What a Republican House Means for Health Reform

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Richard Evans

203.901.1631

richard@sector-sovereign.com

September 22, 2010

What a Republican House Means for Health Reform

  • Current odds of a Republican-led House in 2011 are roughly 2:1; this raises the question of whether and how a Republican House affects the Patient Protection and Affordable Care Act (PPACA)
  • Lacking votes to over-ride a veto, the next Congress cannot repeal PPACA. Funding measures originate in the House, thus a Republican-led House would have the option to defund PPACA
  • Most PPACA programs are authorized (budget earmarked) but not appropriated (no funds made available). A Republican House could deny PPACA appropriations despite pre-existing authorizations
  • Importantly, some major elements of PPACA– in particular MLR regulations and the Independent Payment Advisory Board – are both authorized AND appropriated, meaning a Republican House cannot defund these
  • Defunding PPACA’s discrete ‘authorized but not appropriated’ line items is largely ineffectual – these programs’ effect on PPACA generally or publicly traded healthcare companies specifically is minor. Less obvious but more impactful, a Republican House can deny appropriations to agencies that need new funds in light of new PPACA-related responsibilities – particularly HHS and IRS
  • HHS’ new spending needs under PPACA are only 1-2 % greater than without PPACA, and HHS may be able to meet its functional PPACA obligations by simply reprogramming existing funds. IRS on the other hand cannot – its PPACA obligations require a 5-10 % budget increase
  • Defunding IRS effectively halts the health insurance exchanges (HIEs). The HIEs rely on premium tax credits to subsidize premiums, and the credits are calculated by IRS on a household-by-household basis. No IRS funding, no premium tax credits; no tax credits, no HIEs
  • Note that defunding IRS only delays the HIEs; it does not ‘end’ PPACA, or even do away with other features relevant to publicly traded companies – specifically MLR limits and the IPAB. Defunding IRS simply puts the HIEs in deep freeze for the next political cycle
  • Defunding IRS (and thus HIEs) in perpetuity makes little sense for either party, thus while we fully expect a Republican-led House to go through the motions of defunding IRS, we would also expect the House to entertain any number of compromises in exchange for giving IRS the funds it would need. Whether any compromise can be made before the next Congress is impossible to say
  • Aside from the likelihood of a general healthcare rally in the context of a Republican defunding effort, we see no substantive beneficiaries of a delay to the HIEs. On the margin, smaller insurers and insurers with smaller shares of their geographic markets (CI, AET) are under less pressure if the HIEs are postponed
  • Volume-sensitive healthcare companies would suffer (in particular facilities operators and their suppliers) if the HIEs were delayed or done away with, though we emphasize the odds of the HIEs being entirely eliminated is remote. We favor facilities operators and their (especially commodity) suppliers on the argument that the current slow utilization trend will soon correct, but recognize the headline risks associated with any Republic effort to defund PPACA
  • We see little prospect for relief from investors’ major PPACA-related concerns – namely MLR regulations, the IPAB, and PPACA-related fees and taxes

Summary and Conclusion

Latest polls[1] suggest Republicans have a very good likelihood of winning control of the House for 2011/’12 (65%, Exhibit 1); though the odds of the Senate shifting to Republican control are far more remote (~ 22%). This raises the question of whether and how a Republican House, balanced by a Democratic Senate and White House, might alter the course of health reform.

A Republican House cannot repeal (insufficient votes to override a veto) the Patient Protection and Affordable Care Act (PPACA), but can defund key parts of the law. Many of the law’s explicit, line-item authorizations lack appropriation; however failing to appropriate these discrete line items does little to change PPACA’s impact on the earnings prospects of publicly-traded healthcare companies. Less obvious but more impactful, Congress might defund agencies on which PPACA’s success relies, HHS and IRS being primary among these. Defunding HHS’ PPACA programs is unlikely to be effective, since HHS’ PPACA spending is a small enough fraction of HHS’ overall discretionary spending that the agency presumably could fund its responsibilities through re-programming of its existing accounts. Moreover, many of HHS’ PPACA-related obligations are politically popular, which argues further against blocking HHS’ PPACA-related funds. In contrast, PPACA relies heavily on IRS to determine eligibility for premium tax credits on a household-by-household basis. IRS almost certainly cannot meet this substantial additional burden without receiving new PPACA-related appropriations. And, as a political matter, blocking expansion of IRS is far more straightforward than withholding funds from many popular new HHS programs. All of which leads to a simple bottom-line: it appears that Republicans’ best chance to delay PPACA preparations is to deny PPACA-related funds to IRS.

