About nine months ago SNWAM dug into the municipal not-for-profit hospital sector and saw the tailwinds of the Affordable Care Act (ACA) turning to headwinds. Our sector thesis going into our 2016 strategy meeting was that a larger insured population would lead to less charity care and bad debt expense, and that revenue growth would accelerate. The charts below paint just such a picture. In the top chart we see the decline in the number of uninsured starting in 2013. In the bottom chart we clearly see both charity care as a percent of net patient revenue and bad debt expense of as a percent of net patient revenue fall, which supported high single digit compounded annual revenue growth for the sector. However, leaving our meeting we identified that implementation and execution risk of strategies needed to capture increased patient volumes presented downside risk because the greater number people using Medicaid/Medicare insurance could thin operating margins and begin to pressure revenue growth. Given this outlook, we reduced our overweight to the sector to 5% from 10%. Looking at the charts again (bottom chart), we see thinning operating cash flow margins and revenue growth begin to slow in 2016.
Now let’s get to our current sector outlook. The risks in the not-for-profit hospital sector have materially changed since the presidential election. The durability of the ACA, which provided positive credit trends, is now in doubt. Among the risks of ACA repeal could be the loss of health insurance premium subsidies, reversal of the individual mandate, cutting of the healthcare tax on premium plans and the reversal of Medicaid in expansion states. Repealing any one of these benefits (or of the tax) would likely reduce the number of insured and create negative credit trends. While the outcomes of federal healthcare policy are highly uncertain, we do have a number of stabilizing factors. According to the World Bank, the U.S. spent 17.1% of its GDP on healthcare. That is nearly a fifth of U.S. GDP. The Kaiser Family Foundation data in the chart above shows that nearly 20 million more people now have health insurance as a result of the ACA. That is a lot of people. The point is, highly salient and complex issues (like health care policy) that affect a large portion of the U.S. economy and impact tens of millions of people will take time to change. Any changes will likely be gradual and implemented over many years, just as it took years for the regulations promulgated by the ACA to be implemented. We have a great recent example from the 2015 Kentucky race for governor. Matt Bevin (R) won the race on a platform that opposed the ACA, pledged to shut down Kentucky’s state health insurance marketplace, switch the state to the federal marketplace and repeal Medicaid expansion immediately after taking office. But following taking office, Governor Bevin switched his focus primarily to modifying the state’s Medicaid expansion rather than repealing it outright. This is a great case study in political rhetoric versus policy reality.
But let’s be real. The U.S. Census Bureau forecasts that by 2025 20% of the U.S. population will be over 65 years old and eligible for Medicaid/Medicare insurance. The 20 million who could potentially lose health insurance if the ACA is “repealed” will be quickly replaced by an aging U.S. population. Therefore the hospital sector will regain the lost insured pool fairly quickly, and negative credits from ACA uncertainty will give way to different credit metrics like operational efficiencies, payer mix and the management of contractual allowances and discounts. Given these sector drivers, we are comfortable maintaining our 5% weighting to the sector and believe we are very well positioned to take advantage of any market dislocation from whatever ACA noise lies ahead of us.
Source: Kaiser Family Foundation, World Bank, US Census Bureau, SNW AM Research