Repeal / Replace is Dead – What Happens Next

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Richard Evans / Scott Hinds / Ryan Baum

203.901.1631 /.1632 / .1627

revans@ / shinds@ /


August 13, 2017

Repeal / Replace is Dead – What Happens Next

  • With the Medicaid expansion now on solid legislative footing, we believe hold-out states will give in to their (Keynesian) self-interests, and expand their programs. This, plus the eventual inclusion of dually-eligible Medicare / Medicaid beneficiaries in managed programs works to the benefit of the Medicaid-predominant HMOs (CNC, MOH, WCG). WCG sees the most growth from both drivers (expansion, inclusion of duals), and is least exposed to risks facing the health insurance marketplaces (HIMs)
  • Hospitals’ (e.g. CYH, HCA, LPNT, THC, UHS) net revenue outlook is now more stable, though these cyclical stocks lack any likely sources of volume and/or pricing acceleration. However, of this group HCA is positioned to benefit if states (particularly TX and FL) expand their Medicaid programs, because of the firm’s heavy presence in these states
  • The stabilizing revenue outlook for Hospitals arguably will ease constraints on capabilities-oriented capital spending; as such we’re no longer bearish on these suppliers (e.g. EKTAB, HOLX, ISRG, VAR, ZTLQ)
  • The health insurance marketplaces (HIMs) face the near-term risk that the Trump Administration refuses to fund the cost-sharing reduction (CSR) payments that 59% of HIM beneficiaries rely on. We see the likelihood of this occurring as remote, as the fallout would weigh on Republicans directly, and Congressional Republicans appear to be taking steps to block such a move. Hospitals’ have limited HIM exposure, taking less than 2% of revenues from HIM beneficiaries. CNC and MOH are fairly exposed, with 13% and 20% of enrollment coming from the HIMs; in contrast WCG has little or no exposure
  • After placing CSR funding on a firmer foundation, we expect Congress to turn the page to other non-healthcare related topics; however, we continue to believe that in the medium term (≤ 4 years) adverse selection pressures on the HIMs will force Congress to either restructure the HIMs or let them fail

Summary and Investment Conclusions

Republicans’ failure to repeal / replace the Affordable Care Act (ACA) largely stabilizes health coverage gains brought about by the ACA

The ACA expanded health insurance to roughly 22M Americans, with the majority (roughly 14M[1]) of these gains being attributable to the expansion of Medicaid. Enrollment in individually-purchased health insurance, largely but not exclusively occurring on the ACA’s health insurance marketplaces (HIMs), accounts for coverage gains of approximately 4.9M persons. Remaining coverage gains (circa 2.3M) are driven primarily by an ACA provision allowing children to remain on parents’ policies until the age of 26

We believe the Medicaid program will further expand as hold-out states raise income eligibility thresholds in the near- to mid-term, and that persons dually eligible for both Medicare and Medicaid ultimately will be moved into Medicaid managed care programs. This directly benefits the Medicaid-predominant HMOs (CNC, MOH, WCG), with WCG positioned to see the largest percentage gains. With Medicaid risks having been minimized we once again prefer the Medicaid-predominant HMOs to the commercial-predominant names (e.g. AET, ANTM, CI, UNH). Further Medicaid expansion and incorporation of duals should provide for further Medicaid growth; by comparison the commercial-predominant names are constrained by the broader US economy having reached peak employment

The health insurance marketplaces (HIMs) face the near-term risk that the Trump Administration chooses to eliminate funding for cost-sharing reductions (CSRs), though we see the likelihood as remote. Both CNC and MOH have significant exposure to the HIMs (13% and 20% of enrollment, respectively); WCG has little or no HIM exposure. Hospitals’ exposure to the HIMs is limited, with HIMs accounting for less than 2% of revenues

