An adult son of one of the Redwood Investments portfolio team members recently had surgery to repair a torn shoulder labrum. Before being discharged, the surgeon required the patient to wear a sling to protect the shoulder. Thirty days later when the medical bills arrived and the sling could be removed, there was a $200 charge for the sling. A quick check on Amazon.com found the identical sling available for $40.92 with free 2-day shipping for Prime members. A call to the health care insurance company for an explanation about the premium cost of the sling was met with a recommendation to call the surgeon’s office. The surgeon’s office had no idea about the cost of the sling. This very small microcosm of the health care system highlights the challenges consumers face managing costs in era of rising deductibles, co-pays and insurance premiums. Is there any other product or service in the US economy where the mark-ups and costs are so high and the consumer’s ability to manage costs are so low? Absolutely not! This is not an argument for or against the Affordable Care Act but rather a forecast that as consumers are required to pay more of their health care costs, they will demand more choices, pricing transparency and force more market driven pricing.
Increasing transparency of market based information has and continues to be a dominant and unstoppable wave that we see pervading all industries with health care products and services eventually not being immune. Comparison shopping and consumer reviews are hallmarks of today’s shopping experience with a quick scan of the Internet providing valuable insights for major purchases.
Item & Sample of Easily Accessible Information
New Car. Recent purchase prices in nearby zip codes, dealer experiences and years of repair data
Vacation. Comparison of airline, hotel and rental prices, hotel reviews, and recommended day trips
College. Admission requirements, tuition, books & fees, graduation rates and job placement rate comparisons
In stark contrast, there is little easily accessible information in health care – from health insurance to any non-OTC purchase. What is the cost, quality/outcome or patient experience for a surgery, procedure or drug prescription? Health care costs represent almost 17% of the US economy yet the consumer has almost no ability to understand and control costs. Transparency just does not exist – we encourage you to try. Call your doctor and/or insurance company and ask for specific costs for a procedure, hospital stay or medical device (such as a sling).
Compounding the transparency challenge is the increasing percentage of health care costs being shifted to consumers. Over the past decade, High Deductible Health Plans (HDHP), coverage that mandates the consumer to pay at least the first $1,300 for an individual or $2,600 for a family, have gone from 4% to 25% percent of the market. In 2015, 46% of workers had at least a $1,000 deductible, up from 10% in 2006 but the average deductible for an individual in a HDHP was $2,196. With this shift to HDHPs, deductible costs for consumers increased 67% over the past five years. Moreover, these plans are projected to continue to gain share. Not only are consumers paying a larger part of the health care expenditures, health insurance premiums are rising more rapidly than inflation – an average 40% jump over the past five years for PPOs and 38% for HMOs. Overall, annual out-of-pocket costs for consumers have skyrocketed 230% over the past decade – more than 10x the rate of inflation. Consumers are feeling more pressure than ever before, which is evident at hospitals, which reported a 30% jump in bad debts from patients with insurance in 2015.
We anticipate that the changing consumer payment landscape will materially alter the investing opportunities over the next five years. Health care investing will increasingly be an individual stock decision, with winning investments including companies that can address the challenges facing consumers. For those companies most challenged by the evolving environment, the impact is already evident in decelerating and disappointing revenue growth trends.
Unclear Business Models. Throughout the global economy consumers are gathering more knowledge and shifting purchasing to the products and services offering the best value. Pharmacy Benefit Managers (PBMs) represent the antithesis of this with a business model that is the opposite of transparency. While PBMs have historically helped manage drug costs by filling prescriptions with less expensive generic drugs, their pricing models are secretive and impossible for customers or investors to disaggregate. Express Scripts (ESRX) is a company whose growth could be challenged because its pricing methodology is opaque.
Revenue Growth from Price Increases. Companies driving growth through price will be at risk for disappointments as market forces limit price increases. Historically, branded prescription drug companies have driven significant growth from raising prices. In 2015, the prices for branded drug that treat the symptoms of menopause rose nearly 34%, gout drugs soared 33% and for erectile dysfunction a 20% increase with an overall 15% price jump according to health care analytics firm Truveris. As a result, drugs prices have become the easiest fodder for politicians and activists because of the high absolute costs and the increasing percentage that consumers are responsible to pay. Already several drug companies have announced plans to limit annual prices increases to less <10%. However, this 5x rate of inflation will still draw unwanted attention. The Interfaith Center on Corporate Responsibility (ICCR), which represents 300 institutional investors, has filed shareholder proposals with 11 drug companies asking for the publishing of historical price increases. ICCR is concerned that drug companies will see damaged corporate reputations and cause increased legislation targeting the companies. Moreover, regardless of any changes to the Affordable Care Act, we anticipate a rising level of regulatory limits will pressure drug companies. Amgen (AMGN) is a company that has generated a significant portion of its revenue growth through price increases as opposed to volume growth, which could be unsustainable in the future.
Consumers. Unfortunately, we do not see a solution that will solve the problems for consumers in the near-to-intermediate term. The consumer will continue to be responsible for a growing percentage of their health care expenses.
Retail Spending. If consumers spend more on health care, that reduces spending on other items. Discretionary spending could be an area that experiences disappointing sales. Could this already be happening today? Retailers and restaurants have been reporting slowing sales that have generally been below consensus expectations over the past several years. While the weakness has been attributed to the slow economic growth and eCommerce taking share from traditional retailers, the impact from increasing health care costs on the consumer may also be playing a role.
Products that Save Money and Improve Outcomes. Innovation is almost always a winning business model. Companies that develop new products and improve outcomes while reducing costs will most likely gain market share and garner a disproportionate share of profits. An example of a potential winner is Abiomed (ABMD), which recently developed and received approval for Impella. This product is designed for temporary hemodynamic support and has started to displace to the intra-aortic balloon pump (IABP) as the standard of care because Impella demonstrates reduced inpatient days, readmissions and major adverse coronary events (MACE).As important, Impella reduces overall costs by 30% - 40% compared to traditional treatment.
Services that Reduce Costs and Fraud. The health care bureaucracy has significant issues from years of convoluted rules and regulations. The RAND corporation estimated that fraud by itself annually adds 10% to overall Medicare and Medicaid costs. Companies that untangle the clutter and create more efficient systems could have better than expected growth trends. A company that appears to be capitalizing on this trend is AMN Services (AMN), which provides nursing and physician staffing for health care facilities.
Transparency. Companies that can communicate their business model and increase transparency for consumers should be better positioned for success in the health care industry. The market is in the early stages of adapting to this requirement. VCA Inc. (WOOF), which delivers veterinary services through its hospitals, clinics and laboratories, seems to have created a transparent health care model that human patients would appreciate. The costs for all procedures are explained to pet owners before any health care is provided. This transparency has been one of the factors enabling WOOF to achieve the leading market share position.