Earlier this evening (5/24/17) the Congressional Budget Office (CBO) released its scoring of the amended American Health Care Act (AHCA) that passed in the House of Representatives on 5/4/17. The headline figures around coverage loss and deficit reduction are largely similar; however the CBO repeatedly notes that state waiver flexibility significantly increases the uncertainty of its estimates. The CBO estimates that by 2026 there would be 23M fewer uninsured compared to 24M previous. Medicaid coverage loss would be unchanged (14M) while ~1M more people would be covered in the commercial market (more below). The CBO also notes that it expects “a few million” people would use tax credits to buy coverage that doesn’t cover major medical risks (Mini-Med, Indemnity, Vision, Dental) - these people are counted as uninsured in this analysis. The AHCA as amended would reduce the deficit by $119B from 2017-2026 compared to $152B previously. Please see our notes on the initial CBO scoring and the revised CBO scoring of the AHCA for more details.
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We recently came across a transcript from discovery related arguments in the ANTM / ESRX dispute dated 4/26/2017 that indicate that confirm CVS is the “national PBM vendor” that provided ANTM a market check on the economics of their contract with ESRX. See Exhibit 1 on page 2 for the text and email us for a copy of the transcript. We believe this is the first time that CVS has been confirmed as the market check vendor around the ANTM bid disclosed by the company last year. ANTM has maintained it is entitled to $3B of annual savings its drug spending following a consultant analysis and also after performing a market check with another PBM vendor.
Our conversations w/ management indicate nothing new from Buzzfeed article on FBI/DoD. The DOJ investigation into UHS has been Criminal for some time, as the company has been reporting in its SEC filings since 2013 and as we recently noted the DOJ criminal investigation expanded in April 2017 to include the Shadow Mountain facility that was discussed in the Buzzfeed article. Our point here is that the FBI would have been involved for some time as investigators for the DOJ, a fact that we have confirmed with the company. In terms of the DoD, the company has been vocal that these investigations are around government payments which would include organizations like TRICARE as well as Medicare and Medicaid. From a DoD perspective our conversation w/management indicates that a couple of the facilities being looked at do have an above average DoD patient base. With the stock at 8.2x 2018 EV/EBITDA-NCI as of yesterday’s close and 2017 FCF of $800-$900M indicating a current FCF yield pushing 8%, with think valuation and optionality (2x levered) makes this a stock to buy on weakness even while acknowledging lack of visibility on investigations and behavioral turn.
Last night (5/23/17) Buzzfeed reported that the investigation into UHS’s behavioral business has widened to include the Federal Bureau of Investigation (FBI) and the Department of Defense (DOD). That said, the FBI wouldn’t confirm or deny an investigation into UHS but said that in general the FBI pursues allegations of hospitals inappropriately admitting or holding patients. The involvement of the DOD is reported to be related to UHS’s TRICARE billing and again the DOD would also not confirm or deny investigating UHS but Buzzfeed cites former employees of a Utah behavioral facility that claim to have been interviewed by a DOD investigator.
This Thursday (5/25/17) DVA will host its 2017 Capital Markets Day in New York, after which we will host lunch/meetings with the management team and investors. The past year has been eventful to say the least and we expect management will focus on updating their view of the opportunity for growth in each business segment, with the typical discussion of the potential risks and opportunities that could impact the company’s outlook. Below we review 1Q17 results, highlight our propriety view of ESRD fundamentals and list several key questions on topics we hope to come away from the day with an improved understanding of.
The Trump Administration has officially filed for a 90-day extension in the U.S. House of Representatives v. Thomas E. Price case on the payment of cost-sharing reductions (CSRs), confirming media reports from earlier today that the administration was likely to pursue this strategy. As background, multiple sources reported last week that President Trump was in favor of ending the payment of cost-sharing reductions (CSR) to insurers as leverage to bring Democrats to the table on Repeal and Replace but that many of Trump’s senior advisers were opposed to the move given the potential political fallout of coverage losses and/or large premium increases. While the outcome is positive in the near-term for MCOs and Hospitals, it does mean that insurers will need to submit 2018 exchange rates without clarity on whether these payments will ultimately be made. Kaiser estimated that Silver premiums would need to increase by 19% to compensate for the lack of CSR payments.
