Talking Transitions

Reform Legislation Aside, ICD-10 Unpreparedness Could be Health Care's Biggest Challenge

noreply@blogger.com (SYDNEY WILLIAMS) — Wed, 20 Jan 2010 14:47:00 +0000

Regardless of how reform legislation plays out, the health care industry still has stormy seas to navigate in the months ahead. Business intelligence technology and regulatory compliance will feature among these navigational challenges, perhaps none more prominent than ICD-10 implementation.

On January 14th, Milliman, an actuarial consultancy, blasted a warning shot across the industry's bow. In a white paper surveying ICD-10 readiness, it reported that 70 percent of respondents, mostly health plans, indicates little or no prepared action. It also demonstrated that many payers expect to hand off responsibility to IT vendors.

The International Classification of Diseases, or "ICD", is a diagnostic and procedural coding system originally developed by the World Health Organization, and fully utilized in the United States. The ICD system connects not just the entire $2.5 trillion US health industry, but the global health care system itself.

ICD's ninth edition debuted in the late 70s. The U.S. later revised this version to meet its demands for greater specificity. This "clinical modification", or "CM", roughly doubled the number of categories. ICD-9-CM is now employed in all inpatient, outpatient and physician office settings.

In 1992, the WHO introduced the tenth edition, and, in 2015, it's planning to introduce the eleventh edition, which will adopt Web 2.0 collaboration principles.

At its most basic, ICD establishes the means for dollars to flow between buyers and sellers of health care services. It allows payers and providers to communicate on reimbursement and administrative transactions, in addition to care delivery procedures, such as documentation of a patient's visit, research activities, public health reporting, and quality reporting.

Y2K redux
A year ago, the Department of Health and Human Services ("HHS") mandated ICD-10 adoption by October 1, 2013, a three year postponement to its original 2010 target. The rest of the world, meanwhile, has already switched from the previous version.

The differences between ICD-9 and ICD-10 are stark. Whereas ICD-9 provides about 13,000 diagnosis and 3,000 procedure codes, ICD-10 will provide 68,000 and 87,000 codes, respectively. The format and syntax of the two systems vary substantially, as well.

Many industry insiders, in fact, compare its implementation to the time, effort and dollars spent on Y2K. (Read here.)

For providers, the typical three-physician practice can expect to pay $84,000 in system upgrades, according to the Medical Group Management Association. At the same time, HHS is also mandating that these practices meaningfully use certified electronic health records ("EHRs"), and comply with new HIPAA regulations.

HHS, by comparison, is targeting $44,000 per physician in incentive payments for EHR adoption. No such incentives exist for ICD implementation.

Many practices, as a result, confront not only severe financial challenges, especially in a pressured reimbursement environment, but also significant workflow disruptions, with potential impact on patient care.

Three-physician practices constitute about one of every two practices, and 80 percent of all outpatient visits. Any grassroots upheaval will impact the system as a whole.

Vendor dependence
Milliman argues that, while IT vendors might drive "minimal compliance", most organizations won't want to delegate "business decisions that, when inadequately addressed, will expose themselves to severe operational and financial risks". It points out that covered entities, not their vendors, are owners of the business, and ICD-10 transition will affect a broad scope of operations, not just vendor systems and services.

Among seven categories HHS has indentified as benefits, the agency has calculated a net present value accruing from ICD-10 implementation of more than $3 billion for the top five.

more accurate payments for new procedures
fewer rejected claims
fewer improper claims
better understanding of new procedures
improved disease management
better understanding of health conditions and health care outcomes
harmonization of disease monitoring and reporting worldwide

This calculation, as Milliman emphasizes, does not include strategic benefits that payers would gain in better information about care delivery and utilization.

It also does not include the negative impact of unintended consequences stemming from workflow disruption.

Health information consultancies win
Recently, the market intelligence firm IDC issued its top ten health care payer predictions for 2010; its number one prediction: the renewal of information management business models.

The report's authors highlight "cost containment, a changing competitive market, business efficiency, outcomes improvement, transparency, and partnership efforts among ecosystem participants" as dominant background themes.

Other predictions making up the top ten include:

Business intelligence technology will be the number one investment category.
Actionable advice initiatives will lead health care payer business intelligence priorities and investment.
Legislative and regulatory compliance initiatives will be among the top three technology investment categories in 2010.
Health care payers will seek and prioritize strategic technology partnerships.
Segmentation will become the new strategic asset.
Reform and the value-based health plan model will drive sales and customer acquisition automation ("quote to card") solutions.
Payment reform will drive new investment in provider network, contract, payment, and analytic solutions.
Communications and document management technology investment will appear among the top ten technology investment growth categories.
Medical home best practices will emerge.

Along with health reform, IDC highlights ICD-10 implementation as a core issue impacting the payer marketplace.

As its 2010 predictions clearly establish, information technology continues to emerge as health care's prevailing value driver. No wonder industry watchers expect double digit growth over the next few years. Creative vendor financing and lower cost technologies such as open source software will support rising demand among IT purchasers.

Expect health information consultancies to benefit strongly, as payers and providers increasingly seek external advice. The business impact will be significant, likely not dissimilar to enterprise resource planning ("ERP") system implementation, which has driven consulting profits for two decades—first accelerating in preparation for Y2K.

Just as share prices of health IT vendors performed strongly throughout 2009, shares in health information consultancies could gain in 2010. Since January last year, Allscripts-Misys Healthcare Solutions (MDRX) is up over 130 percent. Cerner Corporation (CERN) is nearly 150 percent higher.

Among the large health information consultancies, Accenture (ACN), IBM (IBM) and even Dell (DELL) and Hewlett-Packard (HPQ) could all see increasing demand for their services.

Small consultancies, though, could be among the biggest winners. Over 5,000 hospitals and 650,000 physicians make up the fragmented provider marketplace. ICD-10's complexity will no doubt generate highly specific needs across this universe.

Perhaps the most basic requirement for ICD-10 implementation will be a mechanism that allows buyers and sellers of this type of consulting service to locate each other in an efficient way.

One for the Ages: Health Reform Will Take Years to Unravel

noreply@blogger.com (SYDNEY WILLIAMS) — Mon, 21 Dec 2009 16:30:00 +0000

As the Senate readies final passage of its version of the health care bill, the country now focuses on the House, and alterations its members might propose in conference committee. Any material change could jeopardize agreements among Senate Democrats, and the bill itself.

Those odds appear quite low, however. Enactment is expected before the president's State of the Union address in January.

In the end, old-fashioned politicking will have enabled the largest health care overhaul in a generation. The Republican party, simply, had little ability to stall a filibuster-proof super majority, other than attempt to win over moderate Democrats and blunt some of the legislation's more pointed provisions.

Applying lessons learned from the past, including the first Clinton administration's attempt at health reform, the Obama administration established an aggressive agenda that centered on the House and Senate majority leaders' ability to shape the manifold details. The Democrats achieve not just a politically, but also an ideologically important victory.

Even with its majority, the party had to coalesce diverse positions on contentious issues. The end result is a substantial milestone in liberal philosophy, and the fundamental belief that health care should be a right just like freedom of speech or national defense. (Lawmakers and lawyers, though, are likely to challenge this notion in terms of the constitutionality of an individual mandate.)

The bill's final version will endure well over 2,000 pages of text, or more than 700,000 words. While lawmakers, congressional staffers, lobbyists and others have pored over its many details, no one has any idea what the total impact will be, or how its different features will intersect. Large sections simply have not yet faced the glare of public disclosure, beyond a coterie of Washington insiders.

As a result, it will take years to assess its full impact. Many of the bill's significant provisions, in fact, don't take effect until after the 2012 presidential election.

Even the independent Congressional Budget Office quantifies just measurable initiatives to existing programs such as Medicare and tax law. For other, more speculative, proposals such as payment reform or comparative effectiveness research, it ascribes less value—if any at all.

And perhaps the best quantifier of all, Wall Street, cannot fully implement its discounting mechanism because it simply does not trade the vast majority of the industry's value. Drugmakers, for example, make up half of health care market capitalization, but prescription drugs account for just 12 percent of $2.4 trillion industry. (Read "The Missing Stakeholder in Health Care Reform" in the Lyceum newsletter Perspectives, volume 5, issue 10.)

With so much uncertainty, folks will dedicate considerable time and effort over the coming months to analyzing and acting on its many consequences—in particular its unintended ones—in countless settings, from corporate water coolers to massive industry conferences. Smart minds will discover loopholes, from which new businesses will emerge as others diminish.

At the bill's heart—and no different than its debate throughout 2009—are fundamental questions of government intervention and consumer choice: How far should public policy extend into the care delivery process? What impact does this have on cost, quality and access? And does this process enable consumer choice? Should it? Its enactment further emphasizes government as the primary price setter (and, therefore, the primary influencer of care), while further diminishing market-based solutions.

However industry practitioners and observers measure its consequences, the public-private tradeoff will always feature as the central framework. One of the biggest tugs-of-war, for example, will be in the expanded number of covered lives: How much economic value do these additional lives create versus the cost of tighter regulation? Does this result in better health outcomes?

Expect the following topics to feature as examples of complex issues that are legislated but which could take months and years to develop and understand fully.

Accountable care organizations: the real-world and virtual integration of care delivery, involving local providers such as physician group practices and hospitals, and their patients
Comparative effectiveness research: the comparison and recommendation of different interventions in patient care.
Follow on biologics: the pathway enabling the manufacturing and distribution of large-molecule medications similar to proprietary predecessors.
Health insurance exchanges: the government regulated marketplace of insurance plans with different levels of coverage.
Independent cost-cutting commission: the expert body or institution exercising politically independent powers to reduce costs and inefficiencies across the health care system.
Payment reform: the shift away from a volume-based, fee-for-service model to something bundled or based on episodes of care.

Borrowing directly from The Wall Street Journal and Washington Post, we've reproduced below a side-by-side comparison of the Senate and House bills, many differences which the conference committee will have to reconcile.

Senate bill: Patient Protection Affordable Care Act
House bill: Affordable Health Care for America Act

Who is covered
Senate

The bill would ensure that 94 percent of legal residents have insurance coverage. The projected number of uninsured in 2019 is 23 million.

House

About 96 percent of legal residents under age 65—compared with 83 percent now. The projected number of uninsured in 2019 is 17 million.

Cost
Senate

The Congressional Budget Office estimates the bill to cost $871 billion and to reduce the federal budget deficit by $130 billion over 10 years

House

The CBO says the bill's cost is $1.05 trillion and reduces the deficit by $109 billion over 10 years
The net cost is $894 billion, factoring in penalties on individuals and employers who don't comply with new requirements. But after adding up a variety of new costs in the bill, including increased prescription drug coverage for seniors under Medicare, the cost is around $1.2 trillion

How it’s paid for
Senate

New excise tax on high-premium insurance plans, equal to 40 percent of premiums paid on plans costing more than $23,000 annually for families, $8,500 for an individual
$480 billion in cuts to Medicare over a decade
A fee on employers whose workers receive government subsidies to help them pay premiums; fines on people who fail to purchase coverage
An increase in the Medicare payroll tax by 0.9 percentage points to 2.35 percent on income over $200,000 a year for individuals, and $250,000 a year for couples.
Fees on insurance companies, drug makers and medical device manufacturers

House

$460 billion over the next decade from new income taxes on single people making more than $500,000 a year and couples making more than $1 million—the threshold was increased from $280,000 and $350,000, in response to lawmakers' concerns that the taxes would hit too many people and small businesses;
More than $400 billion in cuts to Medicare and Medicaid
A new $20 billion fee on medical device makers
$13 billion from limiting contributions to flexible spending accounts
Fines paid by individuals and employers who don't obtain coverage and a mix of other corporate taxes and fees

Requirements for individuals
Senate

Nearly every American would be required to obtain insurance, through either an employer, the exchange or other program
Individuals must purchase insurance or pay a penalty that would be the greater of $750 ($2,250 for a family) or 2 percent of income by 2016.
The maximum amount workers would be required to spend on premiums would be capped at 9.8 percent of income.
Exemptions for economic hardship

House

Individuals must have insurance
People who fail to purchase coverage would face a tax penalty of 2.5 percent of income.
People can apply for hardship waivers if coverage is unaffordable.

Requirements for employers

Senate

Companies with more than 200 employees are required to automatically enroll employees in plans.
Companies with more than 50 full-time workers that do not offer coverage would pay a fee as high as $750 multiplied by the total size of the work force if the government ends up subsidizing employees' coverage.
Tax credits for small employers.

