I recently attended a conference at the prestigious Brookings Institute that was all about Medicare payment reform. The event drew an older crowd, with suit-and-tie attire and coffee that was stronger than I'm used to. It's safe to say I was the youngest person in the room -- by about 30 years.

The investor in me has a vested interest in this topic. Medicare will directly oversee $709 billion of health-related payments this year -- more than the entire GDP of Saudi Arabia. The program plays a crucial role in our nation's healthcare system, which can make or break innovative new companies. After all, its guidelines could determine whether new products and services will be reimbursable or must be paid out of pocket.

A gray-haired man in profile holds his hand to his chin in thought.

Image source: Getty Images.

The times, they are a-changin'

The U.S. wants to get Medicare's costs under control. Its current physician fee schedule (PFS) pays providers based on volume and reimburses strictly for the number of patient visits and procedures. So the next time you spend an hour in the waiting room only to be rushed through your visit with the doctor in 10 minutes, you'll know the PFS is to blame.

Well aware of these issues, Medicare's administrators are pushing for changes. One discussion involves incorporating alternative payment models (APMs), which would tie payments to patient satisfaction and outcomes instead of simply to visits. Other models base payments on capitation, which would pay doctors to keep a certain population of patients healthy regardless of the number of times they come in.

In short, the healthcare payments debate is incredibly complex. It's not easy to change a system that manages nearly three-quarters of a trillion dollars. With that complexity comes strong opinions from a variety of viewpoints.

But from an investor's perspective, here are three important takeaways that I believe should guide a smart healthcare investment strategy: 

  1. The PFS today is far too complex. Medicare created the PFS 25 years ago as a way to understand providers' costs and tie payments to resources required for services. But two and a half decades later, it's become clear that we've created a monster. In an endless attempt to obtain more perfect information, the PFS now has 7,000 codes to describe what procedures were done and 70,000 codes to describe why they were done. This is creating an administrative nightmare for doctors, overburdening them with paperwork instead of allowing them to focus on patient care. There's a huge opportunity here for cloud-based providers of electronic health records (EHRs) that make it easier for providers to get reimbursed, such as Athenahealth, Cerner, and Epic Systems. Provider satisfaction ratings are important to keep an eye on here, as some EHR vendors aren't creating any value. A good vendor should make life for doctors simpler, not more complex.
  2. The PFS is driving bad behavior. Primary-care physicians (PCPs) and family doctors are today reimbursed largely on the volume of patient visits, which is entirely counterproductive to what Medicare wants PCPs to do. The goal is for PCPs to keep populations healthy, prevent conditions in advance, and reduce the total cost of care. To that end, there is a positive reception toward "medical home" solutions, which would allow PCPs to regularly check in with their patients from the comfort of their homes. Teledoc (NYSE:TDOC) is emerging as a leader in this new telehealth space, with roughly 7,500 clients that include 30 healthcare plans and more than 200 companies on the Fortune 1,000 list. With about a 75% market share, Teledoc has done a great job of becoming the giant in the emerging industry.
  3. APMs are interested in genomics. You've heard me say before that we're on the brink of a genomic revolution. With rapidly falling costs and the ability to address health conditions before they've started, genomics will almost certainly have a more prominent role in the future design of Medicare. Watch for Illumina (NASDAQ:ILMN) and Invitae to continue to drive down the costs of sequencing, while building competitive advantages by building out the databases of their growing genomics platforms. Illumina in particular has made great strides in advancing low-cost solutions, with its NovaSeq platform potentially bringing sequencing costs down to the $100 level.

The Foolish bottom line

The healthcare industry is filled with highly trained professionals who have decades of experience in optimizing the procedures they've become comfortable with. Patient lives are at stake, and the data generated is among the most highly personal and sensitive in the world. Investors should therefore always be aware of the changes on the horizon in this industry. Medicare will look vastly different 10 years from today, and those looking ahead of the curve could be in for some very healthy returns.

Simon Erickson owns shares of Athenahealth, Cerner, Illumina, and Invitae. The Motley Fool owns shares of and recommends Illumina. The Motley Fool recommends Athenahealth and Cerner. The Motley Fool has a disclosure policy.