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Originally published Wednesday, November 25, 2009 at 12:09 AM

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Reform won't take bite out of health-care profits

Data compiled by MarketWatch show that profits of the 52 health-care companies in the Standard & Poor's 500 Index nearly tripled in the past decade. And those levels seem unlikely to change anytime soon, even if lawmakers pass the legislation that's working its way through Congress.



It's been a tough 10 years for Corporate America, but you wouldn't know it by looking at the nation's biggest health-care firms.

Examine all the companies in the Standard & Poor's 500 Index and you'll find, on average, they'll end the decade with slightly lower profits. But the health-care companies in the index have been anything but the norm.

Data compiled by MarketWatch show that the 52 health-care companies in the index are about to close out the decade with average profits that nearly tripled.

And that level of moneymaking seems unlikely to change anytime soon, even if lawmakers pass the legislation that's working its way through Congress. Experts say there just aren't many reform proposals that would take a significant bite out of health-care profits.

That shows that Democratic-led efforts to overhaul the system and tamp down its excessively rising costs are being put off to another time, says Les Funtleyder, health-care analyst for Miller Tabak and author of "Health-Care Investing."

"The [cost] curve needs to be bent because it's unsustainable," Funtleyder said.

Through the decade, the industry has proved it's not only recession-proof, but it's also remarkably lucrative by any measure. Along the way, those riches have turned the sector's stocks into Wall Street darlings, second only to the energy sector for a 10-year run that saw their market value rise nearly fourfold.

By the time they close the books on this calendar year, the biggest U.S. health-care companies are expected to net $94 billion on the more than $1 trillion in revenue that they rake in. Some of that change reflects industry consolidation, but much of it came through internal growth.

From drugmakers to biotech firms to insurers, all of the subsectors within the industry showed healthy gains in one realm or another. And every one of them is expected to turn a profit in what has been a difficult year for most other companies.

Health insurers — now popular targets on Capitol Hill in the health-reform debate — more than tripled their income. Six of the insurers on the list are expected together to make more than $10 billion when this year's results are final.

And yet, their performance pales in comparison with a number of other subsectors when measured on the basis of their profit margins. Net margins for biotechnology and pharmaceutical firms are five to seven times greater. Further, medical-device makers and suppliers saw gains in their profit cushion that were six times that of carriers' over the last decade.


Many experts acknowledged the profit numbers show insurers may be playing the scapegoat in this debate.

"So far, [Congress has] focused on one of the less-profitable parts of the industry because insurers are inherently unpopular," said Paul Ginsburg, president of the Center for Studying Health System Change, a nonpartisan policy-research group in Washington.

What is more perplexing is whether spiraling health-care costs — which rose at double-digit rates annually for many of the last 10 years — can be corralled and controlled under current proposals. If that can be done, health-care company profits might end up more in line with the rest of corporate America, they say.

More profits predicted

MarketWatch pulled the financial reports of 52 of the 53 health-care companies now in the S&P 500 for the past 10 years and looked at Wall Street estimates — or in a few cases, the final results — for fiscal 2009, based on surveys tracked by FactSet Research. CareFusion, which was part of Cardinal Health until September, was excluded.

Nine industry groups comprise the vast health-care sector: biotech, health-care services, hospitals, insurers, medical-device makers, medical suppliers, benefits managers, pharmaceutical makers and drug distributors.

On average, the companies in the sector saw sales growth of 160 percent while profits rose 175 percent over the decade. Four of the companies saw their profits drop during the decade, but all still are expected to make money this year.

Eight of the nine sectors should report a collective 10-year gain in income by year's end. Tenet Healthcare, the only hospital group that's part of the index, is expected to see a drop in profits for that period.

How does that compare with the rest of corporate America? Standard & Poor's says earnings for its entire index of 500 companies will drop 7.6 percent. It should be noted that the overall S&P 500 figures include the health-care companies. Without them, the drop in profits would be markedly worse.

Individual sectors break down like this: Of the S&P health-care companies, the six biotech firms in the index prospered the most during the decade, with profits catapulting nearly ninefold. Though its margins dipped slightly, biotech remained the highest-margin business at about 29 percent.

