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U.S.

Health Care Sectors Brace For Change As Reform Looms And The Population Ages
Primary Credit Analysts: Martin D Arrick, New York (1) 212-438-7963; martin.arrick@standardandpoors.com Joseph N Marinucci, New York (1) 212-438-2012; joseph.marinucci@standardandpoors.com Lucy B Patricola, CFA, New York (1) 212-438-3006; lucy.patricola@standardandpoors.com David P Peknay, New York (1) 212-438-7852; david.peknay@standardandpoors.com

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U.S. Health Care Sectors Brace For Change As Reform Looms And The Population Ages
U.S. health care providers and insurers face a tough task in the next few years: preparing for the unknown. While many changes under the Affordable Care Act (ACA), and health reform more broadly, are easy to anticipate, details about how many others will unfold remain to be seen. Given such uncertainty, many health care providers are combining traditional tactics, such as cost cutting and bolstering revenue, with new strategies. One result is a blurring of the lines between care providers and health insurers, with the former acquiring--or, sometimes, simply establishing--their own insurance companies, and the latter forging partnerships to enter into the actual provision of care. Meanwhile, many health care providers Standard & Poor's Ratings Services rates continue to sustain, or possibly even improve, their financial positions by finding new ways to control costs and enhance revenue. This is often done through mergers and acquisitions (M&A) to gain economies of scale as providers try to keep costs low and provide value for consumers. While M&A activity has always been a hallmark of the industry, some unique structures have arisen. Providers and insurers are also considering moving from traditional fee-for-service reimbursement plans to more value-based structures. In many cases, this means looking at a wide variety of projects and joint ventures. These include establishing so-called accountable care organizations (ACOs), which tie reimbursement to quality measures to reduce the total cost of care for patients. The ACO, which consists of a group of coordinated providers, is accountable to patients and payors for the quality and efficiency of care, as well as for taking responsibility for maintaining the health of a large group of people. In any event, the credit quality of U.S. for-profit and not-for-profit health care companies we rate will likely remain broadly stable for the remainder of the year--albeit with a somewhat negative bias. Providers are coping with the effects of sequestration and the looming implementation of the ACA, with many having generally solid balance sheets and the capacity to handle operating challenges. At the same time, growth prospects are somewhat soft throughout the sector, reflecting only nominal increases from U.S. government payors and private insurers, and, for the for-profit health care sector, weak economic conditions in Europe. However, the U.S. capital markets remain favorable, and many borrowers have pushed out their debt maturities, rid themselves of tight loan covenants, or borrowed at low rates to finance growth plans. And given the essential nature of many health care products and services, the credit quality of many of these companies doesn't depend heavily on economic factors. Major pharmaceutical companies, on the other hand, face significant pricing pressures in the longer term amid the steadily rising costs of Medicare and Social Security, combined with the aging of the U.S. population--while both public and private sector payors look to control medical expenses. These companies also face significant pricing pressures in Europe. New products, the absence of significant patent expirations in the near-term, promising pharmaceutical pipelines, and a modestly improving job market in the U.S. are helping to ease these pressures. While we expect there to be significant increases in pharmaceutical sales in the U.S. as the population ages and the ACA expands insurance

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U.S. Health Care Sectors Brace For Change As Reform Looms And The Population Ages

coverage, drug-price declines may more than offset this rise in volume. This could cause material erosion of drug companies' high operating margins and lead to downgrades if these borrowers can't find other ways to boost their margins. This comes amid growing competition from generic-drug manufacturers, which are becoming stronger through consolidation. Meanwhile, credit quality among U.S. health insurers we rate is strong and stable. While industry risk remains somewhat elevated, we believe the potential for significant downside developments is limited. Most companies remain financially sound as they position themselves for the fuller onset of reform. In addition, we believe the sector is capable of withstanding a period of moderate strain that may emerge in connection with cyclical factors and health care reform. Underlying business conditions are favorable, and health insurers' financial fundamentals remain relatively strong. Still, the sector and the federal government have much to prepare for with regard to reform, and we believe some degree of market disruption is likely in the next few years, given the scope and complexity of the undertaking. All this comes as aging populations will likely weigh heavily on countries' budgets. Overall, governments' pensions remain the biggest-ticket item, followed by health care and long-term care. And we expect age-related spending to grow even faster than retirement costs by 2050, with new medical technologies and forms of health care delivery account for much of this increase. The fact that health care expenditures represent the majority of the increases in age-related spending in a number of developed countries indicates that, in general, policy makers have focused more on other areas--particularly pensions--and must now look at improving the design of health care systems and containing health care spending. Some countries have done so through such measures as constraining pharmaceutical expenses, raising health care contributions, cutting public health care sector wage bills, or changing the balance between public- and private-sector financing and delivery of services. All told, Standard & Poor's believes partnerships in the health care industry will proliferate. Hospitals aligning with other providers along the continuum of care will continue to be more commonplace, as will insurers aligning with providers. While the number of large organizational mergers will probably remain small, we expect these sorts of virtual alignments to continue to grow as providers get more comfortable working with each other and insurers. There's simply too much at stake--and too much change on the way--for these companies to survive if they remain stagnant.

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