House

Employers must pay 65 percent of family premiums or pay a penalty of 8 percent of payroll.
Companies with payrolls under $250,000 annually are exempt and the penalty is phased in for companies with payrolls between $500,000 and $750,000.
Businesses with 10 or fewer workers get tax credits to help them provide coverage.

Exchanges/subsidies

Senate

The bill would set up new insurance marketplaces—called exchanges—where people without access to affordable coverage through an employer could purchase comprehensive plans. Tax credits would be available on a sliding scale for individuals and families who earn up to 400 percent of the federal poverty level ($88,200 for a family of four).

House

Subsidies for individuals and families likely making up to 400 percent of the poverty level ($88,200 for a family of four). The subsidies would begin in 2013.

Insurance reforms

Senate

All plans sold to individuals and small businesses would have to cover basic benefits, including bans on lifetime limits, premium disparity based on health status and sex and coverage denials based on preexisting conditions. (Guaranteed issue, community rating, minimum insurance standards)
The government would set four levels of coverage: Under legislation passed by the Senate Finance Committee the least generous would pay an estimated 65 percent of health care costs per year; the most generous would cover an estimated 90 percent. Those numbers could change.
Establishes a national, voluntary insurance program for long-term care under which people would pay into the system while they're healthy and be eligible for cash payments if they need services for daily living needs.

House

A committee would recommend a so-called essential benefits package including preventive services.
Out-of-pocket costs would be capped.
The new benefits package would be the basic benefits package offered in the exchange
Includes bans on lifetime limits, premium disparity based on health status and sex and coverage denials based on preexisting conditions. The bill also would end a federal antitrust exemption that has for decades protected firms from federal investigations. (Guaranteed issue, community rating, minimum insurance standards)

Government-run plan

Senate

Democratic senators dropped a plan that would have had the government directly operate a health-insurance plan, while giving states the right to opt out
In place of that, the senators embraced a more limited proposal that would empower the government's Office of Personnel Management to put in place a new low-cost national health plan
The new national plan would be run by nonprofit entities set up by the private sector, and would be available to the public on the new insurance exchanges that would be created under the bill

House

A new public plan available through the insurance exchanges would be set up and run by the secretary of Health and Human Services
Democrats originally designed the plan to pay Medicare rates plus five percent to doctors. But the final version would let the HHS secretary negotiate rates with providers

How you choose your plan

Senate

Self-employed people and small businesses could pick a plan offered through new state-based purchasing pools
Employees would be generally allowed to keep their work-provided coverage

House

Beginning in 2013 through a new Health Insurance Exchange open to individuals and, initially, small employers
It could be expanded to large employers over time
States could opt to operate their own exchanges in place of the national exchange if they follow federal rules

Changes to Medicaid and Medicare

Senate

Senators dropped a plan to expand Medicare coverage to some people ages 55 to 64
For Medicaid, income eligibility levels likely to be standardized to 133 percent of poverty ($29,327 a year for a family of four)
States could negotiate with insurers to arrange coverage for people with incomes slightly higher than the cutoff for Medicaid
The federal government would pick up the full cost of the expansion for 2014 through 2016; thereafter financing will be shared through an increase in the federal medical assistance percentage ("FMAP")

House

For Medicaid, the federal-state insurance program for the poor would be expanded to cover all individuals under age 65 with incomes up to 150 percent of the federal poverty level ($33,075 per year for a family of four)
The federal government would pick up the full cost of the expansion in 2013 and 2014; thereafter the federal government would pay 90 percent and states would pay 10 percent

Exemptions for economic hardship

House

Individuals must have insurance
People who fail to purchase coverage would face a tax penalty of 2.5 percent of income.
People can apply for hardship waivers if coverage is unaffordable.

Requirements for employers

Senate

Companies with more than 200 employees are required to automatically enroll employees in plans.
Companies with more than 50 full-time workers that do not offer coverage would pay a fee as high as $750 multiplied by the total size of the work force if the government ends up subsidizing employees' coverage.
Tax credits for small employers.

House

Employers must pay 65 percent of family premiums or pay a penalty of 8 percent of payroll.
Companies with payrolls under $250,000 annually are exempt and the penalty is phased in for companies with payrolls between $500,000 and $750,000.
Businesses with 10 or fewer workers get tax credits to help them provide coverage.

Exchanges/subsidies

Senate

The bill would set up new insurance marketplaces—called exchanges—where people without access to affordable coverage through an employer could purchase comprehensive plans. Tax credits would be available on a sliding scale for individuals and families who earn up to 400 percent of the federal poverty level ($88,200 for a family of four).

House

Subsidies for individuals and families likely making up to 400 percent of the poverty level ($88,200 for a family of four). The subsidies would begin in 2013.

Insurance reforms

Senate

All plans sold to individuals and small businesses would have to cover basic benefits, including bans on lifetime limits, premium disparity based on health status and sex and coverage denials based on preexisting conditions. (Guaranteed issue, community rating, minimum insurance standards)
The government would set four levels of coverage: Under legislation passed by the Senate Finance Committee the least generous would pay an estimated 65 percent of health care costs per year; the most generous would cover an estimated 90 percent. Those numbers could change.
Establishes a national, voluntary insurance program for long-term care under which people would pay into the system while they're healthy and be eligible for cash payments if they need services for daily living needs.

House

A committee would recommend a so-called essential benefits package including preventive services.
Out-of-pocket costs would be capped.
The new benefits package would be the basic benefits package offered in the exchange
Includes bans on lifetime limits, premium disparity based on health status and sex and coverage denials based on preexisting conditions. The bill also would end a federal antitrust exemption that has for decades protected firms from federal investigations. (Guaranteed issue, community rating, minimum insurance standards)

Government-run plan

Senate

Democratic senators dropped a plan that would have had the government directly operate a health-insurance plan, while giving states the right to opt out
In place of that, the senators embraced a more limited proposal that would empower the government's Office of Personnel Management to put in place a new low-cost national health plan
The new national plan would be run by nonprofit entities set up by the private sector, and would be available to the public on the new insurance exchanges that would be created under the bill

House

A new public plan available through the insurance exchanges would be set up and run by the secretary of Health and Human Services
Democrats originally designed the plan to pay Medicare rates plus five percent to doctors. But the final version would let the HHS secretary negotiate rates with providers

How you choose your plan

Senate

Self-employed people and small businesses could pick a plan offered through new state-based purchasing pools
Employees would be generally allowed to keep their work-provided coverage

House

Beginning in 2013 through a new Health Insurance Exchange open to individuals and, initially, small employers
It could be expanded to large employers over time
States could opt to operate their own exchanges in place of the national exchange if they follow federal rules

Changes to Medicaid and Medicare

Senate

Senators dropped a plan to expand Medicare coverage to some people ages 55 to 64
For Medicaid, income eligibility levels likely to be standardized to 133 percent of poverty ($29,327 a year for a family of four)
States could negotiate with insurers to arrange coverage for people with incomes slightly higher than the cutoff for Medicaid
The federal government would pick up the full cost of the expansion for 2014 through 2016; thereafter financing will be shared through an increase in the federal medical assistance percentage ("FMAP")

House

For Medicaid, the federal-state insurance program for the poor would be expanded to cover all individuals under age 65 with incomes up to 150 percent of the federal poverty level ($33,075 per year for a family of four)
The federal government would pick up the full cost of the expansion in 2013 and 2014; thereafter the federal government would pay 90 percent and states would pay 10 percent

Controlled Information Exchange

noreply@blogger.com (SYDNEY WILLIAMS) — Sat, 12 Dec 2009 20:24:00 +0000

What's the point of information exchange, if you can't view it, analyze it or pass it along?

On Friday, December 11th, shares in the market research firm IMS Health tumbled on news of a proposed amendment to the Senate health bill that would ban drugmaker access to prescription data. Should this legislative action pass, it would force down the company's valuation just as IMS's management team finalizes the company's sale—the largest private equity transaction of 2009—to TPG and the Canada Pension Plan.

The federal rule's terms are not groundbreaking at the state level. They would mimic similar legislation enacted in New Hampshire, Maine and Vermont over the past four years. In fact, it was also IMS Health that lost a 2008 appeal against the state of New Hampshire and its law banning prescription drug data gathering. In June 2009, the US Supreme Court declined to review the appeal, opening the possibility for other states to legislate similar bans.

Important questions
And while the Senate amendment may not pass, it does raise important questions, none of which is likely to disappear anytime soon:

How important is free flowing information to the economic model of an industry and its value chain?
What are appropriate consumer protection mechanisms?
Do digital data require a different set of rules than analogue data?
What's the balance of power between states and the federal government in controlling information flow?

Because the debate over prescription drug information features—as its key issues—consumer privacy, data ownership and government intervention, its participants are likely to extend across and beyond the health care sector.

To put it simply, the implications of a national law are as vast as the economy itself. They impact not just the usefulness of health information exchange, but the effectiveness of the care delivery system, and—beyond health care—the general application of market analysis to consumer buying behavior.

Consider this just in terms of health care. As part of the March 2009 stimulus bill, lawmakers allocated nearly $20 billion in incentive money that the Department of Health and Human Services ("HHS") will pay out to providers adopting electronic health records in a meaningful way. The first payments are scheduled to begin in little more than a year.

Digital health information, the argument goes, leads to better patient outcomes because it allows for critical data exchange across the care delivery system, which includes not just providers, but also product manufacturers, service vendors, payers, consultants and others.

Already, that system is learning new HIPAA rules, which impose additional restrictions on information flow, and now include both civil and criminal penalties for non-compliance. If government hardens the flow even more, especially as the health industry transitions to a digital framework, it could, in effect, devalue taxpayer money to zero even before HHS doles out the incentives. (Read "Digital Health Records Biggest Obstacle" in the Lyceum newsletter Perspectives, volume 5, issue 10.)

HHS, as an aside, will pay this money through Medicare reimbursement, utilizing the current fee-for-service framework. Many industry people believe Congress missed an important opportunity to shift reimbursement to a value-based system.

The Health Insurance Portability and Accountability Act ("HIPAA") of 1996 established standards for electronic information exchange and the use and disclosure of patient information. Health professionals have complained about its burdensome requirements, often challenging patient care and medical research capabilities, and its added administrative costs. In March 2009, under the American Recovery and Reinvestment Act, Congress introduced the Health Information Technology for Economic and Clinical Health, or "HITECH", Act, which further tightens standards in the handling of patient data—for example, its tracking practices and notification of breaches. HITECH imposes more severe penalties and expands the number of liable parties, or covered entities, to include business associates.

Limited information
Even if providers can implement EHR systems that function appropriately as defined by "meaningful use"—and many industry people don't expect this to lead to substantially higher penetration rates among different provider groups than the single digits that currently exist—few of them would have much use for the patient information that the systems could navigate.

It would be no different than purchasing a fully-loaded, high-performance sports car, when onerous road rules limit its owner just to driving around the block.

While government should establish basic parameters, it risks derailing substantial progress in digital information exchange if it complicates a nascent system. Unintended consequences could have lasting impact.

Government would also establish a precedent that extends to other industries. Lawyers will likely challenge any effort aimed at packaging and selling consumer buying behavior, including highly sophisticated systems in the retail industry. Even companies relying on proprietary systems, such as Walmart and Amazon.com, could see direct challenges to their business models, if a national consumer protection law is aggressively pursued.

At the very least, we're learning how just one small amendment to a massive congressional bill could propagate an economic shock wave. Sorting through the bill's myriad details could take longer than its multi-year roll out.

Perhaps we'll discover that many of these details cancel the net economic impact. Then again, maybe they'll multiply the impact.

Either way, the market's reaction to IMS Health reveals deep-rooted uncertainty that won't soon go away.

Risk Takers Take to Health Care

noreply@blogger.com (SYDNEY WILLIAMS) — Sat, 28 Nov 2009 23:00:00 +0000

What motivates innovation and entrepreneurship? A good business plan, capital—and a propensity for risk taking. Although bright ideas are plentiful, market activity has hardened since the onset of the financial crisis. Capital flows, once voluminous, have eased to a trickle.

Risk taking comes from asking a simple question: "Should I, or shouldn't I?" Should I, or should I not, commit my own wealth to an uncertain venture?

For now the 'Shouldn't Is' fall into the majority. In fact, many economists expect risk aversion to linger for quite some time.

