Update On U.S. Affordable Care Act by Harlan Sonderling, ColumbiaManagement

  • The Affordable Care Act (ACA) has expanded insurance coverage, but will face more legal, logistical, and likely, economic, challenges. 
  • From the investor’s standpoint, the market responded to the law; ACA’s prelude and implementation has been a boon.
  • While the market will fluctuate, there remain attractive investments across the range of healthcare products and services.

The U.S. healthcare landscape has been dominated by political, regulatory and healthcare delivery changes associated with the Affordable Care Act (“ACA” or “Obamacare”). Now that the first year of the law’s implementation has passed, it is worthwhile to review its effects.

The ACA expanded insurance coverage in three basic ways. First, and most significantly, Affordable Care Act expanded Medicaid (federal/state funded and state-managed health insurance for the poor) eligibility from 100% to 138% of the Federal Poverty Level (FPL) and subsidized states which chose to expand eligibility further. Medicaid expansion will likely provide insurance for approximately half of the 48 million Americans who were uninsured when the law went into effect. Notably, Medicaid now covers more than 68 million Americans, over 20% of all Americans. Many states are shifting their Medicaid programs to managed care insurers that are generally paid fixed fees per enrollee. Second, the ACA provided federal subsidies for individuals and families with incomes up to 400% of the FPL to buy insurance on government-run health insurance exchanges. Finally, the ACA established various protections to help expand insurance coverage, such as mandating access for people with preexisting medical conditions and allowing adult children to remain covered under their parents’ insurance up to age 26.

When the ACA was passed, the Congressional Budget Office (CBO) forecast 32 million Americans would gain insurance coverage by 2017 under the law. Largely due to the decision by some states not to expand Medicaid coverage, this estimate has declined to the current estimate of about 25 million additional Americans. CBO estimated the cost of the ACA’s Medicaid expansion and insurance subsidies to be approximately one trillion dollars over 10 years. These funds will come predominantly from new taxes on higher-income individuals, taxes on the healthcare industry (insurers, pharmaceutical companies, medical device makers, etc.) and reduced reimbursement rates to various healthcare providers. The CBO “scores” a law, that is, makes revenue and cost projections, over a 10-year period. However, the taxes imposed by the ACA took effect two years ahead of the Medicaid expansion and insurance exchange subsidies in 2014. Over time, the ACA-related taxes may be insufficient to cover the costs of all subsidies. Should this occur, healthcare companies are easy targets politically for additional taxes and fees. Bear in mind also that the federal government will pay 100% of the costs of Medicaid expansion for three years and 90% for the next seven years, beyond which cost-sharing is uncertain. If the Affordable Care Act proves too costly, it is conceivable that the federal government will contribute less to states, which is one of the reasons that several states have elected not to expand Medicaid coverage.

The ACA will face more legal, logistical, and likely, economic, challenges. While some in the new Republican Congressional majority will seek to de-fund and/or repeal parts of or the entire ACA, the President will veto any such bill. Repeal would terminate coverage for many newly-insured individuals and would be highly disruptive and unpopular. The key legal challenge to the law is King vs. Burwell, for which the Supreme Court will hear arguments on March 4, 2015, with a decision likely by the end of June. The case pertains to health insurance exchange subsidies.  Affordable Care Act  says that these subsidies shall be provided only to people who obtain insurance through state-run exchanges; to date, sixteen states (CA, CO, CT, HI, ID, KY, MA, MD, MN, NM, NV, NY, OR, RI, VT, WA) and DC have established their own exchanges. The others use federally-run exchanges whose enrollees may technically not be eligible for subsidies. Whatever the court’s decision, the federal government will likely conceive creative solutions to transfer control of federally-run exchanges to states so as to keep the subsidies legal. As an aside, 2014 income taxes filed in 2015 will be the first time the Internal Revenue Service’s role in implementing the ACA will be apparent.

Many business and economic responses to the law remain uncertain. For example, more employers may eventually choose to drop insurance coverage, forcing employees to buy health insurance coverage through government-run exchanges or Medicaid. It is also likely that some employers will seek to limit their payrolls to fewer than 50 full-time employees and others to less than 30 hours weekly in order to avoid the ACA’s insurance mandate. Healthcare provider payments to doctors for Medicaid patients are set to decline by as much as 50% beginning in 2015 after being increased temporarily in 2013 and 2014 to encourage doctors to accept more Medicaid patients; this may create a provider shortage.

From the investor’s standpoint, the market responded to the law; Affordable Care Act’s prelude and implementation has been a boon. Increased insurance coverage has led to higher healthcare product and service volumes. Innovation and competition have flourished. Companies have fully absorbed the ACA-related taxes and fees, passing them on in price increases and/or deriving greater operating efficiencies. Focus on pay-for-performance and improved outcomes has become pervasive. Less uncertainty and a higher level of merger and other strategic activity has led to higher earnings multiples. While the market will fluctuate, there remain attractive investments across the range of healthcare products and services. Watch this space for more on therapeutic innovation and M&A.

Update On U.S. Affordable Care Act