through medical necessity.
All these factors look to defray the current imbalances in the risk pool that insurers are faced with and will boost profitability among the health insurance sector as a whole. If high-risk individuals are mostly shifted over to federal programs this will necessitate subsidization from public funds, but will nonetheless better assist the private health insurance market.
Finally, the AHCA also proposes to flush out cost by eliminating the stipulation that those who are both covered and subsidy-eligible be required to enroll in essential health categories. One common criticism of the ACA is that forced enrollment in some of these essential health benefits make no sense relative to the enrollee's medical circumstances (e.g., pregnancy and childbirth services). Such cases have added no benefit but retained the associated cost.
In terms of names, Medicaid's proposed expansion (at least for the next 3-4 years) under the AHCA is a small bit of positive news for Medicaid-oriented insurers, such as Molina (NYSE:MOH) and Centene (NYSE:CNC). The AHCA's plan of putting the kibosh on Medicaid expansion caused Molina's shares to crater around 20% right after the November 8 elections.
The news of Medicaid's expansion through 2020 is only mildly positive news as it's frozen thereafter.
Centene dropped around 25% after the election with its own Medicaid-oriented insurance model. The stock has nevertheless recovered since.
For insurers impacted negatively by the ACA's regulatory stipulation, including Aetna (NYSE:AET) and Humana (NYSE:HUM), the prospective repeal of the legislation and replacement with the AHCA would be viewed as mostly positive.
Aetna's price action after the election reflected this, popping 28% from November 3-December 1.
Over that same period, Humana increased 31%.
In part 2 to follow, I will cover the main losers from the potential repeal and replacement of the ACA with the AHCA. The basic strategy has been to go long the main beneficiaries of the prospective legislative action and shorting those whose business prospects are weakened by the shift such that net exposure to the market is cancelled out. With equities currently so expensive I don't necessarily care to have additional directional exposure to the US equities market beyond what I already have (i.e., still net-long but underweight).
Disclosure: I am/we are long AET, HUM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.