Healthcare Reform: Will Device Makers End Up in the Red or in the Pink?

Tracking the fate of U.S. healthcare reform is like watching a patient being wheeled into the operating room while the surgeons bicker in the corridor over the best way to save his life. Despite the current level of uncertainty surrounding the mid-summer debate, medical device makers should emerge from the legislative operation in relatively good health, according to several industry executives and at least one analyst.

Given the focus on cost containment, obvious concerns have surfaced over the ultimate impact on device sales, company profits, product development, and investor confidence. But a quick roundup of industry opinions reveals both a commitment to the Obama administration's reform push and the overall belief that most device makers will weather pricing pressures—and any attendant business fallout—as they always have.
In June, AdvaMed, which had already announced its own healthcare reform package, helped to launch a “consensus” group with a broad plan to save up to $1.7 trillion within the next decade. In addition to the device industry's trade association, the collaborative effort comprises AMA, America's Health Insurance Plans, the Pharmaceutical Research and Manufacturers of America, the American Hospital Association, and the Service Employees International Union.
Group members point to savings that are just $300 million shy of President Obama's $2-trillion target. A letter sent by the consensus group to Obama cited four areas in which costs could be trimmed. Group members advocate more-efficient use of healthcare tools to improve the quality and safety of care, creation of methods to lower costs in order to benefit more persons, and streamlining claims processing. They also support better management of chronic disease, which accounts for 75% of overall spending on healthcare, the members note.
David Nexon, AdvaMed's executive vice president, says his association's member companies are on the same page in support of the reform efforts, regardless of their respective sizes. “We do have a remarkably unified voice on this issue,” he says. “I think it's a tribute to our member companies, which are so diverse, that they have been able to get a unified position.”
More than two years ago, AdvaMed endorsed its own “comprehensive health plan providing for universal coverage and a responsible approach to cost containment that, in large measure, is reflected in the Obama plan,” Nexon points out. “So we start from a pretty good base.”
‘More Pluralistic System'
Noting that AdvaMed's members are “on board with the general thrust” of the reform effort, Nexon says the association nevertheless has been keeping an eye on a few issues of concern for device makers. These are centralized decision-making, comparative effectiveness research, and the nature of the specific cuts needed to finance a health reform bill.
Nexon argues that centralized decision-making “is bad for patients and bad for medical innovation. I think you have to have some kind of minimum benefits [package] to make universal coverage meaningful, but we don't want to have centralized decision-making over specific devices, drugs, or procedures.” AdvaMed's viewpoint is that medical service providers are served better by “a more pluralistic system” that keeps decisions “in the realm of the patient and the doctor.”
In that regard, Nexon says that AdvaMed supports comparative effectiveness research “as a tool to help doctors and patients make good decisions.” He says the trade association backs a bill cowritten by Democratic senators Kent Conrad and Max Baucus called the Patient Centered Outcomes Research Act of 2009. The legislation would establish a private, nonprofit institute to explore the best clinical approaches for treating patients with diseases and other health problems. Citing the Congressional Budget Office, the bill's backers say that the unbiased data collected by the institute will benefit both doctors and patients and reduce rising healthcare costs. Some of the less-desirable versions of comparative effectiveness legislation flirt with “the-cheapest-is-best” approach, Nexon says.
Calling it “clearly a concern we have to watch out for,” the association's executive vice president says the trade group is closely following the discussion on controlling costs. “We all know that the system has to be reoriented to provide more cost consciousness, more efficiency, and…better quality. Those are all good objectives, but if you don't do that correctly, you can inadvertently have a negative impact on medical innovation.”
Nexon believes the specific cuts to providers that will be required to finance the final reform bill will be among the biggest challenges facing AdvaMed's members. “Some of these are inevitable,” he acknowledges.
Focus on the Outcome
The temptation by reformers to indiscriminately hack at costs is hard to resist, and it's one that worries device company executives like Mike Burke. Brought on board as the new president and CEO of Imalux (Cleveland) this past June, Burke says the worst-case scenario for device makers would be a healthcare bill that focuses on “reimbursements for transactions and not for outcomes.”
Burke says reformers believe “the obvious answer” to rising costs is to focus on the transaction, “where we've got a medical system that is a defensive system to a degree [and] where testing is done in order to protect doctors from litigious clients.” Everyone agrees that this risk-averse approach to medical care is one of the factors fueling high medical costs, but President Obama has ruled out capping malpractice awards as unfair to consumers. Burke, who would like to see a flat rate set for malpractice awards, believes the administration “should be funding studies that define the efficacy of the procedures being done. That shows he'll be going below the tip of the iceberg.”
By focusing on the transaction “everybody misses the value proposition that imaging companies provide,” Burke says. “Our product is a good example. Unlike some of the very expensive imaging [systems], we're going to have low-cost product on the market that allows you to image tissue down to a depth of 2 mm. Cancers occur between 0.4 and 1.4 mm. With this device, you will be able to scan the larynx, cervix, bladder, on and on very inexpensively and see what's both normal and what isn't in each stage up to and including cancer.”