Yale economist Robert Shiller, in a January opinion piece to the Wall Street Jouranl, describes the 'Should I, or I shouldn't I' back-and-forth in terms of market trust, or "animal spirits" as Keynes put it:

[L]ost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place—for why the economy fluctuates as it does.

He argues that without market trust the economy cannot recover fully.

By holding back, industry suitors and investors (suppliers of capital) diminish future opportunities for themselves and their targets. This process perpetuates a vicious cycle of hand-sitting, and suppresses economic momentum.

As we know, the economy encompasses many different pieces, and while its composite may stagnate, certain pockets expand and absorb whatever excess capital exists.

Since the recession's start nearly two years ago, risk takers that exist have mostly targeted health care. Consider this, first, in terms of trends in venture-backed companies and mergers and acquisitions. Next, think of the potential catalyst this creates in altering health care's fundamental economic model.

Venture-backed companies
In the second quarter (2009), health care surpassed information technology as the largest industry in money raised for the first time in a decade. For every dollar health care companies collected in 2008, IT firms brought in $1.37. So far, in 2009, the levels are equal.

The table below illustrates the relative portion of funds raised between the two industries over the past seven quarters, and compares this to the dollar amount for all venture-backed companies. (Source: Dow Jones VentureSource)

	2008
Period	Q1	Q2	Q3	Q4	Total
Health Care	26%	31%	28%	30%	29%
Information Technology	43%	38%	38%	39%	39%
Total Raised (million)	$8,559	$8,347	$8,170	$6,086	$31,163
	2009
Period	Q1	Q2	Q3		Total
Health Care	34%	41%	34%		37%
Information Technology	40%	36%	37%		37%
Total Raised (million)	$4,082	$5,420	$5,086		$14,588

While health care and technology accounted for about 70 percent of funds in each quarter, the mix shifted. Health care increased its portion by nearly 50 percent, from 26 to 37 percent of total.

Comparing the first three quarters of each year, total dollars shrank by 42 percent, from $26 billion to $16 billion. Money invested in IT narrowed by 45 percent, but decreased by a more modest 25 percent in health care, from $7.1 billion to a $5.3 billion.

Mergers and acquisitions
Though more quiet in recent months, the biopharmaceutical industry featured several large-scale, strategic transactions in the first half of 2009. This next table showcases the biggest deals.

Type	Acquirer	Target	Value
Strategic	Abbott Labs	Advanced Medical Optics	$2.8 billion
Strategic	Johnson & Johnson	Mentor Corp	$1 billion
Strategic	Pfizer	Wyeth	$67 billion
Strategic	Merck	Schering-Plough	$41 billion
Pipeline	Johnson & Johnson	Cougar Biotechnology	$1 billion
Pipeline	Roche	Genentech	$47 billion
Pipeline	Bristol-Myer Squibb	Medarex	$2.4 billion
Pipeline	Sanofi-Aventis	Fovea Pharmaceuticals	$500 million

Through October, across all industries, bankers closed nearly 5,800 deals in the US worth $620 billion. Despite levels down considerably from 2008 and 2007, health care's share is a robust 21 percent, six percentage points higher than industrials (second rank) and seven points better than financials (third rank).

Debt placements totaling $58 billion have fueled buyout firms, making 2009 a peak year, surpassing 2007. Just in November, Goldman Sachs financed TPG Capital and Canada Pension Fund's $5.2 billion acquisition of medical data provider IMS Health—the largest private equity transaction so far in 2009.

Expect the following market dynamics to expand deal activity throughout 2010:

Portfolio pressure among private equity firms: Costlier financing and shareholder pressure are likely to force firms to realize exit strategies in the coming months. "2010 and 2011 will see a big explosion in dealmaking activity' as the debt deals that financed the buyouts begin to approach the end of their five-year term," commented Portfolio.com. "Until now, there has been little incentive for private equity owners to try to sell or otherwise capture any profits on their health care acquisitions; doing so would have required them to dismantle their existing cheap financing and replace it with more costly capital."
Drugmaker shortfalls: A reticent FDA and looming patent expiry are forcing big pharma to look to mergers and acquisitions for growth. Products totaling nearly $200 billion in sales are expected to go off-patent in the next five years. Proprietary drugmakers are now paying richly for products to add to pipelines "to offset the revenue they’re losing to lower-priced copies". (Source: Bloomberg News)
Unspent capital: Despite health care's relative buoyancy, private equity firms still boast over $400 billion in unallocated money, noted Bloomberg News. Cost cutting, demographics and the prospect for health care reform are creating new opportunities.
Dollar weakness: Foreign purchasers may take advantage of the greenback's tailspin. Against the euro, yen and other major currencies, the dollar has lost more than a third of its value since its 2002 peak.
Scarcity premium: The recession may have ended, but the recovery process has begun slowly. Health care growth—about 10 percent per annum—ensures a more stable outlook than other industries.
Expanded health care coverage: Both the senate and house reform bills expand coverage to over 30 million people, establishing a large revenue base for many different companies. Health insurance companies are facing margin contraction on more regulation, but many other players could see incremental growth.

Economic model
Health care's sheer economic weight guarantees that its innovators and entrepreneurs will access at least a disproportionate amount of capital relative to other industries. However, even in a dominant risk-taking environment, industry suitors and investors would still require adequate compensation.

In current conditions, suppliers of capital are much less forgiving. Strategic buyers are searching for acquisitions that are immediately accretive. Financial buyers, expecting capital costs to increase, are screening for lasting high returns on capital.

Less evolved companies, or companies confronting uncertain cash flow, will have a tougher time finding shareholders and suitors. Take, for example, private equity portfolios. The private equity universe holds about 100 companies valued in excess of $500 million (Source: Portfolio.com). About a quarter of these companies are publicly traded. The rest would need to demonstrate not just clear, but immediate returns to prospective buyers.

But it's not just a question of financial strength. Companies should also boast an innovative business model. This business model, moreover, needs to center on cost savings—or value—as its money-making mission. Those companies that demonstrate identifiable savings for their clients, no matter their industry segment, should enjoy the best prospects in attracting capital and doing deals.

Until capital constraints ease for the economy as a whole, risk-aversion will firmly control the 'Should I, or shouldn't I' debate. For now, risk takers, in the minority, favor health care, though the degree of their commitment could fluctuate widely depending on returns.

Whether it's the house or senate reform bill, or some combination of both, don't expect legislation to alter health care's fundamental economic framework. Supply and demand still won't transact with each other, and cost growth will only accelerate.

We can be sure that what we know health care to be today will continue indefinitely, at least until the system can no longer afford itself.

Give market dynamics a chance. If financial and strategic investors want to commit capital, then its their choice, and their choice alone—win or loose.

It would be the most effective, and least politicized, way to make health care more efficient.

One day, dealmaking and investing might even repair the economic model.

For observations on the public equity markets, read "The Missing Stakeholder in Health Reform".

Open Letter to the American CEO: Five Need-to-Know Facts About Health Care

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 30 Oct 2009 22:34:00 +0000

Dear CEO of Any Company:

Want in on a little secret? Here's what health care's brightest business people think about reform: whatever lawmakers accomplish this fall, it won't alter how the system works or move the needle on costs.

Now—more than ever—you need to understand health care's fundamental underpinnings. As the corporate leader, you aren't just managing health care costs. Even if your business is in a non-health care industry, you are likely seeing new revenue opportunities emerge in health care as it expands across the economy.

Whether cost control or revenue growth, knowing how the system works is a crucial first step towards margin expansion.

Consider these five must-know facts.

1. Supply and demand do not transact with each other. At a recent Lyceum roundtable on health care reform, one entrepreneur noted: "Are we going to change a system where consumers don't pay and payers don't consume? I don't think so, unless Washington suddenly starts advocating market-based solutions."

It's ironic, and perhaps telling, that a section of the economy as large as health care doesn't perform as a normal industry. At ground level, physicians provide services, but payment is received not from customers but from commercial health plans and government. Because supply does not actually transact with demand—unlike any other industry—there can be no market-determined price or consistent measure of quality and value.

What's more, physician service reimbursement occurs under a volume-based framework, called fee-for-service, where doctors submit claims based on specific inputs, not total care.

Medicare, for example, applies a complex reimbursement formula called the resource-based relative value scale ("RBRVS") to non-hospital rendered physician services—about 25% of total health care expenses. A 29-member committee, determines exactly how much Medicare will pay for these individualized services. Critically, it also serves, de facto, as the basis for commercial health plan reimbursement. This single committee, therefore, controls nearly $600 billion dollars in industry pricing.

Transparency is non-existent. And the medical value chain is left with cost control as its only profit lever.

2. Market forces also don't shape the drug supply chain. While in-patient and out-patient services exist outside standard economic practices, the other 20% of health care—the drug supply chain—does not follow the same framework, except for products that providers directly administer, such as infused and injected biologics. Commercial health plans and pharmacy benefit managers, instead, apply formularies to steer beneficiaries to more effective medication usage.

At least that's the intent. In reality, drug benefit managers also operate in their own opaque system, just not one controlled by a single committee. To optimize business margins, they negotiate directly with drugmakers on behalf of employers, their clients. Volume-driven rebates, pharmacy network spreads and mail service margins all affect formulary placement. Large margins, in particular, characterize generic drugs.

Drug manufacturers, meanwhile, have targeted physicians, directly and indirectly through consumer-directed advertising for branded products. Doctors, however, don't pay for the products. And those eagerly-courted erectile-dysfunctional consumers, happily forking out $30 co-pays, have no conception of actual prices.

Still, Caterpillar's recent effort with Walmart (and now Walgreens) attempts to alter this system by introducing a new competitive force: the retail channel. And unlike the medical side, the entire drug supply chain is publicly-traded, exposing it to shareholder demands and expectations.

The net effect of all this is that prescriptions are prescribed, purchased and paid for outside of anything resembling a normal supply/demand market framework.

3. Information is the most important commodity. In a system as complex as health care, knowing what someone else doesn't know can make all the difference in the world.

Here, there's an important parallel with the financial service industry. Broker-dealers, Wall Street's middlemen, have traditionally operated at the confluence of market data streams. Whether it's corporate news flow or clients orders, no other entity processes as much information. While so-called Chinese walls presumably deter misuse of this information, neither corporations nor institutions possess even a fraction of this information wedge.

In the late 1990s, things changed, as broadband Internet democratized information access. Suddenly, new tools allowed counterparties to know as much—or more than—the broker-dealer. At the same time, electronic share trading networks emerged, allowing institutions to transact directly with each other.

As a result, margins in traditional advisory services shrank, and broker-dealers began turning to high-margin proprietary trading and investment services.

Health records are still 90% paper-based. On the medical side, information is so fragmented that no one entity has a distinct advantage over another. Claims processing, for example, often takes weeks or months to adjudicate, as provider and payer bicker over codes, procedures and contract pricing.

On the pharmacy side, the pharmacy benefit manager functions similarly to the broker-dealer. No other entity controls as much information about manufacturers, payers, providers and consumers.

Just as the Internet revolution recast the financial services landscape, it could likewise upend the traditional flow of information in health care. For medical benefits, it could create new power centers as information is digitized. For the pharmacy side, it threatens to disintermediate existing channels.

4. New revenue opportunities exist across industries. So what if health care is 17% or 30% of GDP? If it's efficient, then it's creating jobs and contributing to economic growth.

Many different opportunities exist for non-health care companies to take advantage of the industry's growth. Take the affordability problem, for example. Why shouldn't bankers explore new lending channels to help consumers reduce the monthly premium burden? And what about information technology? Washington has already passed legislation that will provide incentives for electronic health record adoption. Like Sarbanes-Oxley, myriad rules will apply, a complex intertwining which creates opportunities for sophisticated software and service vendors.

Health care is first and foremost a service industry. Because supply is finite, economic rules apply as in any other industry. The problem with health care is an inability to define value on a consistent basis. If a company is smart in how it navigates the industry's nuances, then plenty of revenue opportunities will exist.

Retail-centered strategies such as convenient care clinics are challenging traditional delivery of care. Emergent, cash-based business models in the primary care profession are challenging traditional reimbursement practices.

As much as regulatory constraints may burden the system, there's no shortage of innovative strategies. It's just a question of matching resolve with the appropriate resources.

