We know what the health care reform legislation due today for a vote in the Senate Finance Committee will cost: $829 billion over ten years.
We know that it will extend coverage to 94% of all Americans, up from 83% now.
And, thanks to the blessings of the Congressional Budget Office we even know that it will pass that committee. And, startlingly for those of us who winced through the August town hall meetings that roasted members of Congress, we even know that something like the committee bill, or stronger, is going to pass Congress.
What you and I as investors now want to know is what stocks are going to make money from health care reform legislation. I think the best way to answer that question is to apply the economics of “externalities” that I explained in my October 6 post https://jubakpicks.com/2009/10/06/capitalism-could-still-get-a-stem-to-stern-overhaul-to-keep-score-in-the-revolution-track-something-economists-call-externalities/
Hope you didn’t think I’d spent all those words building a tool that I wasn’t going to use for stock picking.
The answers are surprising.
Well, at least they were to me after reading all the conventional wisdom on picking winners and losers in the sector.
Let’s start with what we’re reasonably sure any bill is going to do.
The report on Wednesday October 7 from the Congressional Budget Office (CBO) pretty much assured that the Senate Finance Committee would approve the bill cobbled together by Montana Senator Max Baucus and that something like that bill—or something even stronger—would pass the full Senate and the House of Representatives by the end of the year.
The argument against the bill that most resonated with voters, if you believe the polls, was that it was so expensive that the country couldn’t afford it. Republican Senators opposed to the bill—which for sure meant every Republican Senator not from Maine—had been so sure that the CBO would say that this bill would add to the deficit that they had labeled the budget arm of Congress an honest scorekeeper.
And why not? The CBO had scorched the bill that emerged from the Senate Health, Education, Labor, and Pensions Committee by scoring it a shocking $597 billion in the red over 10 years. The bill drawn u by the House did better but not enough better: That one, the CBO said, would have added $239 billion in deficits.
So when the CBO said that the $829 billion bill would actually reduce the budget deficit by $81 billion over the next ten years, the Republican “It costs too much” strategy was left in tatters.
What would the Baucus bill do? In outline it’s very simple: It would make sure that 94% of the populace has health insurance. That’s an extra 29 million Americans. But it’s not everyone. According to the CBO count, 25 million people who live in the United States, including 8 million illegal immigrants, still wouldn’t have health insurance.
Remember how in my piece on externalities I talked about the government’s role in deciding who pays and who profits. Well, this bill would shift costs and profits around like crazy.
Or least that’s what it intends to do. The CBO’s math assumes that intentions are realities. Investors do that at their peril.
On paper, a whole lot of money would go to the insurance industry and the health care industries. The government would spend $461 billion over ten years to give tax credits to people so they could afford insurance. It would also spend $345 billion to expand Medicaid insurance to cover more of the poor.
But the bill, still on paper mind you, also takes away—sometimes from the same groups that it handed profits to just a subsection before. So the bill proposes wringing $404 billion in waste out of Medicare and other government insurance programs. That means the very drug companies, hospitals, doctors, and even in some cases insurance companies that benefit from having 29 million more Americans with health insurance. Another $201 billion comes from taxes on what are being called Cadillac health insurance policies. (Isn’t it nice that Detroit is still the symbol of luxury somewhere? The fight over what’s a Cadillac and what’s a Taurus is going to be especially vicious.)
Billions more will come from a grab bag of fees on insurance companies, medical device-makers, drug companies, and a change in the treatment of medical expenditures come tax time.
The battle over exactly how these pluses and minuses are distributed is going to engage Washington’s best lobbyists for thousands of very expensive billable hours. Already the hospital industry has said that the bill doesn’t cover enough of the currently uninsured to justify the deal it made to give us $155 billion in government payments.
Expect the haggling to reach epic proportions.
But “externality economics” tells us to look at what’s not on the table.
The external costs of the American diet aren’t on the table, for example.
U.S. agribusiness makes good profits from feeding people around the world. Fair enough. I’m all in favor of feeding people and I think the farmers and processors who do the hard work deserve a profit. (And certainly farmers, if we’re talking about family farmers, don’t make much in the way of profit.)