To be clear, major programs that affect the earnings power of publicly traded companies would be unaffected by defunding IRS. Medical loss ratio (MLR) restrictions would still come about, as would the Independent Payment Advisory Board (IPAB) and its attendant effects on innovators’ margins. However, health insurance exchanges (HIE’s), the core structural feature of the reform effort, arguably could not come about without the existence of a compelling economic reason (i.e. premium tax credits) for households to prefer the exchanges over any other option – and premium tax credits almost certainly cannot be implemented without expanding IRS funding.

The 2011 fiscal year actually started last Friday (October 1st); and, as is commonly the case, the fiscal year began without an approved budget. Given the pending election, it is highly likely that 2011 federal expenses are ‘covered’ by a series of continuing resolutions until the new Congress convenes in January — which is to say that this Congress’ failure to pass a 2011 budget effectively hands appropriations authority to the next Congress – which would then hold appropriations authority over 2011, ’12, and ’13. Assuming the House is held by Republicans in 2011, it is quite feasible that IRS’ PPACA-related activities could be starved of funding into, and perhaps[2] through, 2013.

The exchanges (HIE’s) are scheduled to begin operating in 2014; if IRS has no related funding through 2013 then we struggle to see how the exchanges could begin working on schedule. And herein lies a key distinction – a Republican-led House in 2011 can effectively delay the emergence of HIE’s, but cannot eliminate PPACA entirely. In effect, the most the House could do would be to stall the HIE’s, passing the issue on to the next Congress and Administration, at which point PPACA’s fate would be a rather obvious function of the then-prevailing politics. Absent some compromise, getting the HIE’s up and running in the wake of Republican defunding presumably would require some combination of broader public support for PPACA, and/or a return to 3-way Democratic control in 2012. On the other hand, permanently eliminating any or all of PPACA’s components through legislative action arguably would require 3-way Republican control before the point at which the HIE’s begin operating, on the theory that unwinding an existing / functioning[3] public benefit is all but impossible.

In the 33 Congresses since 1945, Republicans have held 3-way control in only two (108th and 109th) under one president (G. W. Bush); Democrats have held 3-way control in 11 Congresses (79th, 81st, 82nd, 87th, 88th, 89th, 90th, 95th, 96th, 103rd and 111th (current)) under 7 presidents (FDR, Truman, JFK, LBJ, Carter, Clinton, and Obama). In purely rational terms, either party (particularly Republicans) would be statistically ill-advised to avoid PPACA-related compromises in hopes of gaining the majorities needed to effectively force its agenda. Accordingly, some compromise that avoids perpetual defunding of the HIE’s is a reasonable likelihood, and we expect Republicans would consider ‘unblocking’ IRS funds in exchange for any of several conservative priorities, key among them being tort-reform.

For the time being we conclude that the HIEs’ timing is very uncertain, and their eventual fate at least somewhat less certain. This eases pressure on smaller insurers and/or insurers with relative low average market shares in each of their geographic markets (CI, AET), as the employer-sponsored to HIE shift we now more tentatively anticipate for 2014 (which places these insurers at a dis-advantage)[4] may be delayed or even eliminated. Uncertainty over HIE’s timing would tend to work against the earnings prospects of companies that benefit from HIE-related volume; these especially include facilities operators, and suppliers of (particularly commodity) inputs to these operators, and also include generic drug manufacturers, as well as drug wholesalers and retailers. Despite the concerns that postponement of HIEs might raise with respect to 2014 volumes for acute care operators and suppliers of commodity inputs to acute care, we continue to believe that both of these sub-sectors’ 2011 and 2012 earnings expectations have been unduly lowered as a result of misplaced concerns regarding present slow utilization[5]. On net, we still favor these sub-sectors on the expectation of an improving utilization trend, though we recognize the headline risks associated with a delay to the HIEs.

