Health Reform Legislation is Unlikely to be Either Very Large or Very Complex; Risk to Insurers Falls

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212.531.6100 Healthcare

Richard Evans


September 8, 2009

Health Reform Legislation is Unlikely to be Either Very Large or Very Complex; Risk to Insurers Falls

Research Highlights:

  • Public opinion on health reform has shifted from support to opposition over the recess; Congressional approval is at a 24-year low; and, the percentage of voters self-identifying as Democrats has fallen sharply since the reform debate began in earnest.
  • This shifts the health policy dynamic from offense to defense; the priority of reform has been displaced by the priority of defending critical elements of power: workable levels of public opinion generally, and workable 2010 Congressional majorities specifically.
  • Congressional – particularly House — dynamics raise the odds of reform legislation passing, but reduce the odds that reforms are either ideologically or politically divisive. Democrats lose a lot of seats if either nothing passes or anything highly controversial (e.g. the public option) passes; Democrats lose comparatively few seats if legislation passes without more controversial provisions.
  • Senate dynamics now favor smaller and less complex healthcare reforms. Fiscal pressures limit new spending here more than in the House. Budget reconciliation offers a path to Senate approval with a simple majority, but this pathway has limited legislative ‘bandwidth,’ and substantial risks.
  • Senate rules require that all provisions of reconciliation bills be germane to the budget; and, that provisions not add to the deficit in fiscal years beyond the budget. Taken alone, these are considerable constraints on the size and complexity of legislation that can pass under reconciliation.
  • Additionally, the Senate’s ‘Byrd’ rule allows for challenges to individual provisions of reconciliation measures – in contrast to the normal practice of up or down votes on entire amendments or bills. This gives opponents the rather dramatic parliamentary advantage of being able to strike provisions as narrow as a single phrase. To date, Byrd rule challenges have an 81% success rate.
  • Moreover, the end result of repeated Byrd rule challenges to a given bill has been to change the legislation’s meaning in often unpredictable ways – the upshot being that reconciliation is a poor legislative pathway for bills having complex and inter-related provisions.
  • Against this backdrop of reduced legislative capacity for scale and complexity, we believe that the un- and under-insured have a priority claim on whatever legislative bandwidth remains. This, plus our increased conviction that a public option is politically infeasible, argues that health insurers’ commercial (i.e. employer-sponsored) books of business are largely beyond the reach of current reform efforts.
  • Insurers see upside from Medicaid lines of business (reduced capacity for complex legislation argues for building on existing programs, rather than creating new ones); Medicaid expansion under HR 3200’s provisions would grow Medicaid lines by 30%. Insurers see risk in the form of Medicare Advantage (MA) re-pricing; MA margins could be forced lower by as much as a fifth.
  • At the level of the health insurance sector, these risks and rewards net to zero. Within the sector, individual firms’ exposure to risks and rewards is diverse; this relative diversity is not reflected in relative share prices.

Congressional (particularly House) dynamics increase the odds of reform legislation passing, but reduce the odds that any legislation passed will include a public option

Healthcare has plainly re-emerged as a focus of American politics (Exhibit 1). Recall our earlier assertion[1] that voters’ advocacy for health reform is readily turned to opposition by shifting focus off of the big picture, and on to narrow self-interests. More specifically, voters’ ideological support for the broad ideals of reform (e.g. universal access to affordable quality care) is easily reversed by shifting attention to the (real or perceived) risks that reforms may pose to each voter’s personal circumstances (e.g. tax burden, availability of private coverage, freedom to choose one’s own provider). In effect this gives opponents of reform a potent electoral veto; this veto was exercised over the August recess, the result being a shift in voter opinion from net support to net opposition (Exhibit 2).

Reversing this shift is a tall order. The President’s approval rating has slipped since the inauguration, though the rate of decline is consistent with historic norms (Exhibit 3). Despite the President’s continued popularity, it’s important to recognize that empirical studies of modern presidential power suggest that even very popular presidents are generally unable to shift voters’ opinions on major social programs[2].

Following on this, we believe it would be incorrect to frame the current reform debate as a question of whether the President can persuade the electorate and Congress to pass his reform agenda. Rather, we believe the appropriate framing is now more defensive than offensive – i.e. to our minds the question has become one of how the President can balance his health reform agenda against the likely greater priority of maintaining a critical element of power, namely workable Congressional majorities.

