How is Healthcare Prepared as Pandemic Turns to Endemic?

Key Points

Value opportunities for 2023

2022 was a rough year for the markets, and healthcare stocks generally suffered worse than most. The S&P Healthcare Services Select Index fell by 19.7%, compared to a 19.2% decline for the S&P 500 Index. Acute care hospital stocks performed especially badly, down 29.8%.

There were healthcare winners too, however. Notably, managed care organizations (MCOs) saw a 5.4% average rise, with the biggest five payers up by 11.2%. Within the S&P 500, too, payers saw a 4.9% increase, while the decline for healthcare facilities providers (4.1%) was far lower than the 19.2% average loss.

MCOs remain strongly positioned for 2023, in our view – but we see relative value opportunities this year among providers, as well as payers.

Labor pressures set to ease

The industry-wide shortage of nurses, exacerbated by the pandemic, continues to affect the industry. Acute care hospitals, in particular, turned to high-cost agency labor, and many nurses left full-time positions to take up these roles.

Wages for full-time employees grew by 5% to 7% last year. Besides labor costs and wage inflation, higher supplies costs will also remain a pressure point for operators this year.

However, providers in our coverage have been able to mitigate this difficulty through efficiency gains. Over the months to come, we expect agency labor rates to continue to moderate, largely offset by full-time wage inflation.

At the same time, Medicare rate updates and commercial contract negotiations should provide some offset. Final 2023 rate updates were above initial proposals, suggesting that CMS is heeding inflation concerns. We are hopeful that reimbursement will continue to adjust to the inflation seen in 2022.

“Over the months to come, we expect agency labor rates to continue to moderate, largely offset by full-time wage inflation.”

Ben Hendrix, Healthcare Services & Managed Care Analyst, RBC Capital Markets

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Robust future for managed care

We expect utilization of MCOs to continue to normalize in 2023, with residual COVID cases reducing further. The aging population will help to drive growth in Medicare Advantage membership.

Managed care benefits from an increasingly recession-resistant business mix, thanks in part to the effects of the Affordable Care Act and recently enhanced exchange subsidies. With more exposure to floating rate investments than liabilities, MCOs are also well positioned as net beneficiaries of rising interest rates.

This explains why managed care was by far the overweight favorite among investors in 2022. This preference should persist this year, according to our polling. Any shift out of managed care seems most likely to benefit the medtech industry.

Cost control key for providers

For providers, the stubbornly difficult labor environment pushed up operating costs and squeezed capacity during 2022.

While these challenges persist, we are encouraged by management teams’ ability to adapt to the ‘new normal’. We believe hospitals and post-acute providers will be well positioned as labor markets move towards stabilization.

Operators must remain focused on managing costs, including innovative care models and supply chain management.

Political gridlock could benefit industry

There appears little chance of substantial new healthcare laws in the near term, which we see as largely positive for the industry. The Democrats’ continued control of the Senate and the Republican takeover of Congress are likely to lead to legislative gridlock.

The industry should be well positioned to weather this period, given the extension of enhanced ACA exchange subsidies until 2025 via the American Rescue Plan Act (ARPA).

“There appears little chance of substantial new healthcare laws in the near term, which we see as largely positive for the industry.”

Ben Hendrix, Healthcare Services & Managed Care Analyst, RBC Capital Markets

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As expected, proposed Medicare cuts under the Statutory Pay-As-You-Go Act (PAYGO) – which were due to take effect at the start of this year – were averted at the last minute.[1] PAYGO had mandated a Medicare sequestration of up to 4% if any legislation increased the federal budget deficit over a five to ten-year period; the ARPA COVID relief package would have triggered this.

The cuts had already been delayed several times. The latest deferral applies until 2025, when Congress will have to deal with the issue again.

Home health cuts loom

One negative aspect of the legislative impasse is that it makes a bill to avert home health cuts unlikely.

The home health industry had gained wide support for action to address Centers for Medicaid and Medicaid Services (CMS) methodology that threatens significant reimbursement cuts. However, CMS’ 2023 final rate update was better than originally proposed, which is likely to mean less appetite in Congress for legislation.

While looming cuts will remain an issue for home health, we believe providers in our coverage are well positioned to navigate these pressures and to benefit from consolidation as smaller regional operators struggle with lower rates.

MA decision finely balanced

For payers, a bigger issue will be the imminent final rule for risk adjustment data validation (RADV) audit process and its potential impact on Medicare Advantage (MA) carriers.

CMS has contentiously proposed eliminating the role of fee-for-service (FFS) adjusters from the process of determining CMS recoupment levels, and applying the revised framework retroactively to 2011. This could have significant financial implications for MA payers.

After much pushback from the industry, CMS is set to finalize the RADV rule shortly. While we believe the leading MA carriers in our coverage are well positioned through sound risk adjustment practices, the decision on FFS adjustors is of some concern and remains difficult to handicap.

Soft landing on Medicaid membership redeterminations

The halting of redetermination of Medicaid eligibility through the pandemic resulted in higher Medicaid membership growth for MCOs. Payers, providers and patients are now focused on the resumption of redetermination that will follow the expected termination of the public health emergency. Management teams expect redeterminations to begin in the second quarter of 2023.

CMS has taken measures to ensure a soft landing for beneficiaries, payers and providers, to avoid leaving large numbers of individuals currently on Medicaid rolls abruptly uninsured. It has mandated that states implement a measured phase-in of redeterminations.

We expect little disruption to result. Payers in our coverage should be well positioned to recapture members falling off state Medicaid rolls, and our poll of MCOs suggests only a modest negative impact. We believe providers, too, will ultimately see a neutral effect.

Ben Hendrix authored “Healthcare Services and MCO 2023 Outlook,” published on December 21, 2022. For more information about the full report, please contact your RBC representative.

¹https://www.healthcarefinancenews.com/news/omnibus-bill-halts-medicare-and-paygo-cuts-providers