Drugmakers remained the next highest-margin business, going to 22 percent from 19 percent. The 14 pharmaceutical firms in the index are expected to see profits more than double to $55 billion in 2009, up from about $26 billion when the decade began.

Profit gains in several other sectors were similarly gaudy — a sixfold increase for medical-device makers and health-care services, a more than fivefold jump for the two pharmacy-benefit managers in the index, Medco Health Solutions and Express Scripts, and more than triple for medical-service companies.

Although margins for biotech and pharmaceutical firms remained in the stratosphere, they didn't make the biggest gains. Medical-device makers and medical suppliers made the greatest leaps during the period, with margins on pace to climb more than 600 basis points when the final numbers come in. Margins for the 10 medical-device makers in the index are likely to reach 15 percent on average, while five medical suppliers will see margins rise to an average 17 percent.

Because Tenet was the lone hospital company in the S&P 500, MarketWatch looked at an additional six operators of hospitals and nursing homes for a more comprehensive look at that sector. Although margins stayed relatively flat, the group's profits jumped nearly fourfold.

And while hospitals are a low-margin business, their profit growth was larger than that of insurers, though carriers still enjoyed large gains. Profits are projected to more than triple to $10.2 billion for the six insurers in the index, up from $3.04 billion a decade ago.

Industry giants UnitedHealth Group and WellPoint made huge gains. With Anthem results included to reflect their merger, WellPoint's profits jumped eightfold during the decade while UnitedHealth's income multiplied nearly seven times.

But sales increases were almost commensurate with profits, and so insurers' margins are paltry compared to the rest of the industry. Their profit cushion grew from 3 percent to 4 percent during the decade, less than half the estimated industry average of 9.4 percent for 2009.

Only three pharmaceutical distributors, two benefit managers and Tenet, the lone hospital company, had narrower profit margins. All other sectors had more than twice the margins that insurers had.

Wasteful spending cited

Policy researchers agree that insurers have been set up as the fall guy in the health-care debate, even though other sectors have racked up beefier profits.

"I'm certainly not surprised [others] did better," said Len Nichols, director of the health-policy program at Washington-based New America Foundation, a nonpartisan public policy institute. "I think [insurers are] more a middleman than a villain."

But Uwe Reinhardt, health economist and professor at Princeton University, says much of what is wrong with the health-care system is linked to wasteful spending by insurers.

"It's still a huge administrative mess," Reinhardt said. "I'd rather see them get 1 percent more [in margin] if they could shave off administrative costs. The real issue is pure waste."

Reinhardt noted, though, that efforts have been made to appease the various factions in the health-care picture to avoid having the industry lobby to kill any legislation. The Obama administration reached out to pharmaceutical companies and others in the debate, including insurers, before Congress started tackling the issue.

"It's a fractured system with powerful tribes, each looking out for its own benefit," Reinhardt said. "If you do health reforms, you have to buy off all the tribal chiefs."

It's unlikely that pressure will ever come from current proposals in health-care reform, says Funtleyder, Miller Tabak's analyst.

"Unless the government does something about prices, I don't think you're going to see anything hurting anybody," he said.

Funtleyder says the details contained within the 2,000-page proposal that recently passed in the House could adversely affect one company or another, but broad sweeping changes to the industry are unlikely to have a major impact. The Senate's upcoming version, however, could hit the industry's bottom line.

Cuts in the Medicare Advantage program are likely to be a drag on the industry overall, but that already has been factored into share prices, Funtleyder says. No bill is expected to take effect until 2013 at the earliest.

Experts say unless price controls are imposed on high-margin businesses, which seems unlikely, the industry could go on charging what it wants.

"No health provider, no hospital, is making it possible for you to comparison shop," said Joseph Antos, a fellow at the American Enterprise Institute.

One popular target is so-called "Cadillac" plans, which offer unlimited coverage by an employer. There, critics say, health-care providers charge what they want, thus driving up costs unnecessarily.

But it will take a concerted effort on a number of fronts to drive down costs, Antos said. "There's not a lot of cost containment in any of the bills," he said. "If we really knew how to deliver high-quality care and reduce spending, we would be doing it already."

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