1 Wall Street s Love Affair With Health Care Data on market activity over the past decade reveal the extent of Wall Street s influence on health system change. b y S r i j a S r i n i v a s a n, L ar r y Le v i t t, a n d Jan e t L u n d y 126 In vesto rs a nd some health care industry executives give credit to market incentives and for-profit health care companies for fundamentally restructuring an industry much in need of change. Some policymakers, providers, and consumer advocates, meanwhile, question whether it is appropriate that profit motives and goals to maximize stock values drive changes in the health care system. The common ground of these two camps is their understanding of the growing influence of for-profit organizations in health care. This influence is especially evident in the growing number of for-profit health maintenance organizations (HMOs). Between 1981 and 1997 for-profit HMOs grew from representing 12 percent to 62 percent of total HMO enrollees and from 18 percent to 75 percent of health plans. 1 Among hospitals, although forprofits have increased their role, nonprofits continue to dominate the industry. Between 1981 and 1996 for-profit companies grew from representing 9 percent to 13 percent of community hospital beds and from 13 percent to 15 percent of community hospitals. 2 Increasingly, both financial analysts and policy analysts have an interest in understanding the role of the stock market within the health care sector. Recent ups and downs in health care stocks have drawn these analysts attention to how health care companies will balance the interests of health care consumers, purchasers, insurers, providers, regulators, and investors. Neither investment analysts nor policy analysts have systematically collected measures of the influence of the stock market on the health care industry. Investment analysts generally have used company-specific information to evaluate individual companies prospects within the health sector. Policy analysts have relied mostly on data sources that provide broad information on industrywide trends encompassing publicly traded and other health care companies. This paper attempts to bridge these historical data-gathering approaches with a set of measures that quantify the role of the stock market within the health care services industry over the past ten years. These data should provide useful reference points for tracking how this role changes over the next decade. MEASURES OF MARKET ACTIVITY n INITIAL PUBLIC OFFERINGS. Many health care organizations have looked to the stock market as a source of financing. During the past ten years 21 health services companies issued initial public offerings (IPOs) of Srija Srinivasan is director of member and information services for Gateway Purchasers for Health, an employer purchasing coalition in St. Louis, Missouri. Before joining Gateway, she was chief author of a chart book for the Henry J. Kaiser Family Foundation s Changing Health Care Marketplace Project. Larry Levitt is director of both the marketplace project and the foundation s California Grants Program. He was formerly a special assistant for health policy to California Insurance Commissioner John Garamendi. Janet Lundy is program officer at the Kaiser Family Foundation for both the marketplace project and the California Grants Program. H E A L T H A F F A I R S ~ V o l u m e 1 7, N u m b e r The People-to-People Health Foundation, Inc.
2 stock, generating capital of more than $6.6 billion. 3 For the HMO sector, twenty-three IPOs raised almost $1.4 billion (Exhibit 1). 4 n EQUITY AS A SOURCE OF FINANCING. Among HMOs, equity (stocks) grew from representing an average of 2 percent of total external capital over the period, to 69 percent between 1991 and 1997 (Exhibit 2). In comparison, the predominantly nonprofit hospital sector continues to rely on debt (bonds) as its primary source of capital. n MARKET CAPITALIZATION. The market capitalization, or total stock value, of health services and HMO companies traded on the stock market has grown dramatically over the past decade. The market capitalization of HMOs traded on the stock market grew from a little more than $3 billion in 1987 to almost $39 billion as of November 1997 (an almost twelvefold increase), while the stock market as a whole grew about fourfold (Exhibit 3). For health services companies, capitalization grew from $16.3 billion to $112.7 billion over the same time frame, a sevenfold increase. Health services remain a relatively small proportion of the overall stock market, representing only slightly more than 1 percent of the total market with respect to market capitalization as of November n INVESTMENT ANALYSTS. As the stock market s capitalization of health care companies has grown, the number of investment analysts following health care stocks has increased as well from 152 in 1987 to 559 in Much of the increase in this following occurred over the past four years. n STOCK PRICE TRENDS. HMO stocks generally outperformed the market as a whole over the past decade, although these companies experienced significant price declines between March and August 1995, between April and July 1996, and between July and November 1997 (Exhibit 4). Health services companies have tracked somewhat above the market through much of the decade, but the ten-year return for the overall market and these companies is equal. Using a University of Chicago index that measures the market-weighted re- 127 EXHIBIT 1 Initial Public Offerings Of Health Services And HMO Stock, Health services companies HMO companies Year Number Value (millions) Number Value (millions) $ ,741 1, , $ Total 21 6,662 b 23 1,371 b SOURCE: Prepared for the Kaiser Family Foundation by Securities Data Company, 6 January NOTES: Health services companies include those with Standard Industrial Classification (SIC) codes 8 through 899. These include the following types of businesses: offices and clinics of doctors of medicine or osteopathy, dentists, or other health care providers; nursing and personal care facilities; hospitals; medical and dental laboratories; home health care services; and miscellaneous health and allied services. Health maintenance organization (HMO) companies include companies we identified as primarily HMO companies (does not include multiline property/casualty insurance companies that may have an HMO line that represents less than half of its business), as well as other companies classifying themselves as medical service plans (SIC 6324). a Not applicable. b Values do not add to total because of rounding. H E A L T H A F F A I R S ~ J u l y / A u g u s t
