There's no doubt that the topic of health-care reform ruled 2010 for health-care stocks -- and 2009, for that matter. This article alone had 284 comments and nearly 150 recommendations
Fortunately, 2010 wasn't the year that health reform sank drugmakers. The industry basically got through the reform with a slap on the wrist, especially considering the potential for a knockout uppercut.
In the next round of reform -- I don't know when, but there will be one -- drugmakers might not be so lucky.
In pretty much every other industry, products are priced based on their features. The 64GB iPad costs more than the 16GB one, because it offers the consumer more.
Drugs don't really work that way. They're often not compared to each other, and when you factor in cheap generics, it's easy to make an argument that brand-name drugs aren't worth their higher cost.
Yet most consumers don't really know what the cost of their medication is -- a $20 co-pay is a $20 co-pay. The only way to encourage lower drug costs is to get the end user to pay the cost directly.
I'm guessing that health insurance will likely look more like house insurance in the future. We expect insurance to protect us through a major issue, but minor issues with the house -- a leaking roof or a stopped-up toilet -- aren't covered. Health insurance will be the same way: Actual catastrophes will be covered, but consumers will be expected to pick up the tab for routine issues.
With consumers more in tune with the cost of health care, there will be more demands for value-based pricing.
You just have to look at the UK's National Institute for Health and Clinical Excellence (NICE) to see an extreme example of where we're headed. The agency isn't convinced that GlaxoSmithKline's
This type of value-based pricing is where the U.S. is headed -- perhaps not in 2011, but someday soon.
How to benefit
To avoid getting caught up in the value-pricing wars when that day arrives, investors need to look for innovation and avoid duplication.
Simply put, innovative drugs treat unmet needs. And by definition, there's no competition, so much of the value-based pricing becomes somewhat moot. We're talking about drugs like Vertex Pharmaceuticals'
At the other extreme, avoid me-too drugs that duplicate what's already out there. Take Bristol-Myers Squibb's
Another area I'd avoid is treatments with a lot of generic competitors, such as depression mediations. The cheap competition works so well that there's limited opportunity for brand-name contenders. If a new drug is 10% better than the current standard, does that mean it'll be priced 10% higher than the generic?
The decision to move toward value-based pricing isn't cut and dry. The cries of nonexistent "death panels" will certainly come roaring back. But when Americans realize that they can't have an all-you-can-eat buffet of health care at reasonable prices -- this isn't Vegas, after all -- they may be willing to make purchases off the a la carte menu to reduce costs.
Investors need to be prepared, and act accordingly.
Buffett thinks this "picks and shovels" company should profit, regardless of Congress' health-care reforms.
Pfizer is a Motley Fool Inside Value selection. Vertex Pharmaceuticals is a Motley Fool Rule Breakers recommendation. GlaxoSmithKline is a Motley Fool Global Gains pick. The Fool owns shares of and has written covered calls on GlaxoSmithKline. 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.