Presidents’ parties not uncommonly lose Congressional seats in mid-term elections; we believe this general trend is made more dangerous for the present administration by immediate political realities, some of which tie directly to the politics of healthcare. Congressional approval is at a 24-year low (Exhibit 4), and voters’ preferences for a Democratic Congress have eroded quite sharply since mid-July – i.e. since the health reform debate went into high gear (Exhibit 5).

Crucially, the Democrats ’08 sweep was entirely the consequence of expanded voter support in the under-65 age groups; voters over age 65 were less supportive of Democrats than in ’04 (Exhibit 6). This is far more of an issue in mid-term than in presidential elections; seniors reliably turn out to vote in the mid-terms, whereas younger age groups do not. As a result, seniors’ share of votes is roughly 5 percent greater in mid-terms than in presidential elections, giving Democrats’ least supportive age demographic a somewhat amplified voice in the make-up of the next Congress (Exhibit 7).

Further on the matter of mid-term turnout, Republican opposition to current reforms is more intense than Democrats’ advocacy (Exhibit 8). In the event health reform remains a potent issue in November of 2010 — i.e. if nothing passes (depressing the Democratic base) or if something passes which is highly polarizing (e.g. a public option) – mid-term turnout might favor Republicans.

Thus our framing of the immediate politics of healthcare have shifted – it’s now less about finding sufficient votes in both chambers to pass reforms, and more about maintaining workable Congressional majorities for the balance of the President’s first term. Correspondingly, our expectations regarding the outcome of the healthcare debate have shifted somewhat as well – we believe the odds of something passing are now higher, whereas the odds of something partisan / controversial passing are now considerably lower. The President and Congressional Democrats can afford neither an outright failure nor a politically divisive legislative victory.

Senate dynamics argue for reduced size and complexity of reforms

Fiscal pressures limit moderate’s support for large new entitlements; we believe these pressures are felt more acutely in the Senate than in the House, and further believe that the larger than expected deficit projection in the August budget update both amplifies moderates’ fiscal concerns, and provides political air cover to moderates who are reluctant to support large reforms. It naturally follows that the Senate is unlikely to pass a large reform package via traditional (i.e. non-reconciliation) means.

Unable to gather 60 Senate votes without every Democratic moderate and perhaps (at least) one Republican, much has been made of budget reconciliation procedures[3] as an opportunity to clear the Senate with a simple majority. While we believe this is quite possible — 22 reconciliation measures have passed the Senate, 7 of these passing with fewer than 60 votes (Exhibit 9) – for procedural reasons we do not believe that health reform legislation passed under reconciliation can be either very large or very complex.

Senate rules normally require 60 yea votes to end debate before an item can be voted on; budget reconciliation rules avoid the 60-vote hurdle by the simple expedient of ending debate after a fixed period of time – 20 hours in the case of Senate bills, 10 hours in the case of conference bills. Generally speaking, once the allotted time has elapsed, bills can be passed by a simple majority of those present.

The trade-offs are substantial, and come in three primary forms. First, legislation brought to the floor as part of the budget reconciliation process must be germane – in its entirety – to the budget. In other words the use of reconciliation rules ‘narrows’ the available legislative bandwidth, which works against large / expansive legislation. If an element of a reconciliation bill is not directly related to the budget, it faces the very real risk of being removed from the legislation on the floor. Clearly this places a premium on careful construction of legislative provisions, but there’s only so much that careful writing can do to color the true budget relevance of any provision[4].

Second, reconciliation rules raise calendar-related requirements and concerns. Reconciliation legislation cannot add to the deficit beyond any fiscal year covered by the budget in question, a considerable hurdle for the reforms favored by liberal Democrats. Similarly crucial, whether programs passed under reconciliation have a sound legal basis beyond the last fiscal year in the budget remains an open question. Bills passed on thin majorities already face relatively high odds of legislative revision in subsequent political cycles; bills passed under reconciliation may face added risks from the judiciary.

