As the collapse of the housing market and the related financial crisis have continued to unfold, the numbers of those struggling to meet mortgage payments, newly unemployed, or simply in financial distress due to lower home equity values or stock market values have continued to grow. These forces have affected consumers' economic well-being, and one by-product of this economic weakness has been a pullback in consumers' use of non-essential health care services.
It has also hurt their ability to pay for health care services they do incur during these times, resulting in increases in the incidence of health care-related bad debt. While in past periods of economic weakness health care was fairly resistant to downturns, given the increased influence of managed care and higher amount of cost sharing in the form of co-pays and deductibles, this appears to be less the case now. These factors have begun to ripple through the health care system, impacting hospital, medical equipment, and managed health care companies.
Health Care Facilities
The housing crisis is affecting the health care facilities in two ways: 1) through declines in elective procedures such as hip and knee replacements, as well as screening procedures such as colonoscopies. (Though these procedures are, in most cases, necessary, many patients put them off when they feel financially constrained.), and 2) via an increase in the numbers of patients whose economic situations have worsened to the point they can no longer meet medical co-pays or deductibles.
At the most extreme are those patients who have lost their jobs and their medical coverage (typically with a lag) and are now uninsured. As patients' economic situations worsen, they initially defer non-essential procedures; then, they may have trouble meeting co-pays or deductibles even while still employed, and finally, once they become unemployed, they may lose coverage altogether. Some may maintain coverage for 18 months at a substantially higher cost, if they can afford to pay for it under what is known as COBRA.
As the current financial crisis continues, we believe these problems and their impacts on health care facilities have only worsened. For example, of the five publicly traded hospitals Standard & Poor's Equity Research follows, three of those reported declines in admissions in the latest quarter. In addition, after having apparently begun to stabilize in the first half of 2008, reported bad debt trends for the publicly traded hospitals have recently begun to rise again. Lastly, even many of those with insurance are feeling the strain of higher medical costs. A recent study by the Center for Studying Health System Change found that approximately 20% of those surveyed report having trouble meeting their medical bills. This has forced health care facilities to cut back on services and expansions, reduce capital budgets and purchases, and, in the worst-case scenario, shutter facilities. Given the continued rising levels of unemployment, we would only expect these forces to be amplified into 2009.
In this economy, we favor those companies with less exposure to bad debt issues and those that deliver care that is less discretionary by nature, such as Psychiatric Solutions (PSYS); AmSurg (AMSG), which has less exposure to elective procedures than many of its peers, in our view; and Sun Healthcare Group (SUNH).
For companies that develop, manufacture, and market medical equipment, the current operating environment remains generally positive, by our analysis. Through the September 2008 quarter, S&P Equity Research continued to see evidence of strong global demand in categories such as oncology equipment, surgical tools and equipment, selected reconstructive orthopedic implants, and even robotic surgical machinery.
However, we are now seeing a rapid decline in procedures such as laser vision correction and cosmetic surgeries, which are elective and typically not covered by insurance. There are mounting fears that the slowdown will spread to areas not typically considered discretionary.
In our opinion, there are two principal areas of concern for the medical equipment companies as we head into 2009. The first revolves around the general state of global economies, which we think will result in a slowdown in medical procedures, and, we believe, an across-the-board reduction in order backlogs and unit pricing. We are increasingly concerned about the impact of rising levels of unemployment in both the United States and Europe, and the possibility of a significant increase in the number of uninsured Americans. The second area of concern is rising rates on variable interest rate-debt, a phenomenon we think is resulting in some deferred purchasing decisions among the hospital and clinic customer base, particularly for expensive high-end equipment. This is having a meaningful impact not only on demand from the for-profit hospital chains, but also from non-profits that rely on funding through the sale of municipal debt to finance their capital expenditure budgets.
In this environment, we favor Becton, Dickinson (BDX); Stryker (SYK); Covidien (COV); and C.R. Bard (BCR).
Managed Health Care
Managed care organizations (MCOs) are also being impacted by the current economic weakness in a number of ways. The rising unemployment rate has led to membership losses among large commercial accounts, while several individual and small- and mid-sized, employer-based commercial accounts have dropped coverage entirely, due to the financial strains on the business and/or their inability to pass along the cost of increases to employees or customers. One large MCO we see poised to realize net membership gains in 2009, however, is Aetna. In addition, all of the MCOs have been realizing a rise in their medical loss-ratios (medical costs as a percentage of premiums) and have almost universally pointed to the increase in hospital unit costs and/or hospital utilization for both in-patient and out-patient care.
Pharmacy benefit managers (PBMs), including Express Scripts (ESRX) and Medco Health Solutions (MHS), and drug distributors, including AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK), have noticed a modest decline in volume growth as consumers make fewer trips to the doctor and decrease their pharmaceutical consumption to save money. However, we see them benefiting from consumers increasing their use of generic drugs, which are less costly but are more profitable for the distributors and PBMs than branded drugs.