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Executive Orders Bring Uncertainty for Healthcare Exchanges

For now, we’re not changing our valuations or moat ratings for the affected companies.

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Last week, President Donald Trump signed two executive orders that will materially change the landscape of the healthcare market. The first allows individuals and small businesses to purchase health insurance plans that offer benefits below current Affordable Care Act mandates and allows these entities to form group purchasing organizations.

The second immediately halts all cost-sharing subsidies for insurers that provide plans on the public exchanges. These subsidies were used by insurers to offer lower copayments and coinsurance to their members. These executive orders have weakened key pillars of the public exchanges and have built material uncertainty into the public exchange market.

From our initial analysis, we believe these actions have offsetting positives and negatives for the managed care and service provider companies we cover. However, we caution investors that the ultimate business ramifications and actual population affected by these executive orders are not as impactful as they may initially seem.

Of the 320 million individuals in the U.S., approximately 20 million or 6%-7% receive insurance through the public exchanges. Additionally, the major managed care companies we cover ( Aetna (AET),  Anthem (ANTM),  Cigna (CI),  Humana (HUM), and  UnitedHealth (UNH)) have scaled back their individual exchange membership dramatically for 2017 and have announced plans to further decrease their participation for 2018. Thus, we estimate ACA exchange membership to be a low-single-digit percentage of total membership for the major five. Even though the impact will be material for the exchange business for these players, the overall downside risk is limited.

The immediate and long-term impact of the two executive orders upon managed care organizations is somewhat uncertain, but we do not expect to change our fair value estimates, moat ratings, or moat trend ratings. Over the near term, we expect there to be increased medical costs and lower earnings per share, given the elimination of cost-sharing subsidies.

Offsetting this near-term negative headwind will be the ability of these companies to underwrite with greater variability moving forward. ACA underwriting mandates and the unwinding of minimum health insurance benefits should allow insurers to drive increased profitability and lessen price competition. However, this positive tailwind will not take hold until 2018 at the earliest, since 2017 plans are already in place.

We do believe the major MCOs will remain cautious toward this market and any large-scale participation will be delayed until 2019 at the earliest, given the extreme uncertainty that the two recent executive orders have injected into the market and the potential for future executive or legislative action. From our perspective, this dynamic will limit the negative effect on the major five MCOs.

Given the small exposure of most healthcare facilities to exchange patients, we don’t anticipate dramatic shifts in our fair value estimates, moat ratings, or moat trend ratings for the service providers we cover,  HCA Healthcare (HCA) and  Tenet Healthcare (THC). However, Trump’s executive orders on association health plans and cost-sharing reduction subsidies would potentially lead to marginally lower volume and higher bad-debt expense as patients drop coverage, lose benefits, or face higher out-of-pocket costs.

We plan to re-evaluate our longer-term assumptions, which may lead to small reductions in our fair value estimates depending in part on how the executive orders are implemented, including any potential fixes from Congress. We continue to place no-moat ratings and very high uncertainty ratings on HCA and Tenet as a result of ongoing reimbursement pressure and uncertainty as well as high financial leverage.

The long-term effect of these actions for the overall healthcare market is also cloudy, as we expect there will eventually be legislation that will address the many issues permeating the individual health insurance market. We believe it’s important for investors to consider one dynamic: No matter what form it takes, subsidized healthcare for the uninsured middle class will be provided by the federal government. As has been demonstrated time and again, it is extremely difficult to unwind any federal entitlement program, given the political ramifications. We believe this is especially the case for healthcare entitlements that affect middle-class voters.

From our perspective, many individuals do not yet fully understand the consequences of lower benefit coverage and lower federal government cost-sharing. The combination of these factors will probably lead to lower overall healthcare coverage and increased out-of-pocket expenses. In reaction to this near-term dynamic, Congress and the current (or future) administration may revisit mandated benefit coverage levels and federal subsidies. On balance, we believe this legislative action would eventually lead to increased healthcare coverage for the U.S. population and should drive demand for the overall healthcare market over the long term.

Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.