America’s health-care system appears unaffordable and unsustainable. Political pressure is mounting, and recent mergers show that the industry itself knows the status quo can’t last. But until real change happens, perhaps through reformed payment models, the US economy will likely pay the price.
US health-care costs are spinning out of control; doctors, hospitals and drug companies will all need to change how they do business
Political pressure to fix the health-care system is rising; American voters want better access, lower costs and better results
If the health-care sector doesn’t embrace reform through increased transparency and payment models based on delivering value, not charging fees, price controls may be inevitable – particularly in the pharmaceutical industry
With the 2020 US presidential election season effectively underway, one topic getting attention from nearly every candidate is the troubled US health-care system. We believe growing political scrutiny could hurt global health-care stocks that rely on the profitable US market, making this traditionally defensive sector less immune to the business cycle. The pharmaceutical industry in particular seems destined to feel the negative effects of mounting political pressure. Here are our views on the key issues at stake.
Rising overall health-care costs
The US health-care system is the world’s largest and most profitable – yet it is also the most expensive and arguably the least effective in terms of life expectancy, cancer mortality and other key metrics.
According to the OECD, the United States has around 325 million citizens and spends about USD 3.1 trillion per year on health care. In comparison, the rest of the OECD has approximately three times as many people – 938 million – but spends about USD 3.7 trillion on health care. This amounts to approximately 17.1% of GDP in the US – double the amount (8.5%) in the rest of the OECD.
The US spends twice as much on health care as other OECD countries
Health care as % of GDP
Source: OECD (Organisation for Economic Co-operation and Development). Data as at 2017.
There are many culprits for high and rising US health-care costs. Prescription drugs can be prohibitively expensive, particularly for the uninsured. Many private hospitals seek to boost their bottom lines by encouraging doctors to do as many tests and procedures as possible. And most doctors begin their practices with heavy student-debt burdens only to be faced with steadily rising malpractice insurance premiums – both of which can lead to higher fees for patients.
Under-regulated pharmaceutical pricing
With health-care costs soaring on many fronts, it seems inevitable that some sort of price controls will have to be enacted – particularly in the pharmaceutical industry.
The pharma industry uses high prices to justify extensive research and development, but successful new drugs are hard to come by. Moreover, many copycat drugs cost the same as the originals even though they don’t require the same R&D.
Despite the fact that drug-manufacturing costs fall as efficiency improves, many manufacturers increase their prices over time – frequently for no other reason than because their competitors do.
Drug prices overall keep rising even though expiring patents for large, brand-name drugs can help generic equivalents cost up to 90% less, according to the IMS Institute.
The governmental agency that provides prescription-drug coverage for the elderly and disabled (via Medicare) and low-income citizens (via Medicaid) is forbidden by law from negotiating with the pharmaceutical industry for better drug prices in most instances.
Pharmacy benefit managers (PBMs) – third-party firms that administer prescription drug programmes for private and public health plans – can seek large discounts from drug companies, yet concerns are rising that PBMs don’t pass these savings to consumers.
There are solutions being proposed to control drug prices and allow more competition in the pharmaceutical industry – but they would likely reduce profit margins.
Impose new pricing structures that would allow new drugs only to fall in price, cap existing drug prices and require use of generic drugs.
Encourage the Food and Drug Administration to approve drugs that boost competition and lower prices, and fix guidelines for drug research and promotion to curb excessive costs and usage.
Encourage payment reform – perhaps as part of a larger move away from “fee-for-service” towards “pay-for-performance” models (also known as “value-based payment”). This could discourage wasteful spending by hospitals that perform unnecessary services.
Encourage digital “e-tailers” with more flexible pharmacy services to disrupt established players in the prescription-drug pipeline.
Political battles and compromises
Public-opinion polls indicate that proposals for cheaper, better health care are popular among voters. Many Democratic presidential candidates want to expand the 2010 Affordable Care Act, known as Obamacare, which aims to make health insurance more ubiquitous and affordable but has its flaws. Some are proposing universal “Medicare for all” coverage, which could shift USD 3 trillion per year in health-care spending from the private sector to the government, but it is facing stiff political resistance. For their part, most Republicans and President Donald Trump want to scrap Obamacare completely, not expand coverage. In its place, some are hoping to implement Medicare price reductions and efficiency enhancements, but there is no consensus on who will pay for those proposals.
Although the current political environment makes it difficult to enact large-scale change, there are some areas of agreement between President Donald Trump and Congressional lawmakers from both parties – though these are arguably window-dressing that won’t fix the real problems:
There is bipartisan support to curb surprise medical bills, which can even hit insured patients when their hospital visits are unexpectedly billed as out-of-network expenses.
Regulators have proposed that consumers must be given the discounts that PBMs receive from drug makers.
Democrats and some Republicans want to guarantee insurance coverage for people with pre-existing medical conditions – a popular component of Obamacare.
With the US health-care sector ensuring that every layer makes a decent profit nearly every step of the way, the only real loser seems to be the patients. Despite being first in costs, the US ranks last among high-income nations in measures of health-care access, efficiency and outcomes, according to the Commonwealth Fund. Yet while there seems to be a growing realisation that something must give, real change would have repercussions for companies and investors.
Comprehensive health-care reform could mean significant additional government spending and a loss of jobs in the insurance and health-provider sectors.
Recent mega-mergers between large US health-care insurers, PBMs and pharmaceutical chains show that the industry realises the status quo is not sustainable. These mergers should result in better outcomes by, for example, emphasising lower-cost clinic visits and pharmaceutical treatments up front instead of expensive hospitalisations down the road.
A shift to a Medicare-for-all model could reduce innovation; the medical-technology sector in particular may be hurt in this scenario.
Mounting political pressure has already caused trouble for US health-care stocks, as the accompanying chart shows.
Unless and until real change is effected, we think the US economy will pay the price as health-care costs reduce other areas of consumer spending.
From our perspective, the biggest issue with the current US health-care system is not just that it is unaffordable, but unsustainable. We think investors should take note of the rising political will to fix these issues, which could spell trouble for a sector that has traditionally been a steady defensive performer. Investors should position themselves accordingly for coming changes by actively seeking out the winners – and aiming to avoid the losers – in the battle to reform health care in America.
Health-care stock performance has suffered
S&P 500 Health Care Sector Index performance (1 year as at April 2019)
Source: Bloomberg. Data as at 29 April 2019.
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Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
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