5. The CEO needs to be in control. The health care dollar begins with the employer. It just doesn't necessarily end there. Health benefits is a cost center, and typically reports up through the human resource department to the CFO. In most cases, CEOs never engage in this business unit other than to monitor trend growth. And while the direct cost exposure could be 5% or more of the cost base, the indirect opportunity cost in employee efficiency is much greater.

The problem, though, is that concepts such as presenteeism and workforce productivity are difficult to quantity, and particularly difficult to justify committing big dollars to when shareholders are assessing quarterly performance.

But how much are changes in market conditions now affecting expectations placed on CEOs? We may be emerging from recession, but few people expect economic growth to sustain an accelerated pace. With trend growth lower than in the previous economic cycle—corresponding to reduced revenue expectations—CEOs have little choice but to re-examine cost structures to preserve margins.

Just as health care may present new revenue opportunities, it also creates opportunities for chief executives to drive internal efficiency, simply because only a handful of companies have taken advantage of this, and so much low-hanging fruit exists.

The CEO needs to drive this process. Whether Caterpillar, General Mills, Pitney Bowes, Safeway or Whole Foods, examples exist of CEOs forcing efficiency. But these are just a handful of companies against the thousands out there that could be doing likewise.

Health care may be complex, but knowing its basic workings puts the corporate leader at an immediate advantage. Whether cost control or revenue growth, this is no time for herd mentality.

Be proactive. How smartly you manage health care's various risks and opportunities will determine your company's success.

Capturing the Employer's Voice: A New Twist in the Health Reform Debate

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 18 Sep 2009 14:53:00 +0000

Every now and then some data point comes along that completely disrupts the flow of a debate. In health care, this occurred in June, when the Congressional Budget Office (CBO) scored the first two health reform bills to emerge from the 111th Congress.

Then, the CBO starkly reminded us that large reductions in spending cannot occur without fundamental changes in the financing and delivery of care. And dollar savings attributed to comparative effectiveness, health IT and other "soft" initiatives vanished, as simple speculation.

With its scoring, the CBO established the ten year/ trillion dollar benchmark as a deciding legislative factor. Immediately, the debate shifted from concepts and theory to economic reality. This drew in the electorate, which arcane medical and insurance language and plain-old inertia had sidelined previously. (Remember, consumerism only factors into the health value chain on a limited basis.)

Now, a just-published survey could similarly disrupt the debate. It reveals just how the biggest payer of health care is thinking. And it's not positive.

This summer, the consultancy Towers Perrin surveyed 433 employers on health reform. Here are excerpts from its press release (published September 17th):

"Employers say they will not absorb any additional costs that result from reform and plan to take actions to avoid doing so, including reducing benefits, raising prices for customers and/or reducing head count"

"Nearly one in four companies (23%) in the survey are currently rethinking benefit changes in light of possible reforms, and nearly all (89%) plan to reexamine their health benefit strategies for active employees in response to the passage of health care reform legislation. And while talent management considerations such as productivity, workforce health, and recruiting and retention remain important even in a tough economy, cost issues will dominate employers’ decision making in a post-reform world, according to the survey."

"In addition, employers do not expect that reform as currently proposed will address some of the fundamental drivers of health care costs. For example, nearly two-thirds of employers (65%) believe that health care reform will have little or no impact on consumer behaviors, an area many leading employers have begun to target as one of their key cost-containment opportunities"

"Towers Perrin’s Health Care Reform Pulse Survey also examined the experience of employers based in Massachusetts, a state that has imposed a pay-or-play mandate on employers and a coverage mandate on individuals similar to those currently proposed in Congress. Among those employers, most are not sure what, if any, impact the three-year-old Massachusetts mandates have had. Most respondents have seen little or no change in employee or employer health care costs or access to or quality of care. Notably, however, more than two-thirds of these employers report that their administrative burdens have increased."

Pretty glum. What's important, though, is that the survey unifies the employer's voice. While different trade associations exist to represent them, politics distort opinion, which too often collides, diminishing what amounts to a potent and relevant stakeholder.

Recently, we've seen political dissonance muffle certain large employers sharing individual experience—Safeway, Walmart and Whole Foods. Rather than focusing on one company, however relevant its message, this survey reflects a cross-section of experience and opinion.

Towers Perrin, a consultancy, grinds no political ax. It makes a living advising employers on managing health benefits, which includes surveys and data collection.

This survey—its timing—provides as clear a window as we're likely to get into how 60% of the health care dollar is thinking.

And if employers are planning for higher capital costs and reduced head counts, then the bill we pay could be much higher than the CBO's current scoring, which measures direct tax revenue and government spending, not indirect economic consequences.

Anyway you cut it, the survey's results present a new twist and a new reality, not likely to disappear anytime soon.

Although it doesn't carry the same headline effect of the CBO suddenly grounding congress in financial responsibility, it does forecast an economic response we could feel for some time to come.

The Capital Markets and Common-Sense Rules

noreply@blogger.com (SYDNEY WILLIAMS) — Tue, 15 Sep 2009 19:47:00 +0000

Private enterprise is taking a beating. Whether in health care or the financial services industry, policy debates rarely feature the economics of supply and demand—much less self-correcting mechanisms. Instead policymakers have re-conceived market dynamics as a web of casual relationships.

Take, for example, these common lines of argument that advocate government intervention in the capital markets. Big Wall Street bonuses lead to excessive risk taking, which forces "bad behavior" in the capital markets. Likewise, improperly incentivized ratings agencies inflate the quality of securities, which bloats leverage ratios. Or, inconsistent regulation fails to curb market excess, which contributes to a moral hazard.

The fix, then, should be simple, right? Legislate—or mandate—bonus limits, new business models for ratings agencies and more comprehensive regulation.

Okay. Let's say we accomplish this and call it common-sense rules. (Read the text of President Obama's Wall Street speech here.) Will it achieve the desired effect? Well, that depends what we mean by "desired effect" or "common-sense".

And here's the rub. The capital markets work as they do exactly because countless thousands (millions) of people interact with them daily, a few directly and many more indirectly, for many different purposes: investing, funding, speculation, arbitrage, price information, short-term needs, long-term needs, and more. Like Facebook or MySpace, the markets are a social network, except much bigger, much broader and much more unifying.

If it's control lawmakers want, then whatever they establish today risks obsolescence tomorrow—or, worse, some significant unintended consequence. Just look at the fallout from the short sale ban last fall. Market volatility elevated and the price discovery process deteriorated: the exact opposite of what the SEC and market participants intended, and needed, to take place.

Rules and regulation designed for control can never keep pace with market innovation. Nor would we necessarily ever want them to keep pace. Because if they ever were to match innovation, innovation could never occur, by definition.

Rules and regulation should, instead, support market innovation. Consider this in terms of Lehman's demise. Whether the Feds were correct in allowing the bank to shutter is secondary to the fact that the business model—Wall Street's business model—failed.

And let's not confuse the markets with Wall Street. The markets themselves didn't err. They got it right, punishing those who got it wrong. And we know government and regulators were far behind, having little clue that the Wall Street business model was failing as badly as it was.

Fast forward one year, and we're at the same place we were before the crisis. Nothing has really changed in terms of a new model taking root. The bulge bracket features new name plates, and one or two old ones. But if we view the landscape as a continuum of capital flows, then money is just as—or more—concentrated among these big guys as it was in September 2008.

In the name of 'Too Big to Fail', taxpayer money is effectively buttressing a broken model, and postponing its inevitable replacement.

The question should be: What's the opportunity cost of not allowing this transition process to take place? Weak economic growth, high unemployment, a diminished dollar, market uncertainty? Likely all four and more, as Wall Street fails to expand money flows between corporations and institutions.

Here are four expectations for the next Wall Street business model, in sequence.

A return to the partnership model. It should be no surprise that Goldman emerged on top because it embraces a model closest to a partnership than any of its competitors. In contrast to a shareholder controlled firm, a partnership ties the firm's capital directly to its manager, so that risk capital is their money, not other people's money.

A breakdown of concentrated capital. Empire building may be instinctive, but emperors will always define themselves by personal gain. It would be naive to expect that market participants would ever curtail their pursuit of personal fortune. That pursuit, though, could be much more lucrative in a different business model, even if the ultimate scale of the business is much smaller than, for example, Sandy Weill's Citigroup at its peak.

A greater sense of firm identity. An important byproduct of the partnership model is less employee turnover. The compensation format ties individuals to a firm. Wall Street had become a battlefield of mercenaries: analysts and bankers, for example, benchmarking themselves against external polls, instead of their own contribution to the firm's bottom line. Firms became faceless and amorphous, as employees sold themselves to the highest bidder.

A shift to longer-term planning. Goldman demonstrates that a partnership-like model can function within a publicly traded company. Other firms, however, may opt to proceed as private businesses. Either way, this shift will allow managers to plan longer-term and respond less to "best practices", which can often standardize quality. Firms may become more cautious, but they will likely become more specialized.

So, who's to say what's right and what's wrong? Definitely not government or regulators, or really anyone but the market itself. That's not to say there is no place for oversight or rules, just not the kind that impose control.

Capital is finite. It's an economic good. If there's one lesson we should take from the health care reform debate it's that we should never depend completely on the expectation that somebody will do something for us. The sooner that policymakers can trust markets, the better off we become, and the faster our economy will recover.

After all, the last thing we can afford is the restriction by non-market forces of a natural market transition.

The Missing Stakeholder in Health Reform

noreply@blogger.com (SYDNEY WILLIAMS) — Mon, 07 Sep 2009 20:15:00 +0000

Pop quiz: who's missing at the health care reform discussion table? Is it: (a) government (b) patients (c) doctors (d) employers or (e) owners of health care companies?

Guess what? Of all the stakeholders in the health care universe, it's the corporate shareholders—the very owners of those health care companies, large and small—who are left out in the cold.

Why is this? Like every other industry, health care depends on Wall Street for much of its capital needs. Growth requires investment, investment requires capital, and the financial markets are the spigot from which capital flows. So why don't shareholders have a voice in the reform debate?

At $2.4 trillion, the total annual spend on health care is well-publicized. Few of us, however, realize that this expenditure translates into a market capitalization just under $2 trillion. Within the S&P 500, only information technology and financials boast higher total values. The 52 companies that comprise health care equal 13.5% of the index's total value.

S&P 500 Health Care Constituents

And while docs, drugmakers and drugstores may come first to mind when we think of health care, shareholders represent a critical stakeholder. Without their money and collective judgment, there is no research and development, no new plant facilities and no incentive for clever business strategies.

Individually, a shareholder might be any other stakeholder: a physician, corporate executive or consumer. No lawmaker, though, is weighing the sum total of these individuals.

Out of sync

Despite the stock market size of the health care industry, it lacks breadth, and does not adequately represent the entire universe. Drugmakers, for example, make up 60% of the listed market capitalization. Hospitals, on the other hand, constitute less than 1%. (Of 5,000 hospitals across the country, just eleven hospital groups are publicly listed.) In terms of total spend, prescription drugs and hospital care represent 12% and 37%, respectively.

National Health Care Expenditures

Source: Centers for Medicare and Medicaid Services

Health Care Industries

Source: Yahoo! Finance

The market, moreover, values commercial health plans—36% of the source of funds spent on health care—at just 4% of the total health care universe. (We wonder: How much does head-to-head competition with government programs contribute to this under-representation?)

If we break down spend between private and public money, majority public- (Medicare/Medicaid-) funded services feature substantially less in the investment universe, and private-funded services substantially more. Of course, the two questions that naturally follow this are: one, what's the impact of market forces? And, two, to what extent do these forces drive efficiency?

While most folks would probably argue that drug manufacturers underachieve in operating efficiency, no one would dispute the fact that the pharmacy "value chain" (the dollar flow from manufacturer to consumer) is inherently more efficient than the public spending-led medical side. The best example for this is claims processing—a major source of administrative inefficiency across health care (more than a half according to one study). Pharmacy systems adjudicate claims instantaneously, whereas the medical system can take several weeks or months.

The table below breaks down types of service by funding source.

Source: Centers for Medicare and Medicaid Services

We can only speculate, unfortunately, whether market forces would drive efficiency the same way in hospital care.

The disconnect between the market and the industry extends to the way Wall Street pros analyze health care. Sell-siders and buy-siders, for instance, still segment drugmakers into biotechnology and non-biotechnology companies, even though all manufacturers—even the generics—now target biological products.