(Eats, Shoots, and Leaves …)

The third trade-off relates to the so-called Byrd rule, which provides for powerful challenges to reconciliation bills. First adopted in 1985 as a means of eliminating extraneous (i.e. non-budgetary) elements from reconciliation measures, the Byrd rule is virtually unique in an important respect – it allows the opposition to challenge, and potentially eliminate, individual provisions of the reconciliation bill. Normally the Senate votes up or down on amendments or bills; in ‘normal’ floor action senators have no means of attacking the legislation at finer levels of detail. This is not so under the Byrd rule, wherein the opposition can challenge individual provisions; and, in that the wording of the Byrd rule is quite loose, ‘provisions’ can be interpreted to mean individual ideas – e.g. an individual paragraph, or even a sentence or phrase. Once a point of order is raised, 60 votes are required to appeal the disposition of that point of order – in other words if the opposition can show that a provision should not be considered under reconciliation, it takes 60 votes to keep the provision in the bill. And quite obviously, if there were 60 votes interested in seeing the legislation make it through floor action in one piece, the bill would never have been presented under reconciliation rules.

The Byrd rule has been used on 53 occasions, 43 (81%) of which were successful (Exhibit 10) – i.e. the Byrd rule plainly works to the benefit of the opposition. In practice, another important feature of the Byrd rule has been its (highly) unpredictable effect on the collective meaning of whatever legislative provisions survive (often repeated) Byrd rule challenges. Despite very careful drafting of reconciliation provisions in anticipation of Byrd rule points of order, reconciliation bills have a history of being pulled apart on the Senate floor in wholly unanticipated ways. Thus our reference to the popular text on punctuation, our point being that a provision here or there can dramatically change the meaning of final legislation, particularly if the legislation is inherently complex and its essential provisions highly inter-related – as would naturally be true in the case of large scale healthcare reforms.

We conclude that the Senate is unlikely to pass either very large or very complex healthcare reform legislation in this cycle, specifically because of the need for moderate Democrats’ votes, these Senators’ focus on rising fiscal pressures, the narrow legislative bandwidth of the reconciliation process, and the tendency of complex programs to unravel under Byrd rule challenges.

The (difficult) short game – build voter support, unify a Democratic bloc, and find grounds for compromise

Despite our belief that even popular presidents cannot change the public’s opinion of large social programs, we naturally expect this President to try – just as they all do. In particular, we would expect the President to try and run the opposition’s formula in reverse. The opposition has moved voters’ health reform perspectives from broad ideals to narrow self interests – not infrequently with mis-information – thus we would expect the President to use his status as the nation’s most popular politician to both counter mis-information, and to build the case that the each voters’ share of the present system’s failings is a greater threat to their narrow self-interests than proposed reforms. On a purely objective level we expect this to fail, as the opposition has sufficient time, material and media coverage to run the equation back in their direction yet again. More subjectively: having seen the health reform debate colored by death panels, abortion, socialism and the right to bear arms during the recess, no one should be surprised if before the leaves start falling, health reform is about flag burning and school prayer as well.

More practically, we see Republicans’ outright opposition to reforms continuing until and unless internal divisions between liberal and conservative Democrats are bridged – Republicans have every political reason to want to deal a failure to a new President and Democratic majority, and can do so at little or no cost as long as the failure to pass legislation can be tied to Democrats’ internal splits. This makes bridging Democratic differences an immediate priority for the President, and we believe that ultimately he can do so – by scaling back the scope (and cost) of reforms, and putting the public option on time delay. Despite party liberals’ ideological convictions in favor of the public option, set against the backdrop of mid-term electoral threats the question of whether to include a public option has an obvious and very practical answer – a lot of Democrats lose their seats if nothing passes, a lot of Democrats lose their seats if the public option passes, whereas not so many Democrats lose their seats if something passes without the public option.

Assuming Democrats can reach an internal consensus, it is clearly in their best interests to do so sooner rather than later. If Democratic unity can (meaningfully) precede floor action on specific reform proposals, Republican opposition is then much less of a free ride – i.e. Republicans cannot oppose the reasonably popular (i.e. modified) reform agenda of a unified Democratic party without paying a considerable political cost. Thus timely unification of a Democratic bloc would create some prospect of recruiting moderate Republicans. In turn, this would give more complex reform elements (e.g. health insurance exchanges, cooperatives) greater odds of becoming law, as reform legislation could avoid reconciliation — and the associated Byrd rule risks — on the floor of the Senate. Early Democratic reconciliation would do very little to improve Democrats’ ability to produce larger scale reforms, as these are limited by fiscal constraints, some respect for which appears essential to any Democratic consensus.

