Binary events -- clinical trial results and FDA approval decisions -- are nothing new to health-care investors, but they usually only affect one or two companies (and perhaps their competitors indirectly).
This week, however, we've seen the prelude to an event that could have an effect on the entire industry: The Supreme Court heard arguments over the constitutionality of the health care mandate in the health care reform bill.
Call it a trinary event
The high court basically has three options when making its ruling:
- The Supreme Court could strike down the entire law.
- It could strike down just the insurance mandate that requires individuals to pay a $700 penalty for not having health insurance coverage and a fine of $2,000 for a company that doesn't offer a plan to its employees.
- It could leave the law alone.
Let's break those options down in more detail and see which companies might prosper in each case.
The new status quo
The Supreme Court's upholding the law wouldn't be so bad for most of the health-care industry.
Drugmakers are certainly getting dinged now with taxes and rebates to help pay for the expenses in the bill. They helped close the Medicare doughnut hole with discounts, which disproportionately hurt companies with drugs used by the elderly -- cholesterol drugs such as Merck's (NYSE: MRK ) Vytorin and Pfizer's Lipitor, for example. And the bill required a discount for drugs sold to Medicaid, which especially cut into margins at Gilead Sciences (Nasdaq: GILD ) and Biogen Idec.
But drugmakers should make up for those costs as more people are insured and taking medications. When the health-care law was coming to a vote, the drug industry was generally behind it, figuring it was close to a long-term wash on their bottom line.
Health insurers are basically in the same boat. Competition with government-run insurance pools might put a little pressure on costs, but large insurers like UnitedHealth Group (NYSE: UNH ) and WellPoint (NYSE: WLP ) should be just fine since they can use their size to limit overhead.
Back to the grind
If the Supreme Court nullifies the entire bill, we're back to where we were before, which wasn't so bad for the health-care industry.
Except, of course, for the fact that the increasing prices weren't sustainable.
If the health-care law is shot down, something will need to come around and replace it eventually. That iteration could be better or worse for the industry than the current version. In the interim, there will be a cloud hanging over health-care companies, which can't be good for valuations.
The one exception is likely the medical device industry, which by most estimations has companies like Intuitive Surgical (Nasdaq: ISRG ) scheduled to pay more than their fair share of the costs to institute whole health-care reform. Throwing the whole thing out would give the lobbyists for the medical device sector a do-over in negotiating fees.
And here's where things get interesting
The third option -- striking down the insurance mandate, but leaving the rest of the bill alone -- would be disastrous. The insurance mandate brings healthy people into the insurance pool, which balances out those with pre-existing conditions. And the added insured patients help reimburse drug and medical device companies for their discounts and fees.
We don't have a mandate now, which is tolerable for most Americans with independent insurance, because the most risky people are kept out of the insurance pool through pre-existing condition clauses. Employer-sponsored insurance usually accepts those patients, but employer-sponsored health care is much like an insurance mandate; employers guarantee a certain percent of the employees, perhaps 100%, be covered under the insurance, bringing in the low-risk patients as balance. Those that are fairly healthy are paying for those with chronic illnesses.
If insurers were required to take all comers in their general policies without a mandate that everyone was covered, you'd see spiraling health-care costs to cover those with high medical bills who are sure to sign up. As prices increase, it no longer becomes feasible for the "mostly healthy" to keep insurance, which makes the pool even more risky and pushes prices up further. And the cycle continues.
If the Supreme Court wields a paring knife rather than a machete striking down the entire law, Congress could repeal the rest of the law or somehow attempt to repair the hole the Supreme Court made. I think it's safe to assume lawmakers would go that route, but the uncertainty about what changes would be made and when -- lawmakers tend to be procrastinators until there's a deadline -- would likely put negative pressure on health-care stocks.
I'm not a lawyer, nor do I play one on the Internet. And if you asked 10 real ones, you'd probably get a range of predictions about what the Supreme Court might do in June. Justice Anthony Kennedy, as seems to be the case in most rulings of late, is likely the swing vote. Chief Justice John Roberts seems to be a wild card, making comments for and against striking down the law.
Risk-averse investors may want to reduce or eliminate their exposure to health-care stocks, but longer-term investors probably don't have much to worry about. The price of health care can't go up forever. If the law is struck down, something will be done to solve the problem. Eventually.
The other option is to find health-care companies growing so fast that any affect the Supreme Court decision has on the industry will be a minor blip on their path upward. Fool analysts think they've found one with multibagger potential. Find out the name of the company and why they like it so much in our new free report: "Discover the Next Rule-Breaking Multibagger."