Rarely do these same "drug analysts" also cover pharmacy benefit managers ("PBMs"), even though these companies directly affect pricing and market share. In fact, Standard & Poors doesn't even categorize CVS Caremark and Walgreen as health care stocks, despite their obvious focus, which includes major PBM franchises. Broader indices also don't include the smaller capitalized health information service companies such as Allscripts-Misys Healthcare and Cerner Corp., and instead add them to the technology sector.

As a result, information does not flow as seamlessly as it could across the marketplace. Compounding this problem, coverage teams on either side of the Street don't normally exist across health care, as, for example, they do in technology between software and hardware.

And what about employers? The employer-based insurance market provides coverage to two-thirds of the US population under the age of 65. A large company with 50,000 employees, for example, likely exceeds $500 million per year in total health care spend, including dependents and retirees. As with Starbucks, this level often surpasses investment in core products and services.

Assuming $500 million of spend on average for the largest 100 companies, we can estimate a total annual budget of $50 billion. How management allocates this money directly affects a company's cash flow. Are shareholders prepared to ask the right questions? Are they asking questions at all?

Still relevant

What if lawmakers did include shareholders as a stakeholder? At a minimum, shareholders would urge more efficiency. They would also articulate viewpoints based on return on investment, and frame health care as an economic good—rather than as a right or privilege.

In a recent Wall Street Journal opinion piece, Greg Karpel describes health care as a value-creating industry: "The $2.4 trillion Americans spend each year for health care doesn't go up in smoke. It's paid to other Americans." Mr. Karpel refers to job growth and medical innovation as two examples, and addresses health care as a "significant, perhaps a principal, driver of the economy".

Shareholders could be advocating this uncommon position in precise fashion—except for dislocations across market participants. Still, the market can provide critical and dispassionate information and assessment, which the health reform debate desperately needs.

Even though the shareholder stakeholder may have far to go in developing his own voice, what he can contribute to the reform discussion would be relevant enough.

We're All "Meaningful" Now: Expect a Busy Fall for Electronic Health Records

noreply@blogger.com (SYDNEY WILLIAMS) — Sun, 30 Aug 2009 17:50:00 +0000

Get ready for lots of news flow on "meaningful use" this fall. The government has set an ambitious yearend deadline for establishing a formal definition, a critical step in its effort to spur electronic health record (EHR) adoption.

"Meaningful use" refers to the way in which the government will expect providers to use electronic health record systems — whether in an appropriate manner or not.

At stake for the provider community are billions of dollars in incentive payments. Starting in 2015, the government expects providers to have adopted and be actively utilizing an EHR in compliance with the meaningful use definition or it will subject them to financial penalties under Medicare.

To defray the cost of EHRs — often tens of thousands of dollars — the government has promised big subsidies ($44,000 per physician), though not without strings attached. It will pay the first incentives in 2011 based on prior performance. A provider not following meaningful use of a certified EHR could risk not receiving any government funding. The American Recovery and Reinvestment Act of 2009 provides a minimum of $19 billion in funds to kick start EHR adoption. Media sources now report a funding level nearly twice the size at $36 billion.

According to the government's website, "The focus on meaningful use is a recognition that better health care does not come solely from the adoption of technology itself, but through the exchange and use of health information to best inform clinical decisions at the point of care." Broadly, meaningful use will encompass different parameters, including patient communication, diagnosis, device usage, patient encounters, specific patient information, laboratory tests, medication usage, physical exam findings, and procedures.

Just recently, the Obama administration announced it would provide $1.2 billion in grants to create 70 HIT centers around the country. David Blumenthal, the president's HIT czar and head of the national EHR effort for the Department of Health and Human Services, meanwhile, has stated that he expects a formal definition of meaningful use by the end of the year. The process began in June.

To put the cost savings opportunity in perspective, about half of health care expenditures constitute waste, whether dollars spent on preventable conditions, redundant tests or back office processing. About half of this waste relates to poor patient behavior: obesity, smoking, non-adherence. A quarter represents clinical inefficiency: readmissions, poorly managed care, medical errors, treatment variance, unnecessary ER visits — the primary target for EHRs.

The remaining quarter reflects operations, or the back office. Of this, claims processing accounts for about half, and ineffective IT a third, staff turnover and paper-based prescriptions the rest. (Note: We have sourced these estimates from a 2008 report by the consultancy PriceWaterhouseCoopers. Click here to view.)

If we exclude from this waste calculation patient behavior, the practice of defensive medicine (more a payment issue than an IT issue) and claims processing (not directly a clinical issue), then we would assume that EHRs would impact about a third of all wasted dollars spent.

In a $2.4 trillion dollar industry, where $1.2 trillion is waste, EHRs could theoretically address about $400 billion of this. A substantial number, it would roughly equal the entire prescription drug market at half this level.

Let’s not forget, too, that each of these numbers is growing at 10% per year. In seven years, $400 billion becomes $800 billion, although — presumably — effectively deployed EHRs would slow this growth rate.

With such a substantial business opportunity at hand, it's no wonder many different organizations are now targeting health IT, and EHRs specifically — including not just traditional technology vendors such as Intel, IBM and Microsoft, but also managed care organizations, plan sponsors, and dozens of venture-backed firms.

Despite this, many problems exist, ranging from cost to lack of a common standard. Even though, for example, several different EHR systems may operate within a single provider setting, one system does not necessarily communicate with another. And for small practices, implementation costs can be prohibitive.

While nearly 40% of physicians report using a full or partial EHR system, only 4% indicate they use a certified, fully functional system, according to a survey by the Centers for Disease Control and Prevention.

Enter the government, and Dr. Blumenthal's mandate to make everything work together. But for EHRs to recoup even the expenditure the federal government is prepared to make, all the different stakeholders must first agree on a definition of meaningful use.

No one anticipates an easy process.

What happens, for instance, if the government defines meaningful use too narrowly — or too broadly? How does the government change the definition? And when?

Providers will also need to submit data that qualifies them for incentives. What does this process entail? How much of a time burden does it create? Also, to what extent will provider inertia drag down future returns?

And none of this includes issues pertaining to the certification process and privacy concerns. Who, for example, owns the data?

In its scoring, the Congressional Budget Office has not allowed significant savings for EHRs simply because the opportunity, while massive, remains highly speculative. Even if the government adheres to its aggressive timeline, EHR savings on a national scale would not occur until well after 2015.

Stay tuned for a busy fall.

Nearing a Market Top

noreply@blogger.com (SYDNEY WILLIAMS) — Mon, 24 Aug 2009 00:56:00 +0000

Nobody wants a good thing to end, especially an historic run in the equity markets. Precedence, though, suggests that we're nearing a conclusion.

From its March 9th low through August 21st, the S&P 500 has rallied 51.7%, the index's best 117-trading-day performance since before 1950. In fact, five of the ten best continuous 117-day periods between June 1950 and August 2009 occurred this month, as the table below illustrates.

January 1983 featured three of these periods, and the end of May/beginning of June 1975 the remaining two. (Both of these periods come closest in showcasing the same type of performance.)

The market has been so strong that of the 14,890 continuous 117-day periods over this six decade time frame, just three periods posted gains over 45%: those ending August 19th, 20th and 21st.

And on only 89 occasions did the market gain more than 30%. That's less than 1% of total. The market, moreover, only managed a 15%-or-more advance during less than 14% of this period.

82% of the time it ranged between -15% and +15%.

Clearly, the current race upwards marks a distinct reversal from the market's nosedive in the first days of March and in November last year. Too far, too fast? Statistically, at least, we've sprinted deep into outlier territory. If we go by our table above, then the more "normal" trend line for the S&P would be the 0% to 15% range.

Let's assume a flat market. It would take 39 trading days at the current 1026 level for the market to mean revert back into the sub 15% range. Under a correction, this could happen more quickly.

On the other hand, for the market to sustain its record-setting 45%+ pace until yearend (for example), it would have to average daily gains of between 0.4% and 0.5%. That would equal a closing level above 1500. Improbable, if not impossible.

While August 2009 showcases trading patterns similar to June 1975 and January 1983, it also features a much different backdrop. These two preceding months actually resemble each other much more closely than either one does August.

In both months, the economy was three months into recovery, after severe, protracted downturns. In both cases, cyclical unemployment peaked exactly one month prior: in May 1975 at 9.0%, and in December 1982 at 10.8%. 10-year Treasurys were yielding 7.86% and 10.46%, respectively, while inflation soared at 8.5% and 6%.

Politically, the Democrats held both the house and senate in 1975, but not the White House. The Republicans under Reagan controlled the White House in 1983 and the senate, but not the house. Unlike today, free trade and capitalism energized a small minority of the world's population.

Tax policy varied, however. Rates sharply declined throughout the 80s. Gasoline prices also varied. In 1975, they were rising, and, in 1983, falling.

Market direction tracked differently, too. The S&P 500 after June 1975 closed the year 5% lower, and would not sustain higher levels for another three years. After January 1983, the market finished the year 14% higher, but had also gained 15% over the subsequent six-month period, equal to the same period-to-end-of-year time frame as 1975. Also, the nearly two-decade long bull run had just begun.

August 2009 is unique in many aspects: the global landscape, the point of time in the economic cycle, the credit and banking systems, the regulatory and legislative outlooks, to name a few.

Whether we're facing a lengthy flat market or a sharp pullback, don't expect the historic resurgence to continue.

Listen to the Market: "Health Reform Won't Distort the Insurance Business Model"

noreply@blogger.com (SYDNEY WILLIAMS) — Sun, 16 Aug 2009 21:18:00 +0000

When it comes to health care reform, it seems the more likely that government will pass legislation, the more sanguine Wall Street gets that nothing will occur. Government-run health care? Won't happen. An evisceration of the private insurance business model? No way.

Consider this. From its March 9th low to August 14th, the S&P 500 surged 48%. Over the same period, four of the five largest commercial health plans (by lives and market capitalization) outperformed the major index.

In fact, during this stretch of 111 trading days – that's five and a half calendar months – Cigna never underperformed the market. Humana did so once, way back on March 11th. And WellPoint dipped below the market on seven occasions, the last time on April 3rd.

UnitedHealth Group stumbled 19 times, mostly during a bad stretch in late March and early April. Now, its shares stand ten percentage points higher than the market average. Even Aetna, which consistently underperformed, is 38% higher on an absolute basis.

See the chart below covering this trading period. The red line is the S&P 500.

Click to enlarge.

The comparison also extends to other components of the health value chain. The maligned health plans have outperformed each of the major stakeholders. The S&P 500 is higher (marginally) than the major pharmacy benefit mangers – Medco, CVS Caremark and Walgreen – and trouncing the drug manufacturers by more than 20 percentage points.

To be fair, it's FDA uncertainty, not congressional power-broking, that's weighing heavily on the drugmakers. And depending on its structure, a pathway enabling follow-on biological products could improve prospects dramatically. Both house and senate bills feature it, and traditional foes seem closer to finding some sort of resolution than ever before.

So, what's the health reform fuss all about anyway? Well, if you're an investor, it's making for good entertainment.

Indeed, the market's great discounting mechanism reveals prospects so strikingly different than the constant news media coverage that it can't be right, right?

Well, no one can ever be sure. But let's just say this. Not since 1994 have lawmakers threatened major overhaul to this extent. With the party seeking to upend private insurance holding majority control, passage would have seemed inevitable – if not a full-on government option, then something damaging, at least, to the current business model.

That, to several high-minded folks, seemed the intent.

Despite this, and except for company-specific issues, investors never marked down the industry's prospects, even during the worst of the mudslinging and the darkest days of apparent unity among the ruling party.

And let's not lose sight of the fact that this is turning into one fine example of market rationality, while total hysteria grips the Hill and many corners of Main Street.

Maybe Wall Street isn't so villainous after all.

Maybe lawmakers should take care in turning their reform plans to that potent discounting mechanism.

It could be the only thing that keeps us sane.

Rise of the Machines

noreply@blogger.com (SYDNEY WILLIAMS) — Wed, 29 Jul 2009 19:03:00 +0000

In the Terminator series, machines rise up to replace humans. On Wall Street, fiction now appears to be reality, as complex algorithms and super-fast computers conspire to wrest control of market liquidity.

Recently, the New York Times brought attention to the ins-and-outs of high frequency trading, or HFT. (Read here.) And with Goldman Sachs producing eye-popping trading results, many observers – looking to identify the next weapon of mass destruction – are crying foul. (Read here, Goldman's profits in HFT.)

