Medicare, Health Care, and Megabucks

Earlier this week, the Centers for Medicare and Medicaid Services (CMS) released its forecast for health-care spending over the next 10 years. With the aging baby boomers creating one of the biggest demographic shifts in history, the report actually makes for an interesting read.

The most important takeaway from the CMS report is that both publicly provided health care like Medicare and private health-care spending are expected to grow much faster than the economy and inflation for the next 10 years. Through 2017, all health-care spending is expected to jump an average of 6.8% annually, much higher than CMS' expectation of 4.9% annual growth in nominal gross domestic product over this period.  

The CMS report is relatively congruent with other independent reports forecasting growth in health-care spending. A 2006 Blue Cross and Blue Shield Association report titled National Healthcare Trends estimated that public and private health-care spending would account for "as much as 20% of GDP by 2015," and CMS expects health-care spending to be 19.5% of GDP in 2017, compared to the 16.3% of GDP it accounts for today.

OK, so what does all this massive growth in health-care spending mean for the pharmaceuticals industry? For investors who own shares of big pharmas and biotechs like Wyeth (NYSE: WYE) or Novartis (NYSE: NVS), the most interesting part of the CMS report is that prescription-drug spending is expected to grow more than 6.7% annually and "accelerate" from 2008 through 2017. Consider that inflation is expected to be only 2.4% annually for this period, and you can see that there is some real major growth expected for the pharmaceuticals sector in the coming years.  

While this forecast for increased prescription-drug spending might be a positive omen for the pharmaceuticals industry, the reality is that if health-care spending does jump to a fifth of GDP, there will be a lot of pushback from government and private health-care payers. For example, as we're seeing now, the leading presidential candidates are agitating to allow prescription-drug importation from less-costly developed countries, or to give Medicare and Medicaid more direct negotiating power over drug prices.

Nonetheless, there are strong demographic trends favoring the pharma industry. With the large dividends that many large-cap drugmakers like GlaxoSmithKline (NYSE: GSK) pay out and the relatively recession-proof nature of the pharma industry, investors should keep a keen eye on the sector in the coming years.