The Patient Protection and Affordable Care Act (PPACA), also dubbed national health care reform, was signed into law over a year ago. The act, which has been praised and criticized by a variety of constituents, has implications for many parts of the medical services sector. Though there is still a lot of uncertainty surrounding this piece of legislation, a few laws have already been implemented and will have a significant effect on the performance of healthcare companies in 2011. Other measures will be put into place over the next few years that will also shift the dynamics of the medical industry.
One of the law’s major features involves the regulation of the medical loss ratio, which applies to benefit providers such as WellPoint (WLP), Coventry Health (CVH), UnitedHealth (UNH), Aetna (AET) and other companies that specialize in health plans. The medical loss ratio is defined as the ratio of benefit claims (expenses paid by the company for care received by its customers) to premiums earned (the monthly payments by customers for coverage). A high ratio indicates that the company is returning most of its premiums to customer healthcare, while a low ratio indicates a high level of profitability. Medical loss ratios vary from company to company.
The new legislation forces insurance companies to maintain a medical loss ratio of 80% of premiums on small commercial customers and 85% of premiums on large businesses. If insurers do not meet these thresholds, they will be forced to pay rebates to their customers. Benefits manager Coventry Health had a medical loss ratio of 79.4% in 2010, below both commercial thresholds. As a result, Coventry will be forced to reduce profits by as much as $0.55 to $0.85 a share in 2011. WellPoint and Aetna’s ratios were within the small and large commercial threshold, so the effects are likely to be less severe. However, there is likely to be some upward impact on the ratios this year, and, thus, downward pressure on margins (all other factors held constant). Another implemented law includes guaranteed insurance for minors with pre-existing conditions and the inability of insurers to drop sick patients. All of the major benefits providers will be hurt by these measures, as they will be forced to take on riskier and costlier members.
Measures that are not yet in effect will also likely reduce profitability for benefits providers. In 2014, the act imposes mandatory health care exchanges, which will drive down the price of premiums. Insurance companies will also have to extend benefits to everyone with pre-existing conditions. These companies may also face higher tax rates based on their market share.
While it is evident that benefits providers will bear the greatest burden from the PPACA, one portion of the sector that may benefit is hospital operators, such as LifePoint (LPNT), Community Health (CYH), and Tenet Healthcare (THC). Hospitals have historically absorbed the brunt of uninsured patients. They are forced to provide for these customers with a low probability of being compensated. This can be seen in the allowance for doubtful accounts. For LifePoint, the reserve was $459.8 million (54% of gross receivables) in 2010 and Community Health had a doubtful accounts balance of over $1.6 billion (48% of gross receivables) last year. These companies should feel some relief from healthcare legislation, as some of the cost of formerly risky patients will be absorbed by insurance providers. At the same time, a greater number of insured patients should result in more effective collection rates and more timely payments. There are other issues that hospitals will likely have to contend with, namely declining reimbursement rates for Medicare. However, the impact of this part of the legislation could boost the profitability of hospital operators.
There have been efforts to eliminate the act. The House of Representatives voted to repeal the act in January. However, this motion was blocked by the Senate and any further efforts would probably be vetoed by the President. The Supreme Court may review the constitutionality of the act sometime within the next year. However, for the time being, it appears that financial implications on the healthcare management sector are likely here to stay.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.