Financial Crisis Hits Health-Care Companies

Health-care facilities, medical equipment, and managed health-care companies have all been affected

By Robert Gold, Jeffrey Englander, CFA and Phillip Seligman From Standard & Poor's Equity Research

As the collapse of the housing market and the related financial crisis have continued to unfold, the numbers of those struggling to meet mortgage payments, newly unemployed, or simply in financial distress due to lower home equity values or stock market values have continued to grow. These forces have affected consumers' economic well-being, and one by-product of this economic weakness has been a pullback in consumers' use of non-essential health care services.

It has also hurt their ability to pay for health care services they do incur during these times, resulting in increases in the incidence of health care-related bad debt. While in past periods of economic weakness health care was fairly resistant to downturns, given the increased influence of managed care and higher amount of cost sharing in the form of co-pays and deductibles, this appears to be less the case now. These factors have begun to ripple through the health care system, impacting hospital, medical equipment, and managed health care companies.

Health Care Facilities

The housing crisis is affecting the health care facilities in two ways: 1) through declines in elective procedures such as hip and knee replacements, as well as screening procedures such as colonoscopies. (Though these procedures are, in most cases, necessary, many patients put them off when they feel financially constrained.), and 2) via an increase in the numbers of patients whose economic situations have worsened to the point they can no longer meet medical co-pays or deductibles.

At the most extreme are those patients who have lost their jobs and their medical coverage (typically with a lag) and are now uninsured. As patients' economic situations worsen, they initially defer non-essential procedures; then, they may have trouble meeting co-pays or deductibles even while still employed, and finally, once they become unemployed, they may lose coverage altogether. Some may maintain coverage for 18 months at a substantially higher cost, if they can afford to pay for it under what is known as COBRA.

As the current financial crisis continues, we believe these problems and their impacts on health care facilities have only worsened. For example, of the five publicly traded hospitals Standard & Poor's Equity Research follows, three of those reported declines in admissions in the latest quarter. In addition, after having apparently begun to stabilize in the first half of 2008, reported bad debt trends for the publicly traded hospitals have recently begun to rise again. Lastly, even many of those with insurance are feeling the strain of higher medical costs. A recent study by the Center for Studying Health System Change found that approximately 20% of those surveyed report having trouble meeting their medical bills. This has forced health care facilities to cut back on services and expansions, reduce capital budgets and purchases, and, in the worst-case scenario, shutter facilities. Given the continued rising levels of unemployment, we would only expect these forces to be amplified into 2009.

In this economy, we favor those companies with less exposure to bad debt issues and those that deliver care that is less discretionary by nature, such as Psychiatric Solutions (PSYS); AmSurg (AMSG), which has less exposure to elective procedures than many of its peers, in our view; and Sun Healthcare Group (SUNH).

Medical Equipment

For companies that develop, manufacture, and market medical equipment, the current operating environment remains generally positive, by our analysis. Through the September 2008 quarter, S&P Equity Research continued to see evidence of strong global demand in categories such as oncology equipment, surgical tools and equipment, selected reconstructive orthopedic implants, and even robotic surgical machinery.