The Imalux system uses optical coherence tomography (OCT) to visualize tissue in real-time “at the site of patient care,” according to the description on the company's Web site. Burke obviously wants his company's system to have a chance in the market. However, he's worried about the effect that low-ball reductions in payments for imaging procedures based on AMA's current procedural terminology (CPT) imaging codes will have on Imalux's chances.
“Knocking down all imaging CPT codes…is not an intelligent way” to cut costs, Burke insists. “It's a gut-reaction way of doing it. You see a $500 or $600 CPT imaging code, why not just knock it down 20%? That's easy.” You take that 20% reduction “times a million transactions, [and reformers say] ‘look at all we're going to save, because outcomes are somewhat difficult to measure, and it will take time.' And right now the last thing Obama has is time.”
The status of Medicare reimbursements worries Dominic Caruso, CFO of Johnson & Johnson. In a July interview with Bloomberg News, Caruso said device makers will suffer a decline in sales because of a $155-billion agreement between hospitals and the Obama administration. “The deal that the hospitals struck will obviously have an impact on the medical-device business,” Caruso told the publication. “Medicare reimburses the hospital for a basket of costs related to a procedure, of which medical devices are included.”
‘Just Good Enough'
Device manufacturers can adapt to such changes, says Steve Meyer, president USA/Canada and executive vice president of Welch Allyn (Skaneateles Falls, NY). “Pricing pressures are always there, but I think this depends on what parts of the incentive equation change,” he says. “Most customers are sophisticated enough to understand ROI, and they are constantly looking for ways to manage this formula. A device being used for a procedure that has just had its reimbursement lowered or eliminated has a pretty immediate impact on usage.
“But this isn't a new phenomenon,” Meyer adds. “It's been the leading driver of certain procedures moving from the hospital to ambulatory surgery centers. Device companies have adapted to those changes as well.”
Meyer believes the chances are high that hospitals or other care providers will pressure device manufacturers to lower the prices on their products. “On the one hand I would expect the competitive environment to increase, especially in the more commoditized areas. ‘Just good enough is what I need' may be the mantra of customers in the new environment. Frankly, I think it's that way today. On the other hand, for those who are innovating and can demonstrate real solutions to problems that exist now, there will be plenty of opportunity.”
If more Americans were insured, could larger sales volume compensate for a possible drop in revenue caused by lower device prices? Meyer believes that at least two factors will determine how this scenario plays out. “I think this depends entirely on how rapidly the uninsured are actually covered. More important, it's how they are covered in terms of what gets paid for and how they are incentivized.”
Nexon notes that even if all the currently uninsured receive care under universal coverage, “it's not like you're going from zero to 100% [insured.]” He points out that persons without insurance are typically “younger or healthier patients” who are less likely to use devices. “There is an upside just in the commercial sense,” he says, “but it's not as big as you might think.”
“I believe we need to think of it as an environment which in some ways is an ‘open field,' Meyer says. “You can't just think about the numbers of new patients coming in. In reality, today most who want some form of care can get it. What we really need to think about is where they are served and where the focus will be. If it's on prevention and better management of chronic disease, then that says a lot about where the market is going to be moving. Today, incentives are very much aligned around reactive care. In other words, fixing things that are ‘broken.' I don't think there are many reimbursement codes for prevention.”
Meyer thinks Welch Allyn should do well if healthcare reform does indeed focus on greater preventive care. He points out that most of the company's devices “are used in frontline care settings where clinicians are engaging patients to better understand and manage their care—either in primary care physicians offices or in acute care environments such as medsurg floors. Our focus is on enabling clinicians to more efficiently move patients to or manage them in lower acuity settings. The healthcare reform that is currently being talked about seems to support this endeavor, so we are quite pleased at the direction it is taking. Added focus on primary and preventive care supports our strategy to help frontline caregivers find solutions to their patient care problems.”
‘Less Doom and Gloom'
It's likely, as Meyer and Caruso note, that medical devices sold as commodities may fare poorly in a postreform world. Other types of devices, though, may benefit, says Thomas Gunderson, medical technology analyst for Piper Jaffray & Co. “Devices that, when compared with others, can be shown to be more effective for a given procedure can certainly benefit more from reform,” Gunderson says. “All things considered, that does not necessarily mean they are the lowest cost to acquire up front. Also, given the focus on preventive and chronic disease management, device companies that operate in these areas should be in a good position to benefit.”
Does it follow then that some device manufacturers will perform better financially than others? “The short answer is yes,” Gunderson replies. “There are going to be companies and management teams smart enough and facile enough to say, ‘we've got to shift here. How can we turn lemons into lemonade and make this competitively better for us?'”
In terms of the reform's focus on cost reduction, Gunderson emphasizes a point that AdvaMed has made. “I will quote the AdvaMed numbers that of the $2 billion plus we spent on healthcare, AdvaMed says 6.2% of that…went for devices. A lot of that device expense was for hypodermic needles and gauze and the kinds of hospital supplies that are in highly GPO-bargained businesses.