But U.S. agribusiness racks up huge external costs. Our heavy plowing often of margin areas amounts to soil mining in many parts of the farm belt. Our high rate of application of fertilizers, herbicides, and pesticides produces run off that pollutes everything from Chesapeake Bay to our drinking water. (Ever heard of atrazine, a common weed killer, found in 40% of the ground water and 75% of the surface water in agricultural areas? You will. The Environmental Protection Agency has finally decided to study the health effects of this herbicide after new research showed there might disrupt male sexual development. The chemical has been in use since 1958.)
Producing heavily refined foods that are high in fats and sugars also results in external costs.
Adult-onset diabetes (Type II) has a genetic and a dietary component, according to the American Diabetes Association. If you have a genetic predisposition to diabetes eating what the association calls a Western diet is a great way to trigger it.
No wonder, then, that diabetes is one of the fastest growing diseases in the United States. From 1996 to 2003 the number of adults with diabetes climbed to 13.7 million from 9.9 million, according to the Health and Human Services Agency for Healthcare Research and Quality.
In those same years the annual cost of treating a person with diabetes soared to $1,714 from $1,299. Do the math: The bill for this disease was $23.5 billion annually in 2003 up from $12.9 billion annually in 1996.
That’s an increase big enough to eat up the entire $81 billion in savings in the CBO calculations over 10 years.
And the problem has gotten worse since 2003. The American Diabetes Association now estimates that there are 17.9 million people in the United States with diagnosed diabetes. (Another 5.7 million, the association says, are undiagnosed.)
I don’t want to harp on the health effects of the U.S. diet or of our heavy use to agriculture chemicals. These are just two examples of the massive externalities in what we can call health care for lack of a better word.
You can, I’m sure, come up with other examples.
I haven’t mentioned the biggest one, aging. It’s a good thing that we’re living longer. I’m personally very much in favor of it. If there were an election, I’d try to stuff the ballot box in favor of living longer.
But there’s a huge difference in cost between living a longer healthy life and simply living longer. The second imposes huge costs on the health care system that are a result of decisions that we made decades earlier. We never cost out those decisions. There’s no economic method for doing so. Yet deciding to smoke or drink or not to exercise or to eat more steaks and less broccoli all impose end of life costs.
I bring this all up not to lecture you on the need to eat your vegetables or on the evils of corn syrup or pesticides.
I merely want to point out that these societal decisions impose huge external costs that have to be paid by someone. The bills before Congress shift existing, well measured costs around, but they don’t even begin to address the need to make some of these externalities into the day to day or year to year cost of doing business or living.
And since these bills don’t, they’re doomed to long run failure. The externalities that we can already see—and ones that aren’t on the radar screen now—are going to eat these bills and their estimates of costs and cost-savings alive.
So what does this mean for you as an investor? Three things, I think.
First, these bills set up a cost containment strategy that will fail in the not so long run. The process of failing won’t be quick or pretty. The government will keep attempting to keep pace with the ever-increasing bill for these externalities by putting more pressure on hospitals and doctors and drug companies and device makers. Margins in these industries, under pressure for a decade, are going to face even more pressure in the years ahead. If you buy these stocks on the health care bump, don’t fall asleep with them in your portfolio.
Second, companies that are in the business of treating patients created by these externalities will face the same cost cutting pressures but the epidemic of disease in these areas will keep profits growing faster than bureaucrats and politicians can cut costs.
Third, companies that can deliver simple and easily understood cost cutting products or strategies will prosper during this battle. They will be seen as the good guys by anybody trying to cut a cost.
Externality economics pushes me toward stocks such as generics giant Teva Pharmaceuticals (TEVA), diabetes drug and hormone developer Novo Nordisk (NONOF), low-cost pharmacy and clinic operator CVSCaremark (CVS), physician-to-patient information provider WebMD Health (WBMD), and orthopedic replacement parts maker Zimmer Holdings (ZMH)
I’m going to add Teva Pharmaceuticals to Jubak’s Picks with this column. I’ll have a full write up of the logic to that pick and my target price in a post in a few hours.