Why Markets Are Bearish on Hospitals (Though They Shouldn't Be)

The stocks of the five major publicly traded hospital chains have been ailing lately, and analysts blame a recession-fueled decline in patient volume. The other major for-profit hospital operator, HCA, reports its revenues are up, but it has yet to launch its long-promised public offering. Something besides declining patient interest in elective tests and procedures seems to be at work here, and the key is probably healthcare reform.

The long-term impact of the Affordable Care Act on hospitals will be mixed. On one hand, the law will reduce the rate of growth in hospital's Medicare reimbursement; on the other hand, the arrival of 32 million more insured patients in 2014 is expected to compensate for that. The Independent Payment Advisory Board, which will have a lot of power over Medicare rates, won't be able to touch hospitals for the rest of this decade. And if the federal government continues to pay a larger share of Medicaid costs, hospitals will benefit -- as shown by the surge in their stock prices a few weeks ago, when Congress extended the feds' extra Medicaid subsidy to the states.

The bigger uncertainty about hospitals (and the healthcare sector in general) is the fact that doctors and hospitals will increasingly be paid on their ability to actually make patients healthier, not just for doing more procedures under the "fee for service" system that's dominated reimbursement for decades. The new methodology, which will put providers at financial risk, stands hospitals' current business model on its head -- possibly explaining the nervousness of investors.

Risk-based contracting is not exactly new. For decades, some commercial and Medicare HMOs have delegated part or all of the financial responsibility for patient care to hospitals and/or large physician groups. In parts of California, this "delegated risk" model still prevails. But in most of the country, risk contracts largely died when managed care retreated in the late 1990s and early aughts.

Now they're on the verge of a comeback, as Medicare encourages the formation of what are known as "accountable care organizations" (ACOs). These groups of doctors and hospitals -- some of them integrated healthcare systems, others coalitions of unrelated providers -- will be held accountable for the cost and quality of care. While Medicare is officially planning to launch a "shared-savings" program for ACOs in 2012, healthcare providers widely believe that this is the first step toward requiring them to take direct financial responsibility for care.

So what does that have to do with the price of pork bellies? Everything. If ACOs really come to fruition, and if the Republicans fail to sabotage healthcare reform, hospitals will have to actually collaborate with physicians to improve the quality and restrain the cost of medical care. Many hospitals are already scooping up all of the doctors in sight, and there are signs that greater consolidation among hospitals and between hospitals and physicians may be on the horizon. Much of this consolidation may be financed with investor capital, but what's in it for the investors?

If healthcare continues on its current course, failing to cut rampant waste even as costs soar out of sight, investors will be right to dump their hospital stocks. If, on the other hand, healthcare starts moving toward a population health management model, only the hospitals that make the necessary investment in infrastructure and get doctors' cooperation will do well. Even the extra volume from newly insured patients won't change that equation, because hospitals that proceed on the old assumptions will lose money under the new reimbursement methods.

So if this is what's deterring investors from buying healthcare stocks, they may be partly right. But what's going to determine the future of the sector will be the behavior of individual players.

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Ken Terry

Ken Terry, a former senior editor at Medical Economics Magazine, is the author of the book Rx For Health Care Reform.

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