Sen. Charles Schumer (D-NY), pushing to ban components of HFT, is increasing visibility even more.

HFT, basically, is rapid-fire buying and selling of securities, in milliseconds. Proprietary trading desks and hedge funds orchestrate it for own-account gains, trading for pennies or less literally in the blink of an eye. By constantly churning, these funds' trading activity often constitutes the market for many different securities. (Read explanatory diagram here.)

Here's where problems arise. When a mutual fund submits a buy order with a limit price, HFT funds can buy-and-sell the difference between the current price and the limit price. If, for example, a dealer looks to execute a buy-order with a $25 limit and the price is $24.90, HFT funds could theoretically profit from the entire 10c difference.

As the mutual fund portfolio manager, you worry that your best price should have been something less than $25. You know that pennies on millions of shares represent a material cost, and that your shareholders bear this.

In this case, the market isn't achieving true price discovery for the security in relation to its liquidity. A substantial amount of liquidity is addressing price movement alone (irrespective of the security), while only a portion is takng into account the security's actual value.

HFT is controversial because it potentially creates information asymmetry and false liquidity. Its proponents argue, however, that barriers to entry are low (once you get past the set up costs), so pricing is actually transparent; and some liquidity (albeit low quality) is better than no liquidity.

As with derivatives, the problem – if we want to call it that – in HFT isn't the product itself, but the typical inefficiencies of a marketplace that can never be completely uniform. Some folks are just really clever at exploiting those inefficiencies, and market functions take time to keep pace.

Whatever response lawmakers and regulators take, as long as there's money to be made, the folks who brought you CDOs and HFT will spawn something new and different.

That is, until the machines actually do rise up, and all humanity is finally gone.

The Art of Medicine and Variance in Care

noreply@blogger.com (SYDNEY WILLIAMS) — Sat, 25 Jul 2009 15:42:00 +0000

How much of medicine is art? How much is science? And how should this affect the health care reform debate?

Consider this in terms of variance in care.

Experts, no matter their point of view, roundly reference the Dartmouth Atlas Project more than any other study as proof positive that care delivery varies widely across the United States, and contributes directly to massive inefficiency across the system.

These experts frequently cite two related statistics:

1. 30% of health spending doesn't yield healthy outcomes, and
2. $700 billion is the total cost of this system-wide inefficiency per year.

Lawmakers have responded by emphasizing medical guidelines and protocols in their various bills, in an attempt to narrow variance – some might say an effort to standardize care delivery. CMS and commercial health plans, by the way, have long supported these measures in their reimbursement practices.

Recently, the Wall Street Journal published an editorial that raises the issue of medicine as an art. "By 'medicine' I mean that ancient art and science with origins before Hippocrates, that discipline that has the patient at its center," the author writes. "I'm talking about the 'medicine' that deans across the country will invoke in a few weeks as they exhort first-year medical students to embrace the ideals and values of the noble profession." (Read here.)

As a science, medicine is continuously evolving. Best practice today may not be best practice tomorrow. A physician's ability to respond to a patient's individual needs allows this process to take shape.

While stepped-up centralized control might reduce intervention risk on the downside, it's also likely to limit intervention risk on the upside (treatment that produces healthy outcomes). The result could be more automated patient–provider interaction, and less opportunity for medicine as an art.

If medicine is, in fact, partly an art, then any reform approach that targets more centralized control would immediately contradict this characteristic, by definition.

The best way to eliminate variance and protect the art–science balance is to enable a system that's fully transparent to all components of the health value chain, from consumer on down.

Best practice would be more clearly understood than it is today, and the art that produces healthier outcomes more easily recognized.

Public Opinion and Goldman Sachs

noreply@blogger.com (SYDNEY WILLIAMS) — Wed, 22 Jul 2009 15:33:00 +0000

Hate 'em, hate 'em, hate 'em. From the left, right and center, the attacks are flying, and polticos have been quick to jump on the bandwagen. As David Reilly notes in Bloomberg News, "Weathering the aftermath of the financial crisis may prove tougher than surviving the storm." (Read here.)

But let's not forget. In September 2008, the system had to be saved. And though in hindsight we may disparage the choices Messrs Paulson, Bernanke and Geithner made, they've worked – at least for now. AIG bailout or no AIG bailout, Goldman adroitly swerved around the chasms that obliterated others. In fact, as we've noted recently, it pressed its accelerator, increasing its value-at-risk throughout the worst of the descent.

If Wall Street is to restore itself, then risk-takers have to come back into the market. While taxpayer subsidies may have aided Goldman's resurgence, the bank did take calculated risks where others didn't, or couldn't.

And so it should reap its reward.

Longer-term, a healthy Wall Street is a vital contributor to wealth creation on Main Street. This begins with a balanced risk-reward equation. Distortions still exist, and we're not there yet.

Goldman's success, we hope, is a step in the right direction.

And now politicos may be letting emotional short-sightedness blind them into creating new distortions.

In a healthy market, others will share Goldman's smarts, and a host of others, extending well into Main Street, its opportunity for success.

A Sudden Appetite for Web-based Computers

noreply@blogger.com (SYDNEY WILLIAMS) — Mon, 20 Jul 2009 18:44:00 +0000

Is the computer business model fundamentally changing? The explosive growth of netbooks – low cost, high performance PCs – suggests that it's already underway.

Priced at between $200 and $500, netbooks function mostly as web browser tools (offering the same performance in this regard as traditional PCs), but feature only limited storage (which means big cost savings). Experts see them as gateways to Internet-based computer services, or cloud computing.

The category’s sales are surging. According to industry trackers, global netbook shipments will reach 33 million units in 2009. That’s 100% year-on-year growth for an already substantial category, which only began a few years ago.

(No doubt, Microsoft and Intel, netbooks' primary software and microprocessor suppliers, welcome the category's growth. Desktop and traditional notebook sales, meanwhile, are languishing.)

Geographically, EMEA (13.3 million units), North America (8.8 million units) and greater China (3.9 million units) are expected to be the three largest purchasers. Growth rates, though, will be highest in emerging markets.

The Gateway LT2000 Series is a one-inch thick netbook with a 10.1-inch display. The mini-notebook weighs 2.62 pounds and includes features common among netbooks, such as an Intel Atom processor, Windows XP, a built-in Webcam and microphone and Wi-Fi support. Price: $300.

The recession has certainly aided netbooks' gains. But the consumer's expanding use of web-based applications could also signify a market shift away from traditional desktop computing. For phone companies, netbooks are the next significant growth opportunity after smart phones. Verizon, for example, gives them away for free, recouping its investment in high-speed Internet access fees.

Because the category is so new and growing so quickly, industry people haven't fully defined it. For now, it just covers slimmed-down notebooks. Perhaps, one day, it could evolve to encompass smart phones and other devises. Future generations of Apple's iPhone, already more a computer than a phone, could resemble netbooks, and vice versa, as user functionality advances.

Another product that might fall into this category is Amazon's hugely successful Kindle, the upmarket electronic book reader, and pure web-based tool. Besides clearing space in travelbags, the Kindle is also familiarizing its users, mostly high-end consumers, with the ease and convenience of a web access-only devise.

Let's not forget, too, all the mobile devices targeting the health care industry. The federal government has earmarked billions of dollars for health IT. Hardware will need to evolve to support docs on the hoof, mostly in the form of tablets and handhelds. This entire system and its various components are likely to utilize web-based architecture.

Computing in the business world, generally, could transform, as processing and applications shift in the same fashion, from the desktop to a central server, or a virtualized desktop. What's left is a simple access terminal, or thin client.

The netbook category is also attracting high-caliber software developers. Just recently, Google announced the development of Chrome OS, an open source, lightweight operating system, which will address the netbook market specifically: "people who live on the web — searching for information, checking email, catching up on the news, shopping or just staying in touch with friends".

What stops (or limits) its growth? Economic recovery could do so short-term – depending on how long it sustains. Replacement cycles and wealth effects will likely favor traditional categories, especially if the recovery is deep and long-lasting. (Four times as many notebooks are expected to ship this year, making it a much bigger category in the way that practitioners currently define it.)

Longer-term, consumers could see data control as a severely limiting factor. The reality of Google or Microsoft storing personal data in one of its vast server farms might unnerve folks enough that they'll want to keep the old, reliable desktop close at hand.

Then again, consumers unveil themselves constantly, whether in social networks or in their online search results. De-sensitization to personal information might be high enough that people don't really care.

If consumers continue migrating to Web-based services, and computers merely provide access, then netbooks will accelerate industry transformation (anticipated by some), though not without other Web-access devices also contributing.

In this environment, product design and ease of use are still likely to determine pricing differences as before, except now the hard drive plays an inconsequential role, if any at all.

(Skeptics, on the other hand, will point to the deep-rooted market inertia that constantly bogs down the computer industry, and protects the incumbent business model.)

Now and then, economic conditions and technology do conspire to create major inflection points.

This looks to be one such occasion.

How Much is Preventive Care Worth?

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 17 Jul 2009 19:12:00 +0000

Zero, according to the Congressional Budget Office. In fact, the CBO views preventive care only in terms of the dollars lawmakers intend to spend on it – that is, as an expense item.

“CBO’s scoring is a little bit wacky,” Sen. Charles Schumer (D-NY) said in an interview today. “They are not quite fair because they don’t measure the cost savings down the road, just the immediate spending.”

But how else should the CBO view preventive care? Conceptually, the idea of prevention makes perfect sense: Lead a healthier lifestyle, and pay less in medical expenses. Unfortunately, there's little precedent for its success, and nothing for a nationwide program that would cover the scale of the United States. (Read about preventive care in the New England Journal of Medicine here.)

Whatever savings number a politician ascribes to it, it's immediately contestable. You say, '$200 billion.' I say, '$400 billion.' What about $250 billion or $100 billion? Why not $600 billion? Then again, why not $5 billion, or $5 million?

Also, gains in prevention occur on an individual basis, and aren't always the result of provider intervention. (Medication adherence statistics, anyone? One third of all drug prescriptions aren't filled.)

And can we ever agree on what motivates someone to change his lifestyle? For some, the trigger can be financial; for others, peer pressure; for others still, getting out of bed on the wrong side. Sometimes these factors work in combination. Sometimes they don't.

The point is, there's no tried and true formula. As in behavioral economics, we might try to build a system that "nudges" people, but how do we measure this? What happens when the parameters change, or become obsolete? Just as quickly as our home and work environments evolve, so does the study of medicine – faster than government-derived rules could ever adjust.

Intuitively, we know prevention is a good idea. We also know that, for it to succeed, we have to realize its merits ourselves, individually.

Its worth, then, is the personal value we take from it, not what a national system imposes on us collectively.

It's really just a matter of respecting who we are.

Price Discovery's Back, But Wall Street's a Long Way from Recovery

noreply@blogger.com (SYDNEY WILLIAMS) — Wed, 15 Jul 2009 12:00:00 +0000

Is Wall Street better off than a few months ago? Yes, but uncertainty still clouds its future. In fact, the risk is growing that it will suffer a persistent, structural imbalance, skewed towards trading and own-account price discovery functions.

Take, for example, Goldman Sachs' second quarter earnings report. It bristles all over with the dominance of trading: $9.3 billion in revenue, six and a half times what investment bankers produced and nearly ten times what asset managers yielded.

In terms of total revenue, Goldman's trading operations now stand at 80%, sixteen percentage points higher than a year ago. Investment banking and asset management, meanwhile, muster about half the impact that they used to (12% and 8% of total down from 21% and 15%, respectively).

We see this best illustrated in the firm's risk measurement tool, value-at-risk (VaR). The following chart shows this for the 12 month period ending in March 2009 (the most recent reading). The next two charts feature the VIX index and TED spread over the corresponding period, to illustrate the market backdrop.

Even as capital markets wilted, Goldman never stepped off of its accelerator, revving harder in the worst of the meltdown.

Goldman Sachs daily value-at-risk (first quarter Form 10-Q, May 6, 2009)

VIX index, Historical Volatility (Equity Risk)

TED spread (Credit Risk)

One by one, Goldman's competitors imploded, and it sped that much faster, to where, now, it exposes itself to 35% more risk than the same period 12 months ago ($245 million versus $184 million, per day).

If anything, Goldman's success validates the aggressive trading/hedge fund model. But while the price discovery process in the public markets might be back in place, all's not well with other capital market components, including the private equity and venture capital industries, and the flow of funds from institution to corporation.