3 128 turn of stocks, a 1987 investment of $1 in the market as a whole or in health services companies would have grown to $492 by the end of November In comparison, an investment of $1 in HMOs would have grown to $821. Recently, average annual returns for HMOs and health services companies have not kept pace with the record growth in the overall market. HMO companies stock prices have taken a downturn, as average annual returns fell from +32 percent over the period to 7 percent over For health services companies, average annual returns fell from 21 percent in the first period to 3 percent in the second. In contrast, for the market as a whole, average annual returns rose from 15 percent in the first period to 25 percent in the second. 6 H E A L T H A F F A I R S ~ V o l u m e 1 7, N u m b e r 4
4 129 n MERGERS AND ACQUISITIONS. High stock values and interest in improving market share have propelled many health care organizations to pursue growth through mergers and acquisitions. As a result, the number of publicly traded health services and HMO companies has decreased in recent years as some of these companies have combined. Over the past decade merger and acquisition activity peaked in 1996 for both health services and HMO companies (Exhibit 5). In 1996 there were 483 completed mergers and acquisitions involving health services companies, totaling almost $27. billion. For HMOs thirty-three merger and acquisition deals totaled more than $13.3 billion in 1996 (Exhibit 6). The decade saw 2,753 mergers and acquisitions involving health services companies and 162 involving HMOs. The patterns in number and value of these transactions are similar for health services and HMO companies, reflecting how consolidation within the payer sector has fueled consolidation in the provider sector, and vice versa. IMPLICATIONS AND QUESTIONS Although these data help to identify the growing connection between the stock market and health care organizations, questions remain regarding the impact of this connection on future prospects for the industry s growth, structure, and efficiency, as well as the quality of care delivered. n INVESTORS. Many investors were drawn to health services and managed care companies as growth stocks that would achieve success by meeting the rapidly growing demand for lower-cost managed care products, as well as the potential to increase efficiency. More than three-quarters of persons with employment-based health insurance are now enrolled in managed care. Opinions differ on whether recent stock price declines of HMOs and leveled stock price growth of health services companies represent revaluations of now mature industries or temporary blips in industries with continued growth prospects. The level of continued investor interest in health care companies will H E A L T H A F F A I R S ~ J u l y / A u g u s t
5 13 affect the level of capital available to fuel continued growth and innovation. n SAFETY-NET PROVIDERS. As marketbased competition has driven change in the nation s health care system, much of the role of public policy has been to respond to the impact of such competition on health care consumers, including those who depend on the health care safety net. For example, several state attorneys general have reviewed potential conversions involving nonprofit hospitals or health plans that have historically fulfilled a charitable purpose within a given community. Some not-for-profit assets have been transformed to conversion foundations established to preserve the charitable missions of not-for-profit health plans and health care systems. As of 1 September 1997 there were eighty-one conversion foundations in the United States, with assets totaling $9.3 billion. 7 For health plan conversions in particular, a method used for ensuring that assets are fairly valued upon conversion has been to transfer ownership of some portion of the newly created for-profit companies stock to the conversion foundation. Decreasing attractiveness of health care and HMO stocks will decrease the endowment levels of conversion foundations that hold the stocks of their formerly not-for-profit organizations and may mute the financial advantages of conversion. At the same time, companies seeking acquisition targets may focus on not-for-profit companies, given a diminishing number of available for-profit candidates that have not been involved in a recent acquisition. n HEALTH CARE COSTS AND QUALITY. The balance of influence among investors, purchasers, insurers, providers, and consumers will affect who ultimately bears the cost of health care services. Over the past decade health care purchasers desires to constrain health insurance premium increases and the resulting competition among and between insurers and providers have contributed to declines in health insurance premium inflation. Today the prospect of accelerated growth in health insurance premiums tends to comfort investors who have witnessed decreases in managed care companies profitability and some accompanying declines in stock prices. At the same time, consumers, purchasers, and policymakers are becoming more interested in health care quality. There is little evidence, H E A L T H A F F A I R S ~ V o l u m e 1 7, N u m b e r 4
6 however, that high marks on quality or consumer satisfaction measures increase the attractiveness of a health plan or health services company to investors. Ongoing tracking of the role of the stock market within the health care industry will help observers to analyze the connection between decisions intended to maximize shareholders value and those intended to guarantee high-quality health care. Further research is needed to understand how investors goals influence the behavior of health care organizations and the implications for consumers. The data in this paper were presented at a briefing for journalists who write on health issues, sponsored by the Henry J. Kaiser Family Foundation, 11 February 1998, in New York City, as part of the foundation s Changing Health Care Marketplace Project. These data will appear in a forthcoming chart book on the health care marketplace, to be published by the foundation. NOTES 1. InterStudy, HMO Summary, June 1985 (Excelsior, Minn.: InterStudy, 1985), 7; and The InterStudy Competitive Edge 7.2: Part II: HMO Industry Report (Bloomington, Minn.: InterStudy, 1997), Kaiser Family Foundation analysis of American Hospital Association (AHA) data, from AHA, Hospital Statistics, ed. (Chicago: AHA, 1998), Includes companies involved in the delivery of health care, such as physician, dentist, and other provider offices; nursing and personal care facilities; hospitals; medical and dental laboratories; home health care services; and miscellaneous health and allied services. 4. Includes companies whose primary line of business is an HMO. 5. Kaiser Family Foundation tabulation from Nelson s Directory of Investment Research, annual volumes for (Port Chester, N.Y.: Nelson Publications, ). 6. Center for Research in Security Prices, University of Chicago, 14 January S.L. Isaacs, W. Carr, and D.F. Beatrice, Health Care Conversion Foundations: 1997 Status Report (Washington: Grantmakers in Health, October 1997), H E A L T H A F F A I R S ~ J u l y / A u g u s t