On Friday (5/19/17), Politico reported that President Trump was in favor of ending the payment of cost-sharing reductions (CSR) to insurers as leverage to bring Democrats to the table on Repeal and Replace. Cost-sharing reductions are required for 100-250% federal poverty level exchange enrollees choosing a Silver plan. Insurers are then reimbursed for the amount of the cost-sharing reductions. Recall that in May 2016 a federal district court Judge found that that the Obama administration couldn’t reimburse insurers but immediately stayed the decision given the expectation of an appeal. In February 2017 House Republicans and the Trump DOJ filed a joint motion asking the court to hold the case in abeyance given the potential for legislative changes that would make a ruling unnecessary. With an update due to the U.S. Court of Appeals for D.C. today, the Trump administration could choose to drop the current appeal and unilaterally stop payments. The administration could also ask for a 90-day extension to make their decision. Many of Trump’s senior advisers are reported to oppose the move to end CSR payments given the potential political fallout of coverage losses and/or large premium increases. Kaiser estimated that Silver premiums would need to increase by 19% to compensate for the lack of CSR payments.
Following our recent launch on the Medicaid space (slides, webcast replay) with a cautious view given concerns on margin pressure, we examine the recently proposed Governor’s budget in California for the 2017-2018 fiscal year starting 7/1/17. For background a Governor’s budget is typically offered as a potential blueprint but state legislatures are ultimately responsible for passing a budget and sending it to the Governor, who then would need to sign it into law (typically with some line items vetoed). As illustrated below, the CA Governor’s budget proposal would appear to indicate a cut of 7.4% for Medicaid expansion lives, not entirely surprising given the significant margins being enjoyed by MCOs in the state on the expansion population to date. MOH/CNC/ANTM are public MCOs with with exposure here and we see potential for headwinds to 2H’17 and FY2018 EPS should this rate be enacted as proposed.
Late Tuesday (5/11/17) the Department of Justice filed a complaint against UNH related to the company’s Med Adv risk adjustment practices. The DOJ’s complaint here was fully expected given the February announcement that the DOJ was joining the Benjamin Poehling v. Unitedhealth Group Inc whistleblower case originally filed in 2011. In addition to the DOJ’s compliant, an amended complaint from Poehling was also filed (nothing new here). What’s new: (1) the complaint lays out how UNH terminated its Chart Review (CV) program and reversed a $250M CV liability accrual (2012-2014) in order to make #s in Q2’14 despite a budget shortfall Exhibit 3 Pg 5 and (2) the DOJ alleges that by failing to look “both ways” UNH received at least $1B of risk adj payments that it shouldn’t have gotten between 2011-2014 – Exhibit 4 Pg 5 – indicating $3B of risk at treble damages w/potential for greater outside 2011-2014. Overall the DOJ complaint will likely cause greater concerns here and while acknowledging that risk scores in general are the greatest uncertainty in Med Adv we would still be buyers of the stock on material weakness and lay out our view below.
Yesterday (5/15/17) the New York Times published a detailed overview of the ongoing litigation against UNH related to Med Adv risk adjustment practices. We are getting a lot of questions about MCO underperformance (particularly HUM and UNH) and despite the article containing no new information this seems to be the driver. Importantly, we remain very confident that any issues found here will be backward looking – our 10+ years of work on the topic of risk scores and plan coding coupled with further checks post the UNH news several weeks ago continue to leave us confident that coding practices and documentation across the industry have sufficiently evolved over the past 5+ years to the point that there is unlikely to be a meaningful impact going forward on Med Adv reimbursement or economics from the lawsuit and continuing investigations in terms of significant coding compliance changes by plans. For more information please see our recent notes on the lawsuits here, here and here as well as our 2/17/17 webinar and accompanying slides.
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