Can $634 Billion Save the U.S. Health Care System?

Health care in the U.S. needs to be fixed. President Obama and almost all investors can probably agree with that.

But investors probably aren't nearly as excited about how the president is planning on solving things.

The good news is that Obama's budget includes a $634 billion down payment on getting insurance for the 48 million uninsured. The bad news is that the president has to pay for that by cutting costs in other areas.

Ensuring lower margins
Health insurers have taken the brunt of the pain from the budget proposal. Obama wants insurers such as Humana and UnitedHealth Group (NYSE: UNH  ) to bid for Medicare Advantage members rather than use the current formula that helps the companies rake in 14% more than the cost of government-sponsored Medicare.

Moats are good; competition is bad. Anyone with a basic understanding of investing knows that. A competitive bidding process will almost certainly pinch margins, although there's a possibility that lower costs could bring in more members, which would take a little bit of the sting out of the bottom line.

The health insurers aren't going to go down without a fight, though. Many of them have issued press releases condemning the cuts -- in the nicest possible way, of course -- and Cigna even went as far as releasing a podcast on the subject.

I'm not sure seniors are going to go for the change, either. The popularity of Medicare Advantage is that it can provide additional services beyond Medicare -- that's the "advantage." Cutting payments to HMOs is ultimately going to hurt seniors.

Importing lower margins
Obama is also revisiting the idea of allowing the importation of drugs from other countries. Pharmaceutical companies such as Pfizer (NYSE: PFE  ) and Merck (NYSE: MRK  ) sell drugs for lower margins overseas because the countries force them to. Whether you like it or not, the U.S. subsidizes the innovation of drugs.

In theory, importing drugs could hurt drugmakers, but in reality, it shouldn't be a major problem, since pharmaceutical companies control who gets their drugs. If a Canadian pharmacy started selling drugs in the U.S. to any significant degree, the drugmakers would just cut off their supply.

The solution to keeping innovation going is to get other countries to pay their fair share, not for the U.S. to try finding a back door to cheaper drugs. But good luck with that.

Lower-margin copycats
Generic-drug makers weren't nearly as sad about the budget. Their margins won't be going up, but Obama's support for generic versions of biotech drugs is a boon. Finally, someone's benefiting from this budget.

Right now, generic-drug markers can sell generic versions of small-molecule drugs that are generally made through chemical synthesis after the exclusivity period runs out. But there's no regulatory pathway to approve biotech drugs that are produced by live cells.

The big fight is going to be the length of time before biotech drugs see generic competition. Currently, a small-molecule drug can get a five-year bonus added to its patent, thus extending the time before it sees generic competition, but biotech companies such as Amgen (Nasdaq: AMGN  ) and Genentech want an even longer bonus period, because biotech drugs are harder to develop.

Even if Congress sets up a regulatory pathway, companies such as Teva Pharmaceuticals (Nasdaq: TEVA  ) and Merck (NYSE: MRK  ) that are planning on developing follow-on biologics aren't home free. The FDA will still need to be convinced that the drugs are as efficient as the brand-name drugs. That might not be as easy as it sounds, since Genzyme has had trouble convincing the FDA that it can produce equivalent versions of one of its drugs after stepping up its manufacturing scale. If a company can't replicate producing its own drug, generic-drug companies are going to have a difficult time replicating other companies' drugs.

It's not over till it's over
Although health-care companies have been mostly insulated from the politics lately and haven't seen nearly as much volatility as banks such as Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) have, that seems likely to change.

Suddenly, every change to the budget -- this was just a budget proposal, after all -- is going to have monstrous effects on the sector. Take some motion-sickness medicine, Fools -- this is going to be a roller coaster.

More Foolishness on government intervention:

UnitedHealth and Pfizer are Motley Fool Inside Value picks. If you're interested in picking through the wreckage for possible turnaround candidates, you should have the Inside Value team on your side. Check it out for free with a 30-day trial.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is a former Motley Fool Income Investor recommendation. The Fool owns shares of UnitedHealth, which is a Motley Fool Stock Advisor recommendation. The Fool's disclosure policy has a budget but rarely sticks to it.


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