On March 23, 2010, President Barack Obama signed into law the Patient Protection and Affordable Care Act (PPACA). The Senate voted the legislation through on December 24, 2009, on a straight party-line vote: 60-39. The House vote on March 21, 2010 was less partisan and much closer: 219-212, with 34 Democrats voting nay. The bill’s ostensible purpose was to establish universal health coverage and provide health insurance for 30 million uninsured Americans.
The legislation’s authors also intended to lower health care costs generally, with a specific plan to cut Medicare expenditures by slowing the growth in payment rates to doctors. In summary, PPACA has five key provisions, which have notable implications for the markets:
1. The Individual Mandate: Anyone not covered by employer health insurance, Medicare, Medicaid, or other public program, must purchase private insurance in a state exchange, or pay a penalty.
2. Create State-level system of Health Insurance Exchanges in conjunction with Federal subsidies.
3. Dependents can remain on parents’ insurance until their 26th birthday.
4. Insurers cannot deny coverage based on pre-existing conditions.
5. Insurers cannot drop policy-holders due to illness.
SCOTUS In Play
From March 26-28th, the Supreme Court of the United States (SCOTUS) heard six hours of oral arguments on three separate challenges to PPACA. These were the lengthiest oral arguments allotted for a single piece of legislation since 1967. To be sure, the Act is contentious, both politically and constitutionally. The Supreme Court justices have made their decisions on the merits of the case, but they have not yet released the official opinion. We expect that they will rule in the next few weeks, and when they do, the market – especially those health care and insurance sectors directly affected by the legislation – will react to incorporate the news.
Typically, the Court adjourns at the end of June for its summer break, but there is no official last day of the term. It’s a tradition to hold the release of the most controversial opinions until the final day of the term, which could be as late as July 1st/2nd.
Three Scenarios
With the Supreme Court’s opinion pending, we see three possible outcomes worth outlining:
1. Severability- SCOTUS rules the Individual Mandate unconstitutional, but upholds the rest of the legislation.
Implications – Without the Mandate, the markets remain uncertain about the regulatory landscape and therefore will likely reduce the value of the sector. In turn, the federal government may take advantage of the ruling to allow the revenue raising portions of the bill to remain in place to be utilized outside the sector for deficit reduction.
According to the CBO, eliminating the Mandate would mean the government foregoes $27 bln in new revenues (derived from penalties paid by non-participants), but also lowers the deficit by $282 bln over the next decade due to the additional revenue raising provisions in the law. The Mandate was a key provision as the law required 30 million uninsured people to buy coverage or face fines. Insurance companies were the major beneficiaries of this massive new group of clients and therefore they provided reduced costs through broader coverage for their services which generated savings for the law. Without the Individual Mandate, the insurance industry will need to be redesigned as the increased costs associated with keeping the rest of PPACA will negatively impact earnings. As an example, insurance companies are already stating that they will adhere to portions of the law even if it’s ruled unconstitutional to remain competitive within the industry as clients now demand the new benefits. This increases their costs without the “benefit” of getting a large amount of new clients.
2. Constitutional- SCOTUS rules the entire law is constitutional.
Implications – PPACA remains in place and it’s business-as-usual with the planned implementation of the law.
In this case, it would be as if the Supreme Court never heard the case and all implementation procedures and phase-ins continue as currently planned. Any federal budget calculations based on ‘current law’ will remain, and stocks continue under the earnings expectations built-up before the SCOTUS review injected uncertainty. Still we expect regulatory “drift” continues with deadlines missed and timelines extended similar to the implementation of Dodd-Frank. Also, there is always the possibility of re-legislating the PPACA.
As a percentage of GDP, US health care spending will rise from 17.9 percent in 2011 to 20 percent by 2021 as people who are now uninsured can begin obtaining government-subsidized coverage. According to researchers at the Centers for Medicare and Medicaid Services, health care spending would actually be smaller by 0.1% if PPACA was not enacted. This is in direct opposition to one of the major reasons the law was supported and passed. It underscores the need for additional changes to the law should it be upheld. Also, there will still be a need for legislation to fill the hole in payments to doctors known as the “Doc-fix,” due to the Sustainable Growth Rate (SGR). In February, Congress overrode the SGR and promised to cover Medicare reimbursements until year-end, at which point the “Doc-fix” becomes part of the “Fiscal Cliff”. The cost of renewing the “Doc-fix” is estimated to be $30 billion for one year and $270 billion over a decade. This component will not only add to the overall US budget deficit, but also can cause a 30 percent decrease in physician’s fees and materially affect the quantity of Medicare services.
3. Unconstitutional- The Court rules the entire law is unconstitutional.
Implications – Congress and the health care industry return to a 2009, pre-PPACA policy baseline.
The premiere domestic policy action of Obama administration is rendered moot and will reflect negatively on his reelection campaign. This scenario creates a new uncertainty for the entire health care sector and will likely increase share price volatility as politicians flesh out what parts of the law will be kept and how those will be paid for by the industry. And with national elections in November, President Obama’s plan for national health care policy will certainly differ significantly from a plan by Republican presidential candidate Mitt Romney.
In a recent speech, Romney laid out his vision for a new health care system which he describes as being more market driven. According to Bloomberg BusinessWeek, Romney promised to help maintain coverage for those with pre-existing health conditions and expand tax breaks to individuals wishing to purchase health insurance directly, instead of through their employer. “As president, Romney’s plan to cover the nation’s uninsured involves sending federal Medicaid dollars directly to states, allowing each state government to address the situation in its own way.” While more details are needed, this is clearly a shift away from the Massachusetts law that Romney signed as governor.
The impact of the elections in this scenario is not limited to the Presidential race. Congress is acutely attuned to the political implications of a health care restart. In fact, anticipating the Supreme Court ruling, House Republicans are scheduling a week long debate on health care that will likely focus on how to reduce costs for small businesses.
Market implications
While we are not experts on constitutional law, the most probable outcome remains to have the Supreme Court rule against only the Individual Mandate. To our limited knowledge, there is no component of the Constitution that allows Congress to mandate the purchase of a specific good. If the Individual Mandate was a tax, there would be no basis for a challenge, an issue the Supreme Court considered directly. Of course, Congress would not have likely passed the law in the first place if it included a headline tax hike. Clearly, eliminating the Mandate will create uncertainty as to what national health care policy ultimately looks like. And the uncertainty will not likely be resolved until after the elections and the new Congress is seated.
As stated above, the entire health care sector will be impacted by SCOTUS’ decision, just as the entire health care sector was impacted by PPACA. The initial negative market reaction will likely be centered on insurance companies, generic pharmaceuticals, and hospitals as they were generally seen as the biggest beneficiaries of the law. On the flipside, medical technology, managed care/HMOs and brand name pharmaceuticals were seen as negatively impacted by PPACA, and therefore will likely see a positive impact to their share prices. Caution is needed as these winners and losers may change as the public policy changes due to the new direction Congress takes for health care in the new term.
Health care spending is the major driver of long term spending for the federal government of the United States. Therefore, any new direction will be focused on reducing the cost of health care for the country, while attempting to place the burden of those cost reductions on to those that supply health care services and not to those that receive health care services.
Andrew Busch is a global currency and public policy strategist for BMO Capital Markets. This blog was republished with permission from BMO Financial Group.
