Health Industry Prognosis Looks Good to Wall Street

Health care appears to be in disarray. Hospitals trying desperately to stem losses are refusing to accept stingy contracts from health insurers. Health maintenance organizations are withdrawing from Medicare in protest of cost cuts. And patients are confused and anxious.

Yet Wall Street has fallen in love with health-care stocks. HMOs and hospital management companies have enjoyed robust stock performance this year. Pharmaceutical stocks are up strongly despite threats from Congress of regulation to halt rising drug prices.

Prominent companies, such as Tenet Healthcare, WellPoint Health Networks and the drug companies Pfizer and Watson Pharmaceuticals, have seen their shares rise by 30% to more than 50% in recent months.

The reasons? Recovery after long illness, for one. Recent years have been stringent. The government trimmed Medicare reimbursements in the wake of the Balanced Budget Act of 1997. Total cutbacks amounted to $250 billion. Private insurers cut back as much as possible on payments to hospitals and doctors.

Treating the sick did not become cheaper, but health-care providers became leaner in the pocketbook. Tenet, the Santa Barbara-based owner or manager of 110 hospitals, suffered earnings reversals and stock price declines in 1998 and ’99. PacifiCare Health Systems resigned from Medicare programs in several states rather than lose money.

Nonprofit hospitals saw their bonds downgraded, often to “junk bond” status, by rating agencies because they were no longer considered good risks. Today 85% of commercial lenders will not extend credit to health-care organizations, reports Fred Hessler, a managing director of Salomon Smith Barney. A nonprofit health system in Pennsylvania recently had to agree to a 9.7% interest rate to sell nontaxable bonds.

Clearly a crisis point was reached in one of the nation’s most important industries. Medical-care expenditures in the U.S. now run about $1.4 trillion a year, or 15% of the gross domestic product. Medicine employs well over 10 million people, most in good-paying jobs. And employment has been rising as aging Americans use more health services every year.

So in the last year, an easing has come to medical finance. Insurers are hiking payments to hospitals and doctors, after raising premiums to employer groups buying health insurance. The government is easing up on Medicare stringency. Hospitals and other providers are raising their prices 3% to 6% in turn.

The result is that medical costs are rising 4.4% on an annual basis so far this year, compared with general inflation of about 2%. The cost of medical benefits to employers is rising 5.7% this year.

Wall Street noticed the easing, and the potential for a return of rising profits, and started lifting health-care stocks in February.

But there is more than temporary relief or mere inflation to the new outlook. The U.S. is about to openly acknowledge the need to spend more on health care. The presidential candidates both favor greater spending, although they differ on methods. Republican George W. Bush favors new private insurance incentives; Democrat Al Gore promises government funding of health insurance for the poor and prescription benefits for the elderly. Wall Street doesn’t analyze the economics but simply hears “more money for health care” and judges it a growth industry.

The aging population means growth, of course. “The baby boomers are hitting 55 now and 40% of health expenditures occur after age 55,” notes Jeffrey Barbakow, chairman of Tenet.

Further development of the medical industries won’t be a painless procedure. Efforts at cost containment, and arguments about quality, will continue. Drug prices might not be regulated, but Congress could introduce competition. Both the House and Senate voted last week to allow greater imports of cheaper pharmaceuticals from Canada and Mexico, as long as the Food and Drug Administration deems them safe.

Lawsuits over quality of care will hold HMOs and hospital managers to account.

Employee health insurance plans are about to see major changes. Increasingly, employers will offer a fixed amount of money for health insurance and employees will choose how to spend it. Young and healthy individuals may choose a low-priced, minimal-coverage policy. But families with young children will choose greater coverage and pay more of the premiums.

“Health insurance will become more of a customized consumer business,” says Dr. Schumarry Chao, a physician and analyst at MedImpact Health Services, a San Diego prescription benefits management firm.

Hospital consolidation will continue. Nonprofit hospitals, even major chains such as Catholic Healthcare West, which owns 43 hospitals in California, have suffered repeated downgrades of their credit ratings. That makes it difficult to raise capital for investment in technology to make operations more efficient.

Internet communications systems for physicians, nurses, technicians and patients will increase productivity in coming years. But heavy investment is needed to create such systems.

Nonprofit hospitals are not without assets. Typically they own medical buildings and clinics as well as hospitals. They will have the option of selling some properties and consolidating others to achieve economies of scale.

For-profit hospital management chains such as Tenet, HCA-Healthcare, Quorum Health Group and Universal Health Services, which have access to capital from investors, will be buyers for individual hospitals. “Acquisitions can help us concentrate in specific markets. We want to be No. 1 or 2 in a market to gain leverage in bargaining with insurers,” explains Barbakow, 56, a onetime investment banker in Southern California who has headed Tenet since 1993.

HMOs are confident of growth. PacifiCare, which specializes in Medicare patients through its Secure Horizons insurance, got burned by government cutbacks. But it is not retreating. Last week the company said it would welcome Medicare accounts in California once again and make new risk-sharing arrangements that would allow higher payments to hospitals and doctors. Investors reacted warily to the policies, but PacifiCare is building for long-term growth.

The larger picture in health care supports the long-term view. In the next decade, baby-boom patients will demand more and even better care. Medical technology will advance, perhaps even faster than it has in recent decades. And around the world, expanding middle classes will mean growing markets for pharmaceuticals and for medical procedures such as corneal transplants and open-heart surgery that have improved life for many in the U.S.

Why is Wall Street enamored of health care? Because amid the seeming chaos, investors see that medicine is one of our most productive industries.

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Healthy in California

The stock market is giving positive diagnoses to a selection of health-care companies based in Southern California.

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Latest PE Company Headquarters Stock Price 12 mos ratio Jan.4 Aug. 4 EPS* Aug.4 Allergan Irvine $49.00 $71.75 $1.46 49.3 Amgen Thousand Oaks 58.13 69.13 1.04 66.5 Apria Healthcare Costa Mesa 16.94 15.69 1.23 12.7 PacifiCare Santa Ana 48.94 57.81 7.12 8.4 Tenet Healthcare Santa Barbara 23.88 31.50 1.88 16.8 Watson Pharm. Corona 33.88 54.75 1.70 32.2 WellPoint Health Thousand Oaks 65.50 88.56 4.84 18.3

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* Earnings per share

Sources: Bloomberg News, company reports

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Swift Recovery

Health-care stocks have been robust this year, as the stock prices of HMOs, ranging from Aetna to WellPoint Healtnetworks, show.

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James Flanigan can be reached at jim.flanigan@latimes.com.