Investors in hospitals and health insurance companies can breathe a bit easier after the Supreme Court’s surprising ruling Thursday upholding a requirement in President Barack Obama’s health care law that forces all individuals to buy insurance or else pay a fine.
Yes, the Supreme Court also ruled that the law’s expansion of Medicaid was unconstitutional, which could hurt nursing homes and other heavily Medicaid-dependent names. But the most momentous high court ruling in decades upheld the bulk of the president’s signature legislation, and that’s largely a positive for investors in the health care sector.
In Thursday trading after the ruling was announced, the health care sector followed the broader market lower, while hospitals rallied and large commercial insurers sold off. But past the market’s knee-jerk reaction, the ruling is good news for the industry’s investors.
Partly that’s because of the great changes in both practice and expectations already implemented by all health-care stakeholders in response to the law’s passage.
But more important is that the loss of the individual mandate — a widely expected outcome — would have been a worst-case scenario for insurers and hospitals. As InvestorPlace’s Susan J. Aluise writes, the constitutionality of the controversial individual mandate had the most bearing on health care companies’ bottom lines.
The Supreme Court has now ruled that Congress has the right to require virtually all Americans to buy a product — health insurance — or pay a tax penalty. Had that been struck down, industry costs would likely have soared. Younger, healthier people will now be forced to buy insurance instead of waiting until they get sick. That’s critical, because it will offset the higher costs of insuring people with preexisting conditions, which is another cornerstone of the landmark legislation.
Had the Supremes struck down the individual mandate, it would have weighed heavily on just about every part of the industry, as well as diversified mutual funds and exchange traded funds (ETFs) like Fidelity Select Health Care Portfolio (NYSE:FSPHX) and SPDR Health Care Select Sector ETF (NYSE:XLV) that have broad exposure to large-cap names most affected by the law.
As for the court striking down the expansion of Medicaid, that could have big implications for nursing homes and other Medicaid-dependent names, Aluise notes. Sun Healthcare (NASDAQ:SUNH), Skilled Healthcare (NYSE:SKH) and Kindred Healthcare (NYSE:KND) may be hard-pressed to serve a graying population with fewer government resources. Managed care companies with a large Medicaid patient base like Molina Healthcare (NYSE:MOH), Centene (NYSE:CNC) and Amerigroup (NYSE:AGP) also could be worse off.
Interestingly, health care stocks have been strong outperformers this year, thanks in large part to investors’ preference for defensive names. The health care sector of the S&P 500 is up more than 8% year-to-date, beating the broader market by about 2 percentage points. Over the last month, health care has gained 4% versus a 1.6% rise for the S&P 500, despite uncertainty over the high court’s ruling.
Now that the overhang of the Affordable Care Act’s constitutionality has been removed, health care stocks could actually widen their outperformance if defensive names stay in favor.
Remember: As much as the market hates bad news, it hates the unexpected even more. The Supreme Court’s ruling leaves much of the sector’s costly preparations of the last few years in place. More important, a $2.7 trillion industry representing 18% of the economy at long last knows where it’s headed.
Dan Burrows doesn’t hold any securities mentioned here.