The failure of repeal / replace also stabilizes the outlook for Hospitals (e.g. CYH, HCA, LPNT, THC, UHS), as the loss of coverage for persons picked up in the Medicaid expansion would have meaningfully raised uncompensated care costs. Looking forward, HCA stands to gain the most from further Medicaid expansion; however we remain neutral on Hospitals broadly, as these cyclical names are unlikely to see meaningful revenue acceleration in the near-term. Having a more predictable revenue outlook we believe Hospitals will ease constraints on capital spending, particularly around capabilities-oriented (as opposed to capacity-oriented) capital equipment. Because of this we’re now neutral, rather than bearish, on the capabilities-oriented suppliers of hospital capital equipment (e.g. EKTAB, HOLX, ISRG, VAR, ZLTQ)

In the near-term we believe (congressional) Republicans will seek to stabilize the HIMs by ensuring the funding of CSRs, and will then turn the page to other non-healthcare related legislative priorities. In the medium-term (≤ 4 years), we believe mounting adverse selection pressures will force Congress to either restructure the HIMs, or allow them to fail, thus forcing healthcare back onto the political agenda


Having put the immediate risks of repeal / replace behind it, the size of the Medicaid program going forward will reflect the balance of potential losses from state waiver requests, and potential gains from hold-out states choosing to expand; we see the upside from further expansion being far greater than downside risks from various waivers. The eventual incorporation of dually eligible Medicare / Medicaid beneficiaries into Medicaid managed care programs should further boost both enrollment and average per-beneficiary premiums, to the particular benefit of Medicaid HMOs

Medicaid upside – further state expansions, and incorporation of duals into managed care

There are just over 5.4M potential new Medicaid beneficiaries in the 18 states that have not yet participated in the Medicaid expansion; just over 1.4M of these are Medicare beneficiaries who would become dually eligible for both Medicare and Medicaid if these states choose to expand their Medicaid programs (Exhibit 1)

The Medicaid program came into being in 1966; only 26 states joined the program that year, followed by 11 states in 1967 and just one in 1968. Despite the very generous federal matching rates on offer the remaining states held out until Johnson left office, and all but one of the hold-outs (Alaska) had joined the program by the second year of the Nixon administration. Many of the hold-outs were southern states that loathed Johnson, and chose to prioritize their part in the larger national Republican vs. Democrat and North v. South battles over their local self-interests – at least until Johnson was no longer in the political frame. With the Obama administration out of office, and with the Medicaid expansion having shown itself to be politically durable, we expect the hold-out states to again narrow their focus to their own self-interests. And because expansion clearly serves these self-interests (states can expect on the order of $4,100 in net federal inflows per expansion beneficiary), we expect most of the hold-outs to expand their programs

Exhibit 2 shows the potential impact on Medicaid enrollment (non-duals only) by carrier, under the assumption that each HMOs’ share of beneficiaries in the hold-out states remains constant if and when these states expand their programs. By virtue of its exposure to Texas and Florida, CNC would likely see the largest absolute gains in enrollment from further Medicaid expansion; however in percentage growth terms WCG would see the largest boost. Exhibit 3 sorts publicly traded hospitals by the percent of their beds in states that have not yet expanded their Medicaid programs. HCA (82.5% of beds in non-expansion states) likely would see the greatest benefit from the hold-out states’ expansion

The impact of persons dually-eligible for both Medicare and Medicaid (aka ‘duals’) on near-term managed care earnings is limited by the fact that only a limited number of duals can be included in managed care programs during the ongoing demonstration project; at present only about 360,000 duals are in managed programs. We believe duals eventually will be eligible for enrollment in Medicaid managed care, which would result in potential enrollment gains of roughly 3.6M even in the absence of further Medicaid expansion, and as many as 4.8M under full Medicaid expansion (Exhibit 4). CNC, MOH, and WCG all would benefit similarly in terms of percentage growth from incorporation of duals into managed care absent further expansion; with further expansion WCG again would see the largest growth effect, followed by CNC. Bear in mind the percent growth shown in Exhibit 4 applies to change in number of persons enrolled; however because duals have much larger (circa 5x) premiums as compared to non-duals, the effect on revenue growth would be far greater

