The Triad Perspective

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The Emergency Room

If you're breathing, this topic is relevant. If you're not, well, you're not reading this, are you?
We all have a stake in healthcare, especially our own. If you run a small business, or even a large business, you've probably noticed that healthcare costs seem to go in one direction. Up.
The American healthcare system is vast, consuming almost 20% of all U.S. economic output, or over $3 trillion. That's $1 billion 3,000 times. Real money. Also, as the chart below plainly shows, we're an international outlier. In all other economies healthcare consumes far less economic output:

Why do we stick out like a, well, sore thumb?
We have largely a private-pay, fee-for-service system, while many countries have some form of nationalized, one size fits all, government-run healthcare systems. Many U.S. workers have their premiums paid by employers--or government via Medicare and Medicaid--and can't really compare prices, shop around and negotiate, as in most of other areas of economic life.
Why do other parties pay for your healthcare? Employers got into the health insurance payment game in a big way back in World War II, when Uncle Sam froze worker wages to control wartime inflation, but companies were permitted to pay for employee healthcare to offset the lack of raises. Funny how a policy designed solely for a specific period over seven decades ago, is still going strong!
Government ramped up healthcare spending in the 1960's when Lyndon Johnson's "Great Society" push brought Medicare and Medicaid coverage to life. These seemingly entrenched systems of "third party" payers mean you and I don't always know or care what healthcare costs. Not really a good system for managing costs.

Medical innovation also raises demand, as many new therapies are developed in the U.S. and are often covered by insurance. And let's not forget our health. Or lack thereof. We smoke, eat fast food, drink alcohol, take drugs, and don't get much exercise. Not you, of course. Other people.
A basic human desire also puts upward pressure on spending--longevity. Who doesn't want to live until age 120? Actually, check with me when I'm 100, and I'll let you know. And we also desire to live in perfect health until we take our last breath. A new cancer drug? Give it to me. A new heart procedure, or new hip and knee? I'll take those as well. Meanwhile, we usually expect that someone else is going to pay the bill. Employers, government, that sort of payer. But guess what? We end up paying. There is no free lunch. Whether it's workers, consumers or taxpayers, we all pay.
Companies often seek to raise customer prices or reduce wage costs to offset rising medical costs. And government? You know how government pays for things. Every year through your involuntary donations. Also known as taxes. Or borrowing. That's how. Having these payers make the payments has been a big part of the problem. They're not as price-sensitive, since they can pass the costs on to you and me, directly or indirectly.
As investors, we'll watch and observe how this plays out. Here's how the pie is now divvied up among the major healthcare spending areas:


If I'm looking to make a dent in the size of this pie, as Willie Sutton remarked about why he robbed banks: "because that's where the money is", it's easy to see where the bulk of spending occurs. Hospitals and doctors combine for almost 50%, while drugs kick in another 10% or so.  I've long thought that this is where you'll have to find the big savings. 
The other areas just aren't significant enough.  Even the insurance companies, much maligned for their price increases, are really just a middleman taking around 6-7% of the healthcare pie.
Hospitals have long feasted on healthcare payment systems.  We think it's wise to avoid this area, particularly expensive in-patient services.  Outpatient is where the action is, with much lower costs, speedier procedures and often faster recovery times.
Doctors are also under pressure, and we'd suggest treading carefully in this investment area.  The trend is toward nurses and physician assistants assuming more responsibility at the expense of doctors, and the family doctor playing a larger role than high-priced specialists.
Pharmaceuticals are tougher to handicap.  Clearly some drug prices are wildly excessive, while at the same time new drug treatments let patients avoid hospitalization and other expensive treatments.  Generic drugs now represent the vast majority of the market, creating pressure on drug companies to cut prices unless truly innovative new medicines are developed.
In the end, it's all about getting value for the healthcare dollars spent.  And with patients--that's you and me--getting stuck with more of the bill, it's inevitable that intense scrutiny is coming to the entire healthcare system.  The real patient--our healthcare system--is sick.
There are no easy solutions, but some big players are taking matters into their own hands.  Amazon, J.P. Morgan Chase, and Berkshire Hathaway--with 1 million employees between the three of them--recently announced a partnership seeking to deliver healthcare to their employees at lower cost and with improved outcomes.  I'd say their eventual goal might be to roll this out to a wider audience further down the road.  Once they peel this onion, I think they'll be able to go big.
Reform is on the horizon.  Healthcare is increasingly unaffordable, and it's swallowing our economy.  Something's gotta give.  The big squeeze is coming.
I suggest you consider these issues before investing in the healthcare arena.  Your portfolio just might avoid a trip to the emergency room.

-John Heldman, CFA

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