Relevant mechanics of the congressional budget cycle, and how PPACA fits in

By precedent, funding measures originate in the House, thus a Republican House would have the opportunity to defund parts of PPACA.

Federal spending can be categorized as either mandatory or discretionary. Mandatory spending ties to obligations established by entitlement programs such as Medicaid, Medicare, and Social Security; absent congressional modification of the underlying statutes, government has little choice but to fund the current obligations in each budget cycle. PPACA does modify Medicaid and Medicare to some extent, and these modifications appear largely immune to any effort to defund PPACA.

Discretionary spending is everything else, and aside from relatively modest modifications to Medicaid and Medicare obligations, virtually all PPACA-related spending is discretionary. Generally speaking discretionary funding rolls out in three steps: resolution, authorization, and appropriation. Budget resolutions in each budget cycle can be thought of as broad rules of the road, defining limits such as revenue minimums or spending maximums. Authorizations are legislative provisions that authorize future spending; critically important is that authorizations stop short of providing actual dollars to whomever is ultimately intended to receive them. This last step is taken by appropriations, which is the process of actually directing Treasury to make available, for example to a federal agency, the funds that have been authorized.

PPACA authorizes quite a lot of federal spending, but actually appropriates far less (some PPACA programs are both authorized and appropriated, but most are only authorized). Thus in order for funds to be disbursed against most PPACA authorizations, Congress still has to act; specifically Congress has to appropriate funds against these authorizations in order for many of the programs envisioned by PPACA to unfold. If Republicans win the House for 2011/’12, they will be in a position to deny these appropriations.

Republicans might apply this leverage in either of two ways: line-by-line refusal to appropriate funds for PPACA programs that are not yet appropriated; and/or, refusal to appropriate funds needed by agencies (IRS, HHS/ CMS) that are key to bringing PPACA into effect. We expect the latter approach for a simple and practical reason: the cumulative effect of line-by-line defunding does little to change the timing and nature of PPACA-related reforms, whereas the effect of selectively defunding certain agencies (especially IRS) is quite powerfully able to alter the course of PPACA.

  1. Authorized and Appropriated New Programs

Appendix 1 lists those new PPACA programs that are both authorized and appropriated. This list is considerably shorter than the list of programs authorized but not appropriated, though we note that several high impact programs already are fully funded. In particular, PPACA fully appropriates funds to the Independent Payment Advisory Board (IPAB, section 3403), which we believe ultimately places considerable pressure on innovators’ margins[6]. PPACA also fully appropriates funds for the establishment of medical loss ratio (MLR) limits (section 1003). The application of these and other regulatory limits to health insurers might in theory be partially blocked by defunding the actual regulator, though for reasons argued below, the relevant regulator (HHS) is unlikely to be reined-in by defunding.

  1. Authorized New Programs

More than 100 new programs (Appendix 2) are authorized but not yet funded in the PPACA. Authorizations for these programs may be open-ended (Congress may “appropriate sums as may be necessary to carry out this section”); capped in terms of a dollar amount and/or years of availability; or partially appropriated. Generally, these programs are modest in scale, and/or are of a scope that interferes relatively little with the earnings prospects of most publicly traded healthcare companies. Accordingly, we conclude that a refusal to fund these programs in the next Congress does little to change the nature of PPACA generally, or the impact of PPACA on healthcare stocks specifically.

  1. Administrative Expansions of Existing Departments

Per CBO, the costs to existing federal agencies for implementing PPACA “will probably” total $5 – 10b apiece to the IRS and Department of Health and Human Services (i.e. HHS, and within that primarily CMS) over the next 10 years[7]. These implementation costs would need to be paid for out of discretionary (appropriated) funds, and a Republican-controlled Congress in 2011/’12 would be in a position to deny those funds.