Downside risks to Medicaid

Republicans have sought a variety of changes to state Medicaid programs via the waiver process, and these requests may become more frequent and/or more aggressive in the wake of the failure to repeal / replace ACA. Two particular types of waiver requests that might threaten Medicaid enrollment are requirements that able-bodied recipients be employed, as well as requirements for drug testing

At least four states (Indiana, Kentucky, Arizona and Pennsylvania, collectively 10 percent of total US Medicaid enrollment) have submitted waiver requests in an effort to impose work requirements on Medicaid recipients. And, HHS Secretary Price and CMS Administrator Seema Verma made clear in a March 2017 letter[2] to states their interest in using the 1115 waiver process to ‘support innovative approaches to increase employment …’. Evidence shows that about 79 percent of Medicaid beneficiaries already are in homes with a working adult[3], and that about 59 percent of adult recipients are themselves employed. Nationally there are roughly 11M Medicaid beneficiaries who meet the Republicans’ definition[4] of ‘able’ who are unemployed, 8M of whom are not actively looking for work[5]. Of these 8M, most (63 percent) are women, and 29 percent claim to be acting as a caregiver for someone else

Having failed with repeal / replace, Congress and the Administration cannot force a work requirement onto the states, they can only open the door to such a requirement via the waiver process. Democratic states currently account for 30 percent of the nation’s Medicaid beneficiaries, and are wholly unlikely to walk through that door. If we assume, as a very worst-case scenario, that Republican[6] states impose a work requirement on Medicaid beneficiaries, at most 3.4M beneficiaries[7], or less than 5 percent of the national total, would be affected. The true impact would likely be much smaller, as many of these 3.4M beneficiaries are likely to have valid reasons for being unemployed; and, state requirements are more likely to require active pursuit of employment as opposed to actual employment

The potential impact of drug testing looks to be even smaller. The US rate of illicit drug use over a one-month look back period for persons 12 or older is 9.4 percent[8]; however, state-level efforts to drug test applicants for public assistance have tended to produce far lower positive test rates, sometimes less than one percent[9]

States’ efforts to drug test all applicants for public assistance already have run afoul of Fourth Amendment protections in multiple instances, with the general result being that states have adapted their drug testing programs to focus more narrowly on applicants with demonstrable risks of drug use. And, where states require applicants to be drug tested as a condition of receiving aid, in many instances a single positive drug test result simply obligates the applicant to accept substance abuse treatment as a condition of receiving aid

Because drug testing as a condition of receiving Medicaid assistance can only be applied narrowly, will only (if approved) be pursued by a subset of states, tends to capture only low single-digit percentages of applicants, and does not routinely lead to denial of aid, we do not believe state drug-testing of Medicaid applicants is likely to meaningfully impact overall program enrollment

Health Insurance Marketplaces (HIMs)

The HIMs face near-term risk primarily in the form of uncertainty around cost-sharing reduction (CSR) funding, and secondarily from potential further undermining of the individual mandate. In the medium to longer-term the HIMs face far greater risks from adverse selection

The ACA calls for lower income beneficiaries who purchase silver plans on the HIMs to receive not only premium assistance, but also assistance with deductibles and co-payments via so-called cost-sharing reductions, or ‘CSRs’. The ACA authorized spending for CSRs, however the Republican-controlled Congress refused to appropriate spending; despite this the Obama administration paid out the CSRs. The Republican Congress successfully sued the Obama Administration and won at the district court level, an outcome the Obama Administration appealed. If the Trump Administration were to drop the appeal the lower court ruling would stand, and the CSR payments could no longer be made – unless the current Congress passed a specific appropriation

