Financial Sense   Home  l  Broadcast  l  WrapUp  l  Storm Watch  l  About Us  l  Contact Us

Spitzer Investigation and
HMO Implosion Has Wider Implications
by Dr. Joe Duarte
October 22, 2004

Dr. Joe Duarte's is the author of "Successful Biotech Investing."
His Market I.Q. column is available daily at www.joe-duarte.com.

The HMO sector crashed on October 19. Aside from the fact that it happened on the 17th anniversary of another stock market crash, this major decline has significant implications on multiple levels, on Wall Street and Main Street.

New York Attorney General Elliott Spitzer subpoenaed Aetna (NYSE:AET) and Cigna (NYSE:CI) two major health insurers, recently, expanding his probe into the insurance industry.

Chart Courtesy of StockCharts.com

According to AP, Spitzer's reason for the subpoenas is to probe: "whether the brokers are improperly steering business to those who pay the highest fees - paid on top of commissions - rather than seeking the best deals for their customers."

As expected the entire sector fell out of bed, but as with all major investigations there are almost certainly going to be some unintended consequences.

While the Morgan Stanley Health Care Payor Index (HMO) crashed and burned, other health related indexes also retreated. The Morgan Stanley Health Care Products Index (RXP), a broad basket of drug, biotech, and medical equipment names also sold off.

Chart Courtesy of StockCharts.com

Elsewhere, beleaguered, under investigation, and beaten up drug distributor and pharmacy operator Cardinal Health (NYSE:CAH) made a new low on 10-19, despite no major news, and the fact that it had already been sold heavily for months.

Even RXP component Boston Scientific (NYSE:BSX) fell despite the fact that it beat earnings expectations, although it gave a less than optimistic outlook to investors.

Chart Courtesy of StockCharts.com

An Industry Already Under Legal Siege And Financial Strain

The health care industry is already under significant amounts of stress. Physicians are overburdened by paperwork and government regulations. Hospitals are being buried under mountains of bad debt. Drug companies are reeling from unexpected problems with blockbuster drugs. And politicians are threatening to make major changes in the healthcare system.

Corporations in the sector continue to squeeze as much out of expenses as possible trying to meet Wall Street expectations.

And the government and private sector are involved in significant amounts of litigation.

In a recent CBS Marketwatch article, Russ Britt wrote: "The health-care industry's strong financial recovery is coming at a price in the form of patient outrage and added regulatory scrutiny and enforcement."

In the article Britt highlights the current legal status of several class action lawsuits including multiple sub-sectors of the industry.

A Potential Stake Through The Heart

What the major media has not caught on to yet, is that the health insurers, like them or not, are the backbone of the U.S. healthcare system. In essence, they pay the bulk of the bills to doctors, hospitals, equipment makers, and drug companies.

In many cases, large insurers administer health care plans for state and local governments in the form of Medicaid HMOs.

History clearly shows that once an investigation of this nature begins, it takes on a life of its own. Similar to special prosecutors in Washington D.C., these Attorney General probes often begin to uncover information that, although unrelated to the initial complaint, fall within the scope of potential prosecutions or settlements.

If that is what happens in this case, and for example, Spitzer's probe discover other kinds of fraud, such as doctors and hospitals are not being paid, or key benefits to very ill patients have been systematically denied, the probe could expand both in time and scope. And the consequences could be long lasting.

In other words, if Spitzer sinks one or two major health insurers, the entire U.S. health care system could take a major hit, and may possibly be pushed beyond repair, at least for several years.

Market Influences

For investors, aside from the risk of a stock that they own, such as Aetna, getting clobbered, the risk is even potentially greater on multiple global, and personal levels.

If enough insurance companies find themselves in compromising positions, they may have to resort to portfolio liquidation in order to raise capital with which to finance legal proceedings and to meet obligations.

This can only get worse if clients begin to pull their business and or demand retribution or discounts for potential fraud.

The bond market could be the hardest hit, as insurers are heavy investors in bonds.

Since insurers are often international companies, the potential for currency market problems are also something to keep in mind.

The Domino Effect

Health care is already a difficult enough environment in the United States, with rising malpractice costs leading to physicians closing practices, restricting practice schedules, renouncing emergency room duty, and in many cases going to cash only practices.

Nursing shortages are widespread. Vaccine shortages are a hot news item.

Drug companies are having pipeline problems and blockbuster drugs such as Merck's Vioxx are being pulled off the shelf.

Many physicians are building their own cash only outpatient surgery centers and boutique hospitals in order to get out from under the regulatory and operational burden.

Family practitioners, such as William E. Jones M.D., an Austin primary care physician have established cash only practices and are lecturing other physicians on how to give up dealing with third party payors and transform their own practices.

In the current marketplace, there are multiple major dynamics at play simultaneously, creating a situation akin to a perfect storm, that is quite dangerous for the entire health care system.

And Spitzer's move could be the straw that breaks the camel's back.

Here is a potential scenario based on history and probability.

As Mr. Spitzer and crew begin to decipher records, and begin to ask questions, they are likely to find things beyond the scope of what they were looking for.

And while lawbreakers should be prosecuted, there will be unintended consequences.

Here is where the major weak spot lies.

Health insurers are the backbone of the system, since they pay the bills.

Under normal circumstances, health insurers are alleged by many as entities that are always looking for reasons not to pay hospitals, doctors, and drug and medical equipment companies.

Physicians, hospitals, and the government have successfully sued HMOs for cheating on their bills in the past.

In the 1990s, several physician groups in Texas went bankrupt, as HMOs never paid their bills to them.

Thus, if the health insurance industry is under siege, it's reasonable to assume that slow pay is about to become no pay, and that at some point, if things go on long enough, some of these same situations from the 1990s could repeat themselves.

The difference is that with hospitals, physicians, and the overall health care system having already gone through one major round of not getting paid, there is now much less slack in the system.

That means that the crisis, if it indeed materializes, and begins to spiral out of control, will likely be more significant, and hit the marketplace faster and harder.

Mr. Spitzer, by trying to do what may well be the right thing, could be a catalyst in what may turn out to be an acceleration of the health care crisis in the U.S.

Bargain Hunter Alert

To be sure, there are always several sides to a story.

For investors, this kind of crisis is often an opportunity to pick up bargains.

The key is not to get in too early and to remain patient.

For those with a 12-24 month horizon, the HMO, medical equipment, and drug sectors are now places to look with extra interest.

The great equalizer is always management. So aside from the balance sheet, the earnings trends, and the charts, a good review of management is likely the key to distinguishing between the gems and the lumps of coal.

© 2004 Dr. Joe Duarte
Dr. Duarte's Bio and Archive

Joe Duarte, M.D.

Joe Duarte M.D. is founder and Editor in Chief of Joe-Duarte.com. Dr. Duarte is a board certified anesthesiologist, a registered investment advisor, and President of River Willow Capital Management, where he manages individual client accounts. His latest books "Successful Energy Sector Investing" and "Successful Biotech Investing" (Prima/Random House) are available on line at amazon.com, barnesandnoble.com, borders.com, Traders Press, and all major online and brick and mortar bookstores in the U.S., U.K. Europe, and Australia. Dr. Joe Duarte’s Daily Market I.Q. is a subscriber service that provides daily intelligence, trading strategies, and technical analysis at www.joe-duarte.com.