Investor Reaction to Failed Healthcare Reform Built on Faulty Assumption

 | Jul 19, 2017 | 4:00 PM EDT
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The failure of Congress to be able to replace Obamacare is being received in polar-opposite ways by investors.

Efforts appear to have come up short in the Senate to restructure the federal government's participation in funding private sector healthcare insurance before the existing Affordable Care Act collapses and results in many people losing access to insurance.

What's interesting is how it is playing out in the market.

The healthcare providers, hospitals, are being sold while the insurance companies are being bought. There is decided logic to the selloff of the hospitals but the positive response to the insurance companies is indicative of a failure to properly understand the financial and even existential risks to the insurance sector by allowing the ACA to collapse.

The predominant assumption appears to be that whatever the legislative response is to the failure of the ACA, it will be positive for the insurance sector and individual providers.

That's not a prudent assumption.

Many years ago when I was studying for the tests associated with various securities licenses one of the catch-all rules of thumb was that when stumped by the possible answers to a question, given the choices provided, figure out which one provided a bad outcome for all participants.

It's the lose-lose scenario that is quite often the result of the political compromises necessary to pass legislation.

However, there is a purpose in this beyond simply the pragmatic nature of doing what's necessary to pass legislation. It's that all private sector parties should be motivated to self-regulate and to avoid government intervention.

This guiding principal appears to have been forgotten by the insurance industry and the investors in it. A sense of hubris concerning the necessity of the industry to exist and be supported by the government appears to have taken hold.

It's this kind of "heads I win; tails you lose" way of considering the possible legislative actions concerning healthcare that has perversely deluded investors into believing that a collapse of the ACA is to the benefit of the insurance industry.

Of course it is possible that could be the case -- but only if all sectors affected by the necessity for government intervention have coordinated in some fashion to lobby for legislation that supports the industry broadly.

That includes insurance, hospitals and associated healthcare providers, pharmaceuticals, biotechnology, equipment providers, etc.

That's not what's happening, though.

As the cost of healthcare continues to increase at the expense of the rest of the economy, the individual sectors within it, especially insurance, are increasingly concentrating their individual goals versus that of the overall industry.

About a year ago, on Real Money, I discussed the ever increasing percentage of employee costs represented by benefits / healthcare expenses that were coming at the expense of wages.

And that trend has continued unabated over the past year, with benefits expenses rising to 31.7% of total employee compensation costs from 31.4%, and wages decreasing to 68.3% from 68.6%.

This is one of the principal reasons for the wage stagnation that has confounded the Fed's FOMC members, and is a deflationary force on the economy.

The reason for that is that healthcare, including insurance, provides the lowest multiplier effect of all sectors in the economy. When resources have to be reallocated from other higher multiplier sectors of the economy to healthcare, the economy slows, even though it's not evident in the GDP calculations.

For many, this causes broad confusion concerning the real state of the economy -- not just FOMC members.

That confusion is one of reasons people are not aware of the real negative impact healthcare costs are having on the economy and why the need to address it has not entered the "Overton window," which I discussed here.

President Trump, however, is apparently aware of this fact as he's finally decided to "let Obamacare fail" before attempting to address it again.

This is causing hospital investors to fear that the percentage of patients incapable of paying for healthcare provided will increase and cause losses. That's a logical and prudent concern.

Insurance company investors seem to be of the opinion that this will cause the federal government to provide whatever support is necessary to ensure that access to healthcare insurance increases and that it is profitable for the insurance industry.

That is highly unlikely, though, as it would mean essentially another incremental expansion of the model used for Obamacare.

What's more likely is that legislation is structured to allow for greater competition among insurance companies, or some large percentage of the population is provided insurance coverage directly through the government, or both.

Although that may not happen until after Obamacare collapses, the risk in the insurance stocks is decidedly to the downside now.

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