"In the first half of 2009, M&A volume fell 35% globally to $1.14 trillion and IPO issuance was just $12.7 billion – earning just $406 million for underwriters. This year could go down as one of the worst for both businesses, according to Dealogic. There's not much to suggest it will be any different in the coming months," notes David Weidner in Market Watch.

As The New York Times recently reported, "Many in the [venture capital] industry predict that a third to a half of the 882 active venture capital firms could disappear, if only because poor returns will force underperforming firms to shut down. It is already happening: Investment in venture capital funds shrank to $4.3 billion in the first quarter, from $7.1 billion in the same quarter a year ago...

"The source of concern is lower returns brought on in part by a dearth of public stock offerings. Five-year returns in the venture capital industry, which reached 48% in 2000 at the height of the dot-com bubble, were just 6% through 2008, according to the National Venture Capital Association."

Although Wall Street's recovery is moving forward, the throttle's nowhere near open. As a pricing mechanism, it's functioning, but, insofar as Goldman's explosive success is more or less unique, Wall Street runs an increasing risk of concentrating capital, a contributing factor to the credit crunch. (Goldman also appears to have benefited from extreme, short-term market inefficiency.)

As an investment channel supporting business innovation and economic advancement, the markets remain comatose. Wall Street's relationship–or agency–side continues to falter. Even Goldman's vaunted investment banking franchise lost 15% year-on-year, despite having gained a more dominant position.

Two factors overhang the recovery:

Uncertainty over financial market regulation, and its impact on banks' business models.
Uncertainty over cost of capital, namely the impact of higher taxes and administrative burdens.

Once these issues clarify, markets will adjust, whether the outcomes are negative or positive. It's how regulators and policymakers resolve these issues that will determine not only the recovery's trajectory, but also (longer-term) what sort of role Wall Street will play in the broader economy.

Until then, expect others to emulate Goldman's trading-driven approach.

What other choice do they have?

Spotlight on Goldman

noreply@blogger.com (SYDNEY WILLIAMS) — Mon, 13 Jul 2009 19:11:00 +0000

Here we are once again, on the eve of another record earnings report by Goldman Sachs. Are we back to the old days, or on to something new and different?

We can safely agree that the banking crisis is officially over, as this writer and others have recently argued. Whatever we may draw from the Treasury Department and Federal Reserve's methods, they've worked. Confidence is restored, at least enough to allow market-savvy traders to place the kind of aggressive bets that can reap windfalls for bank profits.

What's in store long-term is still a matter for debate, and as financial market regulation nears, no one's holding back on opinion. We just hope to measure the solution in more accountable transparency and more transparent accountability, and an opportunity for a more competitive marketplace in information and capital.

Different tomorrow will be the degree to which Goldman separates itself from the pack. Whatever huge numbers it posts, no competitor – what's left of them – is likely to come close. In the old days, Lehman would lead off with the usual better-than-expected earnings report. Goldman came next, then Bear, Morgan and finally Merrill Lynch. The language was always the same: "We've done a good job in managing risk", or "Our results once again demonstrate the diversity and financial strength of our group".

This go-around, of the big five, just Goldman and Morgan will report – and this time not as investment banks, but as bank holding companies. No one believes that Morgan will come anywhere close to Goldman, certainly not as it may have in the past.

But a new and completely different risk factor overhangs Goldman's once and future success: public opinion. The perpetual leader, Goldman appears to have navigated the crisis so brilliantly that it faces certain questions, many relating to the prowess of its trading operations.

If it's too good to be true, then it can't be. That's the difference between then and now. After Madoff, skepticism runs too deep for anyone achieving outlier success to wade through unchecked. The contrasting pain on imminent double-digit unemployment is too acute.

How far regulators and lawmakers ride this potential public inquisition will also reflect any shifts in the country's political leaning. We'll be able measure our tilt by how long these questions linger on the front pages of the popular press and in the blogosphere.

No doubt, Goldman's leaders will speak cautiously. Everyone knows its numbers will be stellar, so we don't suppose management would desire anything better. Best to be as matter-of-fact as possible.

Perhaps, though, public opinion will see its own success in Goldman's success: a vibrant green-shoot of Wall Street back from the dead.

Maybe opinion will make the connection between a healthy Wall Street and a healthy economy.

We hope that, however Goldman does it, other financial institutions won't necessarily see trading-led profits – betting with Other People's Money, in other words – as the sole route to success.

Marking Real Change in Health Care

noreply@blogger.com (SYDNEY WILLIAMS) — Thu, 09 Jul 2009 15:21:00 +0000

BOOK REVIEW

Changing something familiar can be a huge gamble, especially in policy making. The odds that lawmakers will actually reform the health care system are poor at best. Whatever legislation does emerge won't achieve more than a few tweaks and modifications of what we know so well. No lawmaker is willing to accept the political risk in addressing the underlying problems, no matter how severe they might be – at least not yet.

Myriad cost, quality and access issues mean different things to different people. Hospitals, physicians, benefit managers, health plans, drugmakers, and patients each hold different views on how the system should change, none of which align with each other.

Physicians, for example, follow certain guidelines designed by health plans (the folks who pay them), whose interests often conflict with patients (the folks who don't pay them). A pricing mechanism simply doesn't exist to establish uniform measures of quality among these different stakeholders.

Stephen Hyde's excellent book Cured! The Insider's Handbook for Health Care Reform offers both a refreshing examination of health care's perverse economics and an important framework for putting the system into working order. Cured! is not only relevant to today's reform debate, but will also serve as an important reference document for years to come.

Book Details

Cured! An Insider's Guide to Health Care Reform

By Stephen S. S. Hyde
HobNob Publishing, 490 pages, $19.99

In 1976, Mr. Hyde, an actuary, became the federal government's first chief financial regulator of the nascent HMO industry. He later founded Peak Health Care, which he merged with United Health in 1986 to become the market leader in managed care. Since then he has founded companies functioning in the medical and pharmacy spaces, and serves as an industry consultant and a board member of numerous health care companies. This is his second book, and follows Prescription Drugs for Half Price or Less.

Cured! cuts through political veneers to expose the health care system for what it is: "a balkanized system of private and government programs that lack a comprehensive focus on meeting the medical needs of America's consumers in an economically sustainable fashion".

Health care's market failure begins and ends with the insurance markets, and their method of reimbursement. Not until patients actually purchase medical services themselves, with the protection of catastrophic insurance, can health care ever reform. The litmus test is the consumer's ability to answer two basic questions:

Who are the best doctors and hospitals for my medical needs?
Which of them are the least expensive?

Coverage, the delivery system and funding requirements will each improve substantially to satisfy all political persuasions, once policymakers correct the market failure.

Perhaps Mr. Hyde's best work occurs in his book's detailed background sections. He dedicates over 250 pages to analyzing misconceptions and truths about the bloated $2.3 trillion industry, revealing the dark undersides of complex topics (such as the market positioning of the managed care and pharmacy benefit management industries) so that the man on the street can understand the issues as well as any academic or industry expert.

"One might think of forced health insurance enrollment as a mandatory license to breathe," he writes, in discussing health care as an obligation. "Indeed, once you see the price, sharp inhalations may be unavoidable. The glib but irrelevant argument-by-analogy is 'you must have health insurance, just as car owners must have auto insurance.' But driving has long been viewed as a privilege subject to numerous regulations to protect the public safety. The requirement also includes the right to abstain from driving, and indeed there are almost 100 million non-driving Americans. Also, the purpose of mandatory car accident liability insurance is to protect the victims of the insured drivers' mistakes, not the drivers themselves. Car insurance is not relevant to health insurance."

Mr. Hyde's upfront, concise approach makes Cured! a compelling read. He has written this book for the consumer. But in making it readable, he neither condescends as a 40-year veteran of his stature might, nor circumvents the complex workings of his concepts, whether addressing adverse selection, hybrid managed care models, or philosophical questions about health care as a right.

His readers could – and should –include health care's most seasoned insiders, from corporate CEOs to physician practitioners.

The final third of Cured! features Mr Hyde's solution: the American Choice Health Plan ("ACHP"), a congressionally established regulatory mechanism. He proposes seven basic rules to meet eight goals that he introduces in the first pages and details throughout the entire work: universal insurance access, sustainable value and affordability, free rider prevention, voluntary participation, financial protection, choice of insurance and providers, portability, and personal responsibility for prevention.

ACHP's seven rules enable a self-sustaining regulated market for health insurance to take root. These rules are universal annual open enrollment, competitive and regulated insurance market, conversion from defined benefit to defined contribution, voluntary individual participation, enrollment limitations, health funding account, and BAGLE premium pricing. BAGLE refers to premium adjustments for behavior, age, gender, location, and employment/extracurricular risks. His proposal opens premium pricing to the markets, expunging it from the purview of regulators.

Fundamentally, ACHP removes government and employers from the business of insurance, and exposes providers and health plans to a market-based determination of value. It transforms the current group-based insurance model into a fully individual one, so that insurance can be, well, insurance.

Most important, ACHP's fully transparent, patient-centered structure would satisfy the most aggressive coverage and care delivery goals, and achieve 50 percent cost savings at the same time.

"Like the farmer and the cowman in the musical Oklahoma, insurers and policyholders need to turn in their adversarial relationships to become, if not friends, then co-conspirators. Their common goal? High-quality, low-cost health care. American Choice will deliver that."

To be sure, Mr. Hyde faces a considerable challenge in the degree of reform he proposes. As oppressively inefficient as health care might be today, it's not so terrible that policymakers are willing to consider actually changing the system. Proposals working their way through Congress are half measures that more-or-less emphasize the current system. Large employers will still self-insure, Medicare will still force cost shifting, and individuals will still have no clue about the value of care they receive.

But even if policymakers aren't ready for Cured!, consumers could be. Confusion over what health care reform means provides the perfect opportunity for Mr. Hyde to publish this book. And the more consumers know about what they could have, the more likely they'll demand a new system.

Unfortunately, it may take a complete system failure either financial or in delivery of care for ACHP to receive the attention it deserves.

Let's hope we never reach that point, and that we see its fair hearing well ahead of time.

Medical Rationing and the Most Appropriate Health Care System

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 03 Jul 2009 14:55:00 +0000

Health care as an economic good occurs in limited supply. Providers contribute a finite number of units of service, and payers are supposed to determine what these units are worth.

Rationing as an issue is incontrovertible, argues the health economist Uwe Reinhardt. It would occur both in a single payer system and one that’s fully market-based. The reform debate should, therefore, address the value of dollars spent.

"As I read it,” he notes, “the main thrust of the health care reforms espoused by President Obama and his allies in Congress is first of all to reduce rationing on the basis of price and ability to pay in our health system. An important allied goal is to seek greater value for the dollar in health care, through comparative effectiveness analysis and payment reform."

Better value should lead to better outcomes.

But which mechanism is best at determining that value? A centralized, top-down system, or one that's bottom-up and consumer-driven?

The current system is already highly centralized. Its private sector elements cannot compete under the same market rules as other industries. Insurance laws, for example, prohibit interstate competition. In 2008, economists from the University of Minnesota published a study indicating that allowing people to buy insurance across state lines would reduce the uninsured population by 12 million.

And consumers can only make value-based decisions on a limited basis, and without much consequence. High-deductible health plans are an attempt at this. Market penetration, though, is low, and high-volume health care users, such as the elderly, utilize Medicare and other traditional forms of insurance.

So, if rationing occurs regardless of the system, then Prof. Reinhardt is correct: Rationing, by itself, is an irrational point of contention. He's also correct in that the debate should instead address value.

But insofar as the conversation is about the most appropriate system, aren't we already debating value? Arguments about rationing stem from perceptions of what sort of value the system produces.

Whether that system is top down or bottom up, price will always factor into its decision-making process. Rationing is a byproduct of price.

Wouldn't true reform be a concession that the centralized approach has failed?

Maybe the economics aren't quite bad enough that lawmakers would accept this.

Or, maybe the debate hasn’t yet progressed to address how the competing systems would function in detail. If that’s the case, we’re a long way from thinking of what value means.

"Quality" Health Care Reform

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 19 Jun 2009 15:10:00 +0000

What is health care reform? The debate's convolutions expose extreme differences in priority and understandings of what exactly the problems are, and what legislation should accomplish.

We read a lot about cost as a priority issue. But how should we define this? As price, volume – or how about intensity of use?