Investment Thesis

The broad outlines of our investment thesis remain the same; specifically we favor sub-sectors with stable pricing that are levered to reform-related volume gains, e.g. drug wholesalers, generic drug manufacturers, and to a lesser degree medical device and branded drug manufacturers.

We had previously argued that insurers’ asymmetric exposure to the risks and rewards of reform efforts make them relatively unattractive; we no longer feel that this is the case. In particular, we believe the odds of an immediate and large public option are even more remote than before, and further believe that limits on the scale and complexity of health reform legislation work to keep insurers’ commercial lines of business largely beyond the reach of reforms.

Almost certainly, extending coverage to some portion of the un- and under-insured is a greater legislative priority than reforming the coverage of employees – the majority of whom are satisfied with their present status. It follows that the un- and under-insured have a priority claim on the limited spending and rule-making capacity of smaller and less complex legislation, further supporting our argument that present reform efforts are unlikely to extend to employer-sponsored plans.

Commercial lines still face the risk of benefit taxation, though we see considerable political pressures here as well. Benefit taxation that reaches beyond the very highest paid employees forces the President up against both union opposition and a campaign commitment not to raise taxes on families making less than $250,000 annually. Accordingly we believe that wholesale alteration of health benefits’ tax status – and with it a wholesale alteration of healthcare premium elasticity — is unlikely.

Assuming insurers’ commercial lines are largely beyond reach, the immediate risks of health reform becomes a narrower question of insurers’ exposure to Medicaid and Medicare. Smaller and less complex reform legislation implies that existing systems and infrastructure are likely to be built on, rather than modified or replaced. In the case of Medicaid, it’s reasonably likely that at least some portion of benefit expansion to the un- and under-insured would take the form of expanded Medicaid eligibility. Using the provisions of HR 3200 as a proxy, we might expect roughly 11 million additional lives, or a 30% increase from current enrollment of 35 million.

Conversely, insurers’ Medicare Advantage (MA) business faces re-pricing risks in the current reform effort. Specifically, Congress and the Administration have argued that government spending and insurers’ margins on MA beneficiaries are higher than either anticipated or warranted. The debate has produced fairly specific numbers; in very broad terms government contends that insurers’ MA gross margins should fall by roughly a fifth.

Exhibit 11 provides enrollment breakdowns for each of the US health insurers with market capitalizations at or above $1B. Exhibit 12 estimates the contribution of each population (commercial, Medicaid, Medicare) to each insurer’s gross profit – absolute profit being much higher for commercial than Medicaid beneficiaries, and much higher for Medicare than commercial beneficiaries. We believe that Medicaid expansion and a (further) contraction in MA margins is a reasonable net consequence of reforms for insurers; Exhibit 13 shows the gross profit effect of simultaneously expanding Medicaid enrollment by 11 million members and reducing MA gross margins by a fifth. The largest capitalization insurers are virtually unaffected by these changes, primarily because of a predominance of commercial lines for these firms. Smaller capitalization insurers face very disparate balances of risk and reward. We note that insurers’ relative exposure to the risks and rewards of reform appears to be inefficiently priced (Exhibit 14).

  1. “The Political Economics and Investment Relevance of American Health Reform,” Sector & Sovereign, LLC, August 18, 2009.
  2. See for example:, highlighting Brandice Cane-Wrones’ research in: Who Leads Whom? Presidents, Policy Making, and the Mass Public
  3. Reconciliation was established by the Congressional Budget Act of 1974, and was first used in 1980. The Byrd rule was adopted by the Senate in 1985 and 1986, and made a permanent part of the original Act in 1990.
  4. From: “The Budget Reconciliation Process: House and Senate Procedures” Congressional Research Service, August 10, 2005: “A provision is considered to be extraneous if it falls under one or more of the following six definitions: 1) it does not produce a change in outlays or revenues; 2) it produces an outlay increase or revenue decrease when the instructed committee is not in compliance with its instructions; 3) it is outside of the jurisdiction of the committee that submitted the title or provision for inclusion in the reconciliation measure; 4) it produces a change in outlays or revenues which is merely incidental to the non-budgetary components of the provision; 5) it would increase the deficit for a fiscal year beyond those covered by the reconciliation measure; and 6) it recommends changes in Social Security.
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