Healthcare Recession Proof?

Nashville Post – October 2003

Over the last two quarters, the hospital industry has experienced an unprecedented flattening, and in some cases an absolute decline, in inpatient admissions. In addition, most have experienced a lack of growth in outpatient services. Investors, who have long viewed the healthcare service sector as a recession proof, safe haven in times of economic turmoil, are starting to reassess this view. What has caused this change, and what does it mean for investors and for healthcare service companies?

In preparing this column, we have talked with many senior healthcare executives, and have also reviewed Wall Street research. As is often the case, much of the Wall Street view, in my view, misses the mark. There has been much discussion about the role of higher co-payments and deductibles by employees, the shift of demand caused by technology and increased competition by third-party outpatient service businesses, such as surgery centers and the newer specialty surgical hospitals. While all of these may have a minor role, frankly I see this as fishing in the wrong stream. Higher co-payments might slightly reduce physician visits, but an inpatient hospital visit uses a typical employees co-pay and deductible in the first fifteen minutes of care. I don’t see this significantly impacting admissions. Surgery center competition has been consistent since the 1980’s, and the only significant change is that surgery centers are now economically viable in smaller communities. Nothing in these items suggests a trend strong enough to change admissions by a tenth of a point.

The bulk of the answer, I believe, comes from simple economics. Every economic recession since the early 1980’s has been relatively fast, with downturns coming quickly, and recovery beginning in less then twelve months. This downturn is different, having begun with the collapse of NASDAQ beginning in 2000, and employment through this current quarter still has not begun to recover. If we start with this basic premise, then this is the first long-lasting recession since the introduction of DRGs by Medicare.

In an economic slowdown, employment contracts. This contraction has two primary results: 1) employees get nervous and reduce elective procedures, and 2) employees get laid off, shifting the health insurance coverage to COBRA. The first of these two results reduces admissions. However, the switch to COBRA actually increases admissions, masking the reduction in elective procedures. The result: Little or no impact to same store admission growth.

In a short recession, by the time that the increase in utilization caused by the shift to COBRA benefits subsides, employment is once again accelerating and the consumer is gaining confidence. This reacceleration of employment also increases utilization, as the formerly unemployed gain healthcare benefits, there is an initial spike in utilization. Again, the net impact is that the growth trend remains unscathed.

Wall Street’s conclusion: healthcare is a recession proof industry.

Enter the long-recession. The exact same dynamics govern the first three or four quarters as in a short-recession. COBRA utilization makes up for the lower elective volume, and growth rates seem intact. However, once more and more people join the unemployment or under-employed ranks, and as more of the COBRA benefits have been utilized, same store admissions flatten or go negative. Much of the baby-boomer admission growth is still elective in nature. The hurt knee can be tolerated a little longer. The cardiac screening is delayed. Economic uncertainty causes deferral.

There is a bright lining to this admissions cloud. Deferred procedures can’t be deferred forever, and it appears that GDP will expand at greater than a 4% annual rate in the third and fourth quarter. While employment growth will lag, we believe it is likely that by the first quarter of 2004, employment figures will show solid growth, which will in turn add more people to healthcare insurance. Initially, these new entrants will use more than a normal amount of services. This should coincide with an increase in elective surgery.

It is also important to note that as admission volume increases in the first quarter, healthcare providers will be comparing against a very weak first quarter of 2003, making comparisons appear very strong. The first quarter of 2003 contained a very mild flu season, combined with a harsh winter that lowered utilization. Anything approaching a normal flu season should combine with a renewed demand for services to produce a very strong beginning to 2004.

Are healthcare services recession proof? Yes, compared to automobiles or housing. But since consumers drive healthcare decisions and consumers are influenced by consumer confidence and employment, or a lack thereof, healthcare will continue to be somewhat cyclical. That said, investors should continue to flock to the healthcare sector in times of economic uncertainty, for if most recessions will be short-term in nature, more times than not, healthcare companies will not demonstrate cyclicality.

Jeffrey C. Villwock is a Managing Partner at Caymus Partners LLC, an investment banking firm focused on middle market healthcare companies. Since the beginning of September, Caymus Partners has completed four assignments, including providing the fairness opinion in HealthMont’s merger with SunLink Health Systems, Inc. In Nashville, Jeff has been an advisor to Province Healthcare, Iasis Healthcare, Surgis, Inc., and HealthMont.