Another cornerstone is access. Does this constitute a right, a privilege or maybe an economic good?

A third contention is quality. But what is quality? Is it something consumers should determine for themselves, or should agencies and third-parties decide it on a top-down basis?

The attempt at universal health care prioritizes access. The consequences of the Congressional Budget Office's scoring this week, however, indicate that cost now supersedes it as an issue. (Recent polls suggest that the electorate concurs.)

These consequences are also defining health care as an economic good, which happens to coincide with some of the discussion on quality. For example, MedPAC, a favorite among reform odds-makers to assume an enhanced role, argues repeatedly for accountability and transparency in its recent biannual report.

The report, importantly, advocates an economic resolution:

"To increase value for beneficiaries and taxpayers, the Medicare program must overcome the limitations of its current payment systems. A reformed system would pay for care that spans across provider types and time (encompassing multiple patient visits and procedures) and would hold providers accountable for the quality of that care and the resources they use to provide it." (From the executive summary)

It stops short, though, of calling for a turned-over system. Even in its advancement of "accountable care organizations", the report still assumes a critical role for Medicare in payment decisions. Of course, if MedPAC were to argue for a complete surrender to consumers as purchasing decision-makers, it would put itself and Medicare's $80 trillion liability out of business.

Let's assume the debate does shift to address quality as the absolute priority. One, this increases the possibility of legislators actually accomplishing something, because it centers the discussion not just on value, but also the payer-provider dynamic.

Hot-button items such as comparative effectiveness and health IT would all come into focus without the risk the CBO not scoring them. Remember, the CBO is only giving credit to tax and payment policies, which these past few days have proven politically unpalatable. Not including access would eliminate both, and the CBO as a factor.

Two, quality-based resolutions that incorporate value could serve as stepping stones to access and cost. That's because they’re likely to result in more accountability and transparency, neither of which can occur without consumer participation. And the more consumers engage, the more likely access will expand in a cost-efficient way.

Perhaps, one day, supply (physicians) and demand (consumers) might actually transact with each other.

Now that would be a noble goal indeed.

Universal Coverage Too Expensive to Finance

noreply@blogger.com (SYDNEY WILLIAMS) — Wed, 17 Jun 2009 14:53:00 +0000

If Congress has learned anything these past few days, it's that the Congressional Budget Office (CBO) and its scoring system are deciding the fate of health care reform. On Monday and Tuesday, the CBO reportedly priced the Kennedy and Baucus bills at over $1 trillion a piece. In doing so, it completely upended the spend-more-to-save-more game plan.

CBO Director Douglas Elmendorf explained the premise behind his agency's scoring in a letter to Sens. Gregg (R-NH) and Conrad (D-ND) and on his blog, "[L]arge reductions in spending will not actually be achieved without fundamental changes in the financing and delivery of health care." He oferred two areas that he believes would reduce federal spending, "payment policies in federal programs" and "the current tax subsidy for health insurance".

In an important reference to proposed efficiency initiatives (comparative effectiveness and health IT, for example), he writes: "Many of the specific changes that might ultimately prove most important cannot be foreseen today and could be developed only over time through experimentation and learning."

So back to the drawing board Congress goes. The political stakes, meanwhile, are rising. So far, health care reform has centered on universal coverage, which no one is disputing. More covered lives addresses both the welfare agenda and the business agenda of an expanded marketplace.

Nevertheless, there's significant political risk in how lawmakers may choose to fund it: higher taxes and pay cuts to providers.

Let's not forget, too, that health care reform will now have to compete with financial market reform for lawmaker and taxpayer attention. This will magnify the economic backdrop, and, in doing so, further diminish the moral argument in the health care debate. As we learned in the 2008 election, it’s financial security that matters most, as well-intended as we might otherwise want to be.

And with the economy muddling along, no one wants to think about how things might look ten years down the road, just how to get things back on track as soon as possible.

If not already, folks will soon frame financing options in terms of cost of capital, and what this means over the next two or three years. Inflation fears and the prospect for higher taxes might be too much for even the most committed reformists on either side of the aisle to stomach.

So, has Mr. Elmendorf effectively quashed health care reform as currently intended? Maybe not, but universal coverage is not the sure thing that it might have been a week ago. There’s still ample opportunity for new attempts. Sen. Conrad’s health-insurance "co-op" might factor into this, and so could modifications to the proposed health care exchange marketplace. Legislative maneuvering, though, is tightening.

The wild card is MedPAC, the Medicare Payment Advisory Commission. As New York Times columnist David Brooks writes: “You can take every thorny issue, throw it to MedPac and consider it solved.”

Making MedPAC the “Federal Reserve” of the health care system could well be the safest approach to payment reform as the central component of health care reform, inside of a government-first agenda.

The market-based folks will still have to wait for another day, and so might universal coverage.

MedPAC Targets Cost Savings in Biologics

noreply@blogger.com (SYDNEY WILLIAMS) — Tue, 16 Jun 2009 01:56:00 +0000

Recently, the health care reform debate has featured little-known MedPAC among its various twists and turns. President Obama has advocated an expanded role for the agency, which advises Congress on issues affecting the Medicare program, while Senator Jay Rockefeller (D-WVA) has introduced legislation that would tranform it into a "Federal Reserve" for the health care system.

These are reasons why folks might want to pay close attention to its June 2009 payment policy report (published today) and, in particular, its chapter dedicated to follow-on biologics (FOBs).

FOBs–or generic biologics–are new versions of innovator products. A legislated pathway does not exist, although Congress has been debating its creation for the past few years. There are currently two bills introduced, both in the House, and neither an attempt at compromise.

A key point of contention: the period during which generic manufacturers cannot utilize innovator test data (data exclusivity). Innovators want a longer period in order to protect profits, and generic makers a shorter period to commence profits. An equally important, but far more complex, issue is the question of patent law, and the fact the biologics may not always be patentable in the same way.

The MedPAC report covers these and other issues in detail. It makes the point that without the FDA providing sufficient cover in designating product "similarity" or "interchangeability", current policy severely limits Medicare's ability to drive price competition.

Significant, therefore, are the report's recommendations for policy change on coding and payment strategies. As MedPAC notes: "The extent to which a regulatory pathway for FOBs could achieve savings in Medicare Part B would depend in part on how these producst are coded and paid under the Medicare Part B payment system." (Part B accounts for 70% of Medicare's $13 billion biologics spend, Part D the rest.)

Recommendations include different approaches for placing FOBs and innovator biologics in the same billing code, seen as a key component of price competition. It also proposes three payment options, notable in their divergence from the fee-for-service payment system:

Reference pricing: a single payment rate established for a group of clinically comparable drugs; patients pay the difference for a higher priced drug
Payment for results: an explicit, risk-sharing link between a drug's payment and patient outcome; manufacturers might, for example, guarantee a clinically defined biomarker or surrogate outcomes
Bundling: a prospectively set payment rate for a group–or bundle–of services providers furnish during an episode of care

Combined with a legislated pathway, these policy changes would substantially increase Medicare's ability to extract savings. And given Medicare's leading stature among all payers, they would also open the door for commercial health plans to do likewise.

Even absent a pathway, Medicare could still leverage these new pricing strategies against rising costs.

Suddenly, the biopharmaceutical value chain finds itself the target of a potent economic force.

Market Policy: We Don't Need a False Sense of Hope

noreply@blogger.com (SYDNEY WILLIAMS) — Thu, 11 Jun 2009 00:31:00 +0000

Here's an important market lesson: Never underestimate its ability to self-correct. Here's another: Never underestimate its capacity to exaggerate bad policy.

It would seem that neither impressed Messrs Greenspan and Bernanke enough to heed. In 2005, Greenspan could not explain price appreciation in long-dated securities as he steered a tighter monetary policy amid inflation fears, and now Bernanke faces his own "conundrum" in long-rates moving higher against his agressive expansion of the monetary base.

For many pundits, Greenspan's ineffectiveness contributed substantially to the 2008 market rout. Is Bernanke about to face (or already facing) a similar fate in inflation-ravaged asset prices?

The issue is price stability, and how markets see this occurring. We can measure this in terms of volatility. The more fearful market participants become, the greater the pressure they exert on bid-ask spreads.

Think, for example, of Treasurys as stores of value. If the market anticipates an erosion in value, then yields rise and prices fall – and vice versa. These continuous market assessments include pitting US paper against other countries' debt. Even when nothing looks good, markets will bid the least bad paper higher in price – a perpetual relative-value play.

And when a massive inflection threatens a country's national price level, markets will act swiftly in judging its monetary policy, especially if its proportionate effect is greater than fiscal policy. Massive budget deficits notwithstanding, for example, market focus is now addressing Bernanke's overheated printing press.

Consider the chart below. It measures Treasury volatility against the 10Y-2Y spread (constant maturity), from June 1976 through May 2009.

The green line depicts the 10 year–2 year yield spread (right-hand scale).
The blue line shows the 10 year unitized risk level (left-hand scale, in percentage)
The pink line shows the 2 year unitized risk level (left-hand scale, in percentage)
Unitized risk is calculated as the ratio of the annualized monthly standard deviation in the Treasury yield to its monthly average. By measuring the relative degree of variation, it helps to compare different time periods on an apples-to-apples basis.

Since 2001, peak levels in unitized risk have increased markedly. These jumps have also sustained for longer periods of time than during the previous 25 years, matching the more intrusive Fed.

Rapid changes in the yield spread (expansion and contraction) occurred during periods of elevated risk. Though intuitive, what's surprising is the contrasting degree of change. While the yield spread's rolling pattern is fairly consistent since 1990, unitized risk has successively increased, from one recession to the next.

Equity market direction, meanwhile, corresponds inversely with Treasury volatility, favoring less stressful periods (no surprise).

Amid complex, interweaving global capital flows, not even the Fed and its presumed omniscience can evaluate monetary conditions as effectively as the marketplace. The central bank overextending itself was a major contributor to the damage wrought in recent years, and quite possibly yet to come.

And whether it's Greenspan's put or Bernanke's helicopter, the last thing the market needs is a false sense of hope. Beware its disappointment, as we've just witnessed.

Better that bankers stay humble, and steer policy in a more respectful manner.

Health Care's Perfect Storms: Which One is Worse?

noreply@blogger.com (SYDNEY WILLIAMS) — Fri, 05 Jun 2009 21:49:00 +0000

In response to a reader's comment (Economix Blog, The New York Times), noted health economist Uwe Reinhardt considers the question, How much do we spend on health care? He answers this as follows – but, in doing so, neglects the other "perfect storm" in the making:

"Consider a family whose breadwinner(s) earn a gross wage of $60,000. By “gross wage” I mean wages that the employer books as labor expense — in accounting parlance, the total debits the employer makes to the payroll-expense account for the employee. It includes the employee’s pay before deducting any contributions that employees make toward their fringe benefits — e.g. health insurance — and any taxes they owe. It also includes the full cost of employer-paid fringe benefits and contributions to Social Security and Medicare.

"In the absence of any government subsidies, this “gross wage base” of a family is the donkey that must carry the full burden of the family’s employment-based health insurance, whether formally paid for by the employer or employee.

"At an annual growth rate of 3 percent, a wage base of $60,000 now will grow to $80,600 in 10 years. On the other hand, at an annual growth rate of 8 percent, a family’s total spending on health care would grow from $16,700 now to $36,000 in 10 years.

"It follows that 10 years hence health care would swallow up 44 percent of this family’s gross wage base in 2019, before any allowance for employer- or employee-paid fringe benefits and taxes..."

His next post will examine the cost of universal coverage, and how to finance it.

Clearly, any way you cut it, the consumer's ability to pay is stressing the system. However, a potentially bigger issue looms on the provider side: specifically, its willingness and ability to accept public funds. More and more providers are dropping Medicare and Medicaid simply because reimbursements don't cover costs – not just physicians, but other service vendors too such as drug stores. At the same time, funding sources are in jeopardy. Medicare's hospital trust fund, for example, is only a few years away from insolvency.

These reinforcing tensions could paralyze the system well before consumer finances reach the precipice.

Creating another entitlement program in universal coverage might exacerbate this provider problem even more. The result: mandated coverage for all, but at the cost of rapidly shrinking access and quality – and, let's not forget, an added tax burden.

On the flip side, at what point do enough providers stepping away from the current system form a viable shadow system? Would this new system offer better value than currently exists?

Time will tell, but the opt-out rate continues to accelerate.