“Can you cut the high price of medical devices?” Gunderson asks. “Yes, you can. Will that solve the runaway healthcare costs that we're seeing? No, you can't solve a problem by cutting a small slice of 6.2% and say, ‘look what we've done.'”
AdvaMed's Nexon acknowledges that “some negotiations over price” may take place with hospitals, but he notes that “price hasn't been a real big issue. We're a very competitive industry, so our prices have stayed pretty low relative to everything else.”
The uncertainty inherent in healthcare reform debate has depressed stock prices, Gunderson says. “From a medical device stock standpoint, they did take a hit. You can see a dip down on February 24 when Obama said, ‘we're going to reform healthcare.'” The analyst says that as investors “start to understand the system a little bit better and the goings-on in Congress, they are becoming less ‘doom-and-gloom.' But there's still a cloud over the sector.”
Once the skies clear and a final reform package emerges, the impact on the device sector will be “minimal,” Gunderson believes. “The reason I say that is because there are methods in place already that can facilitate the hospitals, the pharmaceutical companies, the insurance companies, and other players to adopt leaner, less-costly programs. But most medical devices are part of DRGs, and that system is procedure-based and not device-based. Procedure payments to hospitals can be reduced—or raised—but specific device costs, with some exceptions, are only indirectly affected.”
“Yes, you can push those DRGs down, but my comment would be, ‘so what's new?'” Gunderson says. “They've been pushed for the last five to six years, if not longer. There's been constant pressure on pricing from hospitals.” When the hospital industry agreed to a $155 billion decrease over the next 10 years, “the Obama administration patted them on the head. This is part of the solution. The device side says, ‘well, if the hospitals are going to take something out of their cost structure, then that will put pressure on everything and will put pressure on devices.' But I don't think it's all going to come in one lump. I don't think it's going to be a tectonic plate shift. I think [the effect is] going to be minimal and not too much different from what we've been seeing.
“From a stock standpoint, to conclude, once we start to gain more clarity, the cloud hanging over medical device stock prices dissipates; the storm won't be nearly what we thought it was going to be,” the analyst says. “It will be more like a drizzle.”
It appears that the drizzle of uncertainty hasn't hurt manufacturers such as Boston Scientific (Natick, MA). The device maker reported in mid-July that its second-quarter profit rose compared with the same period a year earlier. The company posted double-digit growth in sales of both its cardiac rhythm management products and stents. Net income in the quarter ended June 2009 rose to $158 million compared with $98 million, and revenue rose slightly to $2.07 billion. The rise in second-quarter net income represented an increase of 10 cents per share compared with 7 cents per share for the second quarter of 2008, the company said.
The Cost of Containment
The storm of comment generated by the public health insurance option backed by the Obama administration and others will likely continue up until the final Senate gavel. Michael Freeman, executive vice president of the Healthcare Leadership Council (HLC), which champions free-market solutions, says the coalition of healthcare industry executives opposes the idea.
“Device company concerns dovetail with other sectors,” says Freeman of the HLC membership, which has executives from companies such as Baxter International and Cardinal Health. HLC's take on some aspects of the current legislative proposals for healthcare reform echo some of the concerns of others on the option. A public plan or a national health board could lead to price controls and stifling of innovation, Freeman asserts.
Freeman acknowledges that cost containment is a major goal of the reform push. “Everyone is reconciled to cost containment. Nobody is fighting the concept. It's a question of how do you do it and maintain quality and innovation? Our members are all in favor of comparative effectiveness, greater clinical outcomes, and more transparency.”
HLC backs better opportunities for patients “to make choices in their healthcare that would lead to bending down the cost curve,” Freeman says. “There are lots of measures out there in terms of insurance reform. While we may be against the public plan, we're all in favor of insurance reform to remove pre-existing conditions as a barrier and get everybody in the system.”
Looking to launch what he calls “a very effective product next year,” Burke of Imalux says he would like to see a provision in the public health insurance plan “that really supports improvements in the cost-effectiveness of treatments.” He adds: “I believe the government needs to encourage new cost-effective…treatment options as they become available, rather than wait and let them take years before they assign CPT codes and reimbursement [procedures].”
‘Most Will Adapt'
It's clear that when it comes to healthcare reform there's no lack of second opinions about the way forward. Whatever the outcome, chief executives such as Welch Allyn's Meyer emphasize the device sector's near unanimity—and its resiliency.
“I doubt if there is much disagreement among device companies about the need for healthcare reform, and much about it is still yet to play out,” Meyers says. “There will be winners and losers, but most will adapt.”
As for the timing of that outcome, it appears that device manufacturers, the other healthcare industry players, and the American public will have to wait. If there is to be one, the operation to fix the U.S. healthcare system has been postponed until September, when the surgeons return to Capitol Hill.

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