For argument’s sake assume that PPACA costs to these agencies are spread evenly over the next 8 years[8] (a conservative assumption; we would expect the bulk of these expenses to cluster around the 2013 – 2015 period). This means $625mm to $1,250mm per year in annual incremental spending for each of HHS and IRS. For HHS these dollar amounts represent only a 1 to 2 percent increase over the FY2011 HHS request for discretionary spending ($77B); for IRS these amounts represent an increase of 5 – 10 percent over the FY2011 request ($13b).

Generally speaking unless it is not specifically precluded, agencies CAN shuffle funds within an account (“reprogramming”) but are prohibited from moving funds from one account to another (“transferring”). Thus even if a Republican-led Congress denies PPACA related funds to HHS in 2011/’12, HHS arguably has sufficient latitude to fund most if not all of its PPACA-related agenda through reprogramming, as this spending is such a small percentage of the HHS discretionary total. In theory, Congress might act to specifically disallow reprogramming within HHS, but this is practically unlikely in that the Senate and White House would have to go along with whatever legislation blocked HHS’ latitude to reprogram – and it is far tougher for a Republican-led House to pass legislation to deny re-programming than to block funding. It follows that HHS probably can fund its PPACA-related activities even in the face of a Republican-led defunding effort. And, we note that much of HHS PPACA-related spending goes to implementing changes to Medicare, Medicaid, and the Children’s Health Insurance Program (CHIP), and that many (though not all) of these changes are politically popular. Thus defunding HHS’ PPACA-related activities is also politically risky, and taking such risks makes little sense when defunding may have little real effect on the agency’s work. All in, this suggests that HHS defunding is somewhat unlikely; and, by extension, that HHS will have both the new authorities which are most immediately relevant to healthcare stocks (e.g. development and oversight of health insurance exchanges and MLR regulations)[9], and the ability to fund its related activities.

IRS is a much different story – its PPACA-related activities are essential to the function of health insurance exchanges (HIE’s); and, its PPACA-related spending is a substantial percentage of its total spending – arguably too much to be met by simple re-programming of existing IRS accounts. Recall that households with incomes below 400% FPL generally are eligible for federal subsidies (assuming among other things that the household does not have suitable employer-sponsored insurance), and in particular that the subsidy takes the form of a premium tax credit. Thus IRS is responsible for making very detailed determinations of applicable credits on a household by household basis, which implies the agency will need substantial additional administrative capacity; i.e. this implies that, unlike HHS, IRS almost certainly cannot meet its PPACA obligations without its incremental funding.

  1. See for example: Fivethirtyeight.blogs.nytimes.com
  2. A return to a Democratically controlled House in 2012 theoretically would allow Congress to appropriate funds ‘off-cycle’ for IRS’ PPACA-related activities in 2013, though this presumes the Senate and White House remain under Democratic control as well
  3. A very real possibility is that the HIE’s won’t function well, i.e. that they falter or even collapse under the weight of adverse selection. We doubt the policy reaction to such a failure would be elimination of the HIE’s; rather, we’d expect Congress to change the underlying rules that govern the HIE’s
  4. “Why UNH and WLP Appear Better Positioned for Reform than AET or CI”, Sector & Sovereign Research LLC, June 15, 2010
  5. “Why US healthcare demand appears to be falling”, Sector & Sovereign Research LLC, September 7, 2010
  6. See “Three Reform Realities that Aren’t Priced In,” March 29, 2010.
  7. CBO letter to Rep. Jerry Lewis, May 11, 2010
  8. We take the costs over 8 rather than 10 years to acknowledge that the CBO horizon starts in 2010 and no funds have been appropriated, or requested, for 2010 or 2011
  9. To be clear, we recognize that the authority to regulate MLR falls mainly to the states, though HHS nevertheless does have considerable ability to influence the translation of the PPACA statutes into regulation, and to set ‘the temperature in the room’ with respect to how strictly the regulations are applied
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