CSR payments are received by most HIM beneficiaries (Exhibit 5); and without these benefits many of these enrollees would be unable to afford care. What’s more, carriers are legally obligated to limit the out-of-pocket (OOP) costs of CSR eligible persons without regard to whether the Administration pays them back for the associated outlays. Faced with uncertainty over funding of the CSRs, many carriers have chosen to set 2018 premiums at a level that assumes plans will have to meet their CSR obligations to beneficiaries, but that the Administration will not honor CSR obligations to plans. The result has been a 20-30% jump in estimated premiums, which if realized would plainly result in outright enrollment declines in 2018

If the Trump Administration chooses not to pay the CSR obligations Congress could still choose to fund these, and at least one key committee (Senate HELP[10]) has announced plans for bipartisan hearings on CSR funding after the August recess

We believe the Republican leadership realizes that choosing not to fund the CSRs would lead to a collapse of the HIMs, and that Republicans would be held responsible by the electorate for the collapse. For this reason, we believe the most likely scenario is funding of CSRs for 2018, though any legislation that provided for 2018 CSR funding might also include language intended to shrink spending on CSRs over time

The Administration might also choose to further undermine the ACA’s individual mandate. In the early days of the current administration Trump signed an order giving executive branch agencies latitude with respect to implementation of ACA requirements, which among other things was seen to give the IRS the freedom not to enforce the individual mandate. The administration might choose to more narrowly and precisely direct the IRS not to enforce the mandate, thus increasing people’s confidence that they can forego compliant coverage and avoid the penalty. In scoring various bills the Congressional Budget Office (CBO) seems to place significant weight on the role of the penalty in influencing enrollment; for our part, we believe the penalty has relatively little effect. Because of this, while we recognize that undermining the penalty would add to adverse selection pressures, we’re not convinced the impact is material

Regardless of whether the CSR payments are funded and/or the individual mandate is left intact, we continue to see evidence that the exchanges are suffering from considerable adverse selection, and that these pressures eventually will force Congress to either modify the HIM marketplaces, or let them fail. We believe the political experience of the repeal / replace effort highlights how difficult it would be for Congress to let the HIMs fail; as such we consider adverse selection to be the force that is most likely to drive health reform back onto Congress’ agenda, rather than as a force that necessarily results in the collapse of the exchanges. We intend to drill down further on adverse selection pressures in an upcoming note

Among the publicly-traded HMOs CNC and MOH are the most reliant (13% and 20% of beneficiaries, respectively) on the HIMs for enrollment; the remaining carriers have very little exposure (Exhibit 6). Hospitals are relatively insulated from the HIMs; using MEPS data[11], we estimate that as of 2015 HIM enrollees accounted for just 1.5% of total hospital expenditures (Exhibit 7)


  1. About 11.1M persons gained coverage because they became newly eligible for Medicaid. About 3.3M persons gained coverage after learning – presumably as the result of ACA-related enrollment campaigns – that they were Medicaid eligible under the pre-ACA standards
  4. Per American Health Care Act (AHCA) bill text
  6. Defined as states with control of at least two of the governor’s mansion, the upper chamber of the state legislature, or the lower chamber of the state legislature
  7. 42 percent of Medicaid beneficiaries in R states x 8M beneficiaries nationally not actively looking for work
  10. Health, Education, Labor, and Pensions
  11. Medical Expenditure Panel Survey

©2017, SSR, LLC, 225 High Ridge Rd, 2nd Floor, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE), Gilead Sciences (GILD), Bristol-Myers Squibb (BMY) and Sanofi (SNY) on both securities-related and non-securities-related topics. One or more of SSR Health’s analysts owns long positions in the following stocks: AAAP, ACOR, AERI, AMGN, ARRY, BMY, DVA, FLXN, GILD, HRTX, KITE, NSTG, ONCE, PTCT, PTLA, RARE, RHHBY (Roche), RIGL, SNPHY, TBPH, THERF, VRTX

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