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Make Sure You Avoid Healthcare Stocks

Make Sure You Avoid Healthcare Stocks

Buffett: Healthcare Costs are an Angry Tapeworm in the Belly of the US Economy

JP Morgan, Berkshire Hathaway and Amazon announced a joint agreement to develop a healthcare alternative on January 31.

This is a BIG deal. Why?

Well first, these companies have a combined 1 million workers. Second, other companies will likely follow suit and join.

Really what’s going on is are businesses are stepping in to fix what politicians won’t.

The history of American healthcare is a history of shared expense and employer supported payments.

Hospitals emerged in the early part of the 20th century and they were business failures from the start.

They have high fixed costs (buildings, equipment) and high operating costs (physicians, nurses, operating staff). That turns into a positive: a large barrier to entry reduces competition. Also, they have a massive base of repeat customers.

The first big development came in the 1920s with the concept of prepaid health care access. That was the start of Blue Cross. For hospitals, a guaranteed revenue stream reduced risk.

The second big development came in the 1950s when employers started to foot the healthcare bill.  

This required two things to come together.  

First was labor’s bargaining strength: after World War II there were fewer workers and stronger labor demand. Second, Washington made healthcare payments a fringe benefit that fell outside of wage definitions. Workers liked it because wages get taxed and healthcare coverage wouldn’t get taxed. Companies liked it because they pay matching taxes on wages, but the healthcare would be exempt.

But this is where things began to go horribly wrong.

This always happens when payments (costs) are spread across a large base: the payers purchasing power gets diluted.

See, the business model was originally like a co-op: members pre-paid for services and that enabled hospitals to thrive and provide services.  But the employer-supported plans created a system of massive greed:

  1. Pool of money surged: more participants contributing more dollars
  2. Buyers (employers) were not the consumers.
  3. Hidden prices: healthcare is probably the only industry where prices are hidden
  4. Guaranteed money

By inflating the guaranteed payment mechanism, the business model pivoted away from guaranteed money in order to stay alive and towards guaranteed money to charge maximum prices.

Hospitals Are Incentivized To Be Expensive

Start with the concept of nonprofits.  The most profitable businesses in America today are non-profit hospitals.

Non-profit means that hospitals can’t show a profit: they must spend all their revenues.  And they do: on executive pay and doctor pay and union pay.  This is why 60% of all hospitals are non-profits – so they can make massive profits and call it take-home pay.

Hospitals are basically local monopolies.  They charge whatever the market will bear.  The hospital system leverages that monopoly to always raise prices.

The customer market is fragmented: companies must negotiate one-on-one. They are doomed to fail.

Where else can you conceive of a system where the intermediaries – the payment system negotiators – are multi-billion dollar profit making companies?

The healthcare system is a runaway train.  healthcare costs go up because the system can raise prices and those higher costs are then spread out across hundreds of millions of payees. You and I may grip about paying another $100 a year. That’s tens of billions of dollars extra per year to line the pockets of the healthcare system.

A successful system would drive down the cost of providing healthcare.  A lot of treatments are routine.

Instead, the healthcare ecosystem actively resists any and all moves to lower costs of services and treatments that are essentially commoditized.  It took forever for nurse practitioners to be allowed to give shots and other routines treatments instead of the higher priced doctors.

Healthcare spending takes away from other forms of spending and the reality is that the cost of providing the service is much lower than the prices charged. This is enabled by (1) the evil of guaranteed and growing funding and (2) a lack of competition.  

In terms of scale and impact, healthcare is indeed an evil tapeworm that needs to be tamed. But how do we restore some balance?

The Amazon Move: Changing The Balance Of Power

There was an attempt to introduce collective bargaining into pricing. The U.S. government is a major purchaser of healthcare services – through the Veterans Administration, through the Defense Department, and through entitlements like Medicare and Medical.

The U.S. government represents tens of millions of users.  But when they attempted to introduce drug price negotiation, Big Pharma lined up lobbyists and successfully blocked the move.

Clearly politicians won’t make the necessary changes.

It’s An Amazon Retail Play

Look at it as another marketplace and one where Amazon does one thing well: creating a marketplace that eliminates the middle-merchants by connecting consumers closer to suppliers. The consequence is lower costs as the supply chain tightens, as competition emerges and as prices are more visible.

Backing the Amazon play is the one million strong base of angry customers who can’t be bought off.

That number will balloon as it gains traction.

Expect Walmart to jump in.

The goal is to reduce the pool of funds available to the healthcare system.

So who loses funds?

  • Healthcare facilities: mixed.  Hospitals are somewhat immune: while they are big abusers, they are also monopolies.  Perhaps they can be cut down to size if the new system rewards the cheaper HMOs and physicians outside of hospitals
  • Drug companies: This will be a bloodbath.  Epipens that enjoyed 10x price hikes?  Sorry, expect alternatives to emerge.
  • Insurance companies: Very exposed.  Ultimately they are playing a middleman role and Amazon is a middleman-killer.  They are glorified paper-pushers adding no value in a digital world.
  • Prescription management: this will get streamlined

There are two bottlenecks in the system which are lovingly maintained by incumbents.

The first is money. Insurance companies control the aggregation and disbursement.  

Hospitals and service providers play hide the price. Both of these will get beaten up because Amazon is all about price clarity.  They could probably develop and deliver a proprietary system for managing the funds, one that will be a lot better and cheaper than what’s out there costing billions.

The second bottleneck is prescriptions. A lot of money goes to drug companies.

Imagine being able to source your medicines as you would a book on Amazon.  Prices would collapse.  But there is an inherent risk – are suppliers delivering quality products?  That’s the same risk you take when buying anything off Amazon today.  But instead of a shirt that  might not fit, it’s drugs that don’t work.  Not good.  So some work is needed here.

KEY TAKEAWAY: Disinvest from Healthcare Stocks

There are no discernible winners at this time.  Oh, some companies will win, that’s for sure.  But it’s not clear which ones.  Amazon will be playing kingmaker and it has the capability to bring certain functionalities in-house.

Biotech and certain device & drug companies will be immune.

But the trend is to cut healthcare funding – which will make the market turn bearish.

It will take time.  The healthcare industry will put up a fight. Don’t expect them to take losing 1 million higher-income consumers lying down.

You don’t have to rush for the exits, but the writing is on the wall.


Andrew Zatlin

Editor of Moneyball Economics

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