VCs: Healthcare reform won't impede med-tech investment
Readers of this website, and this blog, are likely to have a special interest in the business impacts of healthcare legislative and regulatory initiatives. But when those initiatives are complex, with major societal implications and long implementation timelines, the likely effects on business operations, profitability and/or viability may not be obvious. When that is the case — as it most certainly is with this year's healthcare reform legislation — it is often necessary to evaluate diverse perspectives and attempt to determine which among conflicting projections are more likely to be accurate. My personal prejudice? Be skeptical of those who are directly impacted; follow the people who follow — or supply — the money.
The legislative battle over national healthcare reform seems like ancient history. Our political attention span grows ever shorter, and we've moved on to financial system reform and the environmental havoc in the Gulf. So it is sometimes hard to realize that President Barack Obama signed the new healthcare law on March 23, a scant 11 weeks ago. Still, that is time enough for policy wonks (mea culpa), healthcare executives and other attentive publics to think more clearly about the likely impact of reform than they could during the heat of legislative battle.
At the systemic level, there are some things we can know with a high degree of certainty about the effects of reform, because of unambiguous mandates in the law: There will be broader insurance coverage for preventive care; health insurers will no longer be allowed to deny coverage on account of pre-existing conditions; health insurance policies will not have annual or lifetime coverage limits; kids will be able to stay on their parents' policies until age 26; a federal high-risk pool will help the uninsured find insurance until mandated health insurance exchanges take over that task; health insurance policies will need to meet or exceed defined medical loss ratio (the proportion of total expenditures that go to pay for covered services) standards of 85 percent for group policies and 80 percent for individual policies; and expanded Medicaid eligibility standards will provide healthcare coverage for more of the near-indigent.
Other things we can know because of the silence of the reform legislation: There are modest restrictions on Medicare reimbursement rate growth but no draconian provider payment rate cuts mandated; there are no triggers for explicit rationing of any categories of care; there is no legislative impetus toward formal cost-benefit analysis for coverage determinations; but neither are there any meaningful prohibitions against future implementation of any such initiatives. An educated guess on these matters might yield the following prediction: Because these measures would be contrary to long-established values and expectations, and therefore politically dangerous, every effort will be made to avoid them; however, if costs continue to escalate at historic rates, all bets are off.
Answers to the biggest question about healthcare reform remain largely speculative. Will the insurance market reforms, intended to expand coverage, result in unacceptable premium increases? Will the states be able to finance the mandated increases in Medicaid expenditures? Will the short-term increases in public spending yield the intended long-term reduction in total healthcare spending? Will the intended improvements in overall healthcare quality materialize, and at what cost? Will Congress have the political will to implement the Medicare savings that make the finances of reform work? Will all of this really "bend the healthcare cost curve?" The more focused question of impact on medical technology and other life science businesses is among those for which the answer is non-obvious. What will be the impact of all of this on the life sciences innovation economy — the ability of the biotech, pharma and device sectors to develop and commercialize new technologies?
The pharmaceutical industry placed a big bet on healthcare reform, offering up $85 billion in drug price rebates over 10 years in exchange for what it viewed as significant market expansion consequent to broadened health insurance coverage. The biotech segment pays some of that rebate, but received 12 year market exclusivity against "biosimilars" (generic versions of biotech products). The device industry supported reform, largely because of the potential for market expansion, but resisted any quid-pro-quo contribution, arguing that device payments would be controlled through reimbursement measures directed at hospitals and other providers. Device makers were ultimately hit with a 2.3 percent excise tax on sales. Much gnashing of teeth ensued, and continues.
No one wants to pay higher taxes. And it is undeniably the case that subtracting 2.3 percent from the top line will require device companies to employ some combination of belt tightening and/or price adjustment in order to maintain profitability and returns to investors. At the same time, claims that this excise will have calamitous impacts on commercial operations just aren't credible, relying as they do on the necessary assumption that operations are already perfectly efficient and that there is zero pricing headroom. And messages from individual companies have been mixed, combining warnings about adverse effects with projections for — or actual — increased hiring, ongoing expansions and/or acquisitions, etc. Established med-tech companies, it seems safe to say, have some maneuvering room to deal with the excise tax — and they have the time to maneuver as well. The tax doesn't go into effect until 2013! Want proof? Look to the trend in med-tech stock prices since January 2009.
But what about the impact on early-stage, innovative technology companies? Industry sources worry that the excise tax, because it is levied on revenue, not profit, will have an especially debilitating impact on that group by siphoning off cash needed for R&D, clinical trials and product refinement, by lengthening the time to profitability, delaying investor exits, shrinking returns, and simply making device investment opportunities less attractive.
To address that question, I conducted a brief and informal email survey of (primarily) Boston-area device sector venture capitalists. I promised potential respondents confidentiality, posed a single question, and asked for straightforward and brief responses: "How, if at all, has the passage of healthcare reform legislation changed your evaluation of potential new and/or follow-on funding opportunities?" The requests went to people I know, so the response rate was high — 13/17.
Here is what I found:
- The most frequent response was "healthcare reform has no direct affect on investment strategy or analyses"
- Only two of the 13 respondents referenced the device excise tax, and one of them did so to point out that its impact would be marginal, not dispositive;
- The venture capitalists were mixed on the overall quality of the device investment environment; a number thought it is deteriorating because of the confluence of macroeconomic and regulatory factors well beyond healthcare reform;
- Several specifically referenced FDA administrative and policy changes as a significantly greater risk than healthcare reform for medical technology investors;
- Two respondents said they are focusing on different kinds of opportunities because of positive incentives in the reform legislation; healthcare IT, for example, seems more attractive than previously;
- A significant minority took the opportunity to express a strong antipathy to government regulation of markets;
- One senior VC is looking at international market presence and potential as an increasingly important characteristic — clearly a cushion against domestic regulatory initiatives.
There is also a degree of "wait and see" behind the initial responses. My VC respondents aren't convinced that they really have a complete and final understanding of how reform will affect the device sector. And they are probably right about that. There are too many initiatives in play — comparative effectiveness research initiatives, insurance exchange standards, electronic health record mandates, cost-control demonstrations, insurance coverage mandates, etc. — and too much uncertainty about how they will fit together, to warrant a high degree of certainty as to how things will come together and play out.
Edward Berger is a senior healthcare executive with more than 25 years of experience in medical device reimbursement analysis, planning and advocacy. He's the founder of Larchmont Strategic Advisors and the vice president of the Medical Development Group. Check him out at Larchmont Strategic Advisors.