Outside of individual healthcare plans, a large part of the health insurer business model involves negotiating deals with doctors, hospitals, and drugmakers -- deals that actively affect the success or failure of countless potential drugs and treatments.
In this segment from The Motley Fool's Industry Focus: Healthcare podcast, Kristine Harjes and Todd Campbell explain how insurance companies make money, what health insurers are looking for in their interactions with other healthcare-related entities, and more.
Watch now, and your healthcare holdings will thank you later. A transcript follows the video.
This podcast was recorded on Jun. 22, 2016.
Amanda Way: How do health insurance companies affect which companies succeed? How do you investors take this into account?
Kristine Harjes: This is a loaded question. I love this one. I think this one is probably my favorite question that got pitched to us in the healthcare sector because it really is super important. I think we got to take a step back before we go into the answer of how investors should think about this and just talk about how health insurance works. Todd?
Todd Campbell: Right. The impact that health insurers may have across the industry really depends ... It stems from how they operate as a business. Most health insurance companies are for-profit entities. They're in business to make money. They make that money by charging premiums to people, to provide them with insurance, and then pocketing the difference between the premiums that they collect and the amount that they spend on healthcare. They're always actively negotiating deals with healthcare providers, specialists, hospitals, and of course, drug manufacturers, with the hope of collecting more in premiums than they spend providing healthcare services to those members.
Harjes: One of the really direct ways that health insurers can impact a drugmaker's earnings is the fact that they can pretty much decide the game for you. If they don't want to cover a drug or have it on their preferred list, as a drugmaker, you're kind of stuck.
Campbell: Right. It's not just drugmakers that are kind of stuck. You've got primary-care physicians that obviously always are arguing and debating on how much they should be compensated by these insurers. There is a cost crisis that's occurring in our country, if you will. The cost of healthcare is having a massive impact on us as a nation. That's in large part because there are so many of us that are getting older. There are 76 million baby boomers -- 10,000 of them turn 65 every day. The vast majority of healthcare costs are incurred from treating chronic conditions that oftentimes occur when we get older. There's a cost crisis. For healthcare insurers, it is so critical to try and walk that fine line between how much can I charge in premiums and how much am I going to pay out for care. That's where you get into the nitty-gritty of how insurers can make or break an investment in, say, a drugmaker or a medical device maker.
Harjes: You see examples of this all the time, where there are companies that have really, really promising new treatments or devices and then when you get to the actual "Let's see how many people we can get to use it and to pay for it," that's where you see these drugmakers and the medical device makers stumble.
Campbell: It really happens a lot when you can't draw the direct line between the medicine and, say, the outcome.
Harjes: That is extremely true. There has been a lot of talk of changing the way that the U.S. healthcare system works more toward a pay-for-value basis, but that's not how it works at the moment.
Campbell: Right. You've got drug companies individually having to go in and make negotiated deals with insurance companies. As a result, some insurers that are very large and have exposure to many members oftentimes can get a better deal and pay less for the drug than, say, a smaller insurance company. Insurance companies will work in many different ways to control the costs that can limit the sales or the peak sales potential, for example, of a particular drug. We saw that in 2014 with the way that they responded to the new hepatitis C drugs that Gilead Sciences (NASDAQ:GILD) had rolled out. These were fantastic drugs. They changed the paradigm in treatment, but they were incredibly expensive. Insurers started by saying, "You know what, only the sickest patients are going to be allowed access to them."
Harjes: Yeah. The only way that you can really justify the cost is to look at the long term and say, "OK, what would happen if we didn't use this drug? If instead we use what's already on the market or if there's nothing on the market, what would happen if we didn't use anything at all?" Obviously, it is pretty impossible to assign a dollar value to somebody's life or somebody's quality of life. There are things that have a more obvious dollar amount attached to them. Todd, you mentioned the hepatitis C drugs from Gilead. You can talk about the cost of having to get a liver transplant. That's the sort of argument that you see. That, I think, is the best thing an investor can do to look at whether there is a good chance that the drug will be picked up by a lot of insurers or not, is if there is that sort of long-term cost savings argument.
Campbell: Right. If it doesn't exist or it's very hard to quantify, then it becomes a guessing game. Look what happened with MannKind in Afrezza. Here they have this inhaled insulin that theoretically, it makes it easier for patients to dose themselves prior to a meal. It does, inarguably, a better job at controlling blood sugar for those patients. Yet because reimbursement deals weren't able to be made with insurers, the sales never even came close to what the pre-launch expectations were.
Kristine Harjes owns shares of Gilead Sciences. Todd Campbell owns shares of Gilead Sciences. The Motley Fool owns shares of and recommends Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.