Issue 27  

S&P Global Ratings held its annual health care hot topic event on Oct. 1 in New York City; below is a summary of the key takeaways from the different panels.

Will GLP-1 Drugs Bring A Dramatic And Positive Shift To Health Care Delivery?

• The rise of GLP-1 drugs could eventually become a margin headwind for many health care providers.
• In response, over the longer term, a likely change in service mix may require providers to reshape their strategies by increasing their focus toward primary care.

GLP-1 drugs target one of the most pressing health issues today: obesity, which damages metabolic functionality and contributes to a wide array of health problems. The consumption of processed foods leads to metabolic dysfunction, where the brain becomes resistant to vital nutrients and hormones, causing weight gain and further complications. This metabolic damage is at the core of many chronic diseases, such as diabetes, which GLP-1 drugs aim to address. Early treatment of obesity using GLP-1 drugs not only mitigates metabolic damage but also significantly reduces the risk of disease progression. For instance, Dr. Louis Aronne stated that a pre-diabetic patient treated for obesity for three years could have a 94% chance of preventing further disease progression.

As Dr. Aronne put it, "I think we're in the middle of a gigantic shift in health care." The rising use of GLP-1 drugs signifies a broader trend toward addressing root causes like obesity before they escalate into more severe diseases. In fact, "it will soon be standard of care to treat people for obesity who have diseases," said Dr. Aronne.

For this transformation to fully take hold, GLP-1 drugs must become more accessible and affordable. Early intervention is also necessary before the real damage of diseases sets in and progressive deterioration occurs. But currently, GLP-1 drugs are very expensive, and given tremendous demand, are having a large impact on total health care spending. Expanding the robust GLP-1 drug pipeline to include additional indications should lead to much lower prices and improve availability, ensuring that more of the total population can benefit from these treatments. As the landscape shifts, this could lead to GLP-1 drugs becoming not just a treatment for obesity, but also a key tool in both managing and preventing a range of diseases.

However, if the goal of much lower prices and reduction in prevalence of many chronic conditions is eventually achieved, we think GLP-1 drugs will become a margin headwind for providers. David Peknay, Director, Corporate Ratings, highlighted that the mix of services may increase more toward primary care, causing companies to "shift their strategies." Providers might need to reconsider strategies to preserve margins while rethinking capital allocation, which currently prioritizes higher-margin "high-acuity" services over primary care. Providers will also likely reshape capital mergers and acquisitions (M&A) decisions.

Legislative Challenges Remain At The Forefront For Pharma

• November's U.S. presidential election remains a tight race contingent on results in a handful of key battleground states. The outcome will have implications for health care policy.
• Federal Trade Commission (FTC) scrutiny of the pharmacy benefit manager (PBM) business model will likely continue under either Democratic or Republican administrations.
• The 340B Drug Pricing Program remains mired in numerous issues, most notably a lack of transparency into the use of funds and operational difficulties including drug shortages.
• The rollout of Medicare's drug price negotiations under the Inflation Reduction Act (IRA) has been manageable for Big Pharma thus far but will begin to weigh on downstream business development decisions.

Tom Evegan, Principal and National Consulting Leader for Life Sciences at RSM, shared his thoughts on the evolving legislative landscape in the U.S. and how it might affect the health care sector. The conversation opened with an overview of the upcoming November election. Polling indicates that candidates Donald Trump and Kamala Harris remain in a tight race for the presidency that will likely be decided by the results in seven key battleground states, including Pennsylvania and Georgia. Drug pricing reform gets significant bipartisan support, but the direction will vary depending on which administration gains power. Evegan noted that both administrations would likely support a continuation of the FTC's current investigation into the PBM business model, but that a Harris administration would also promote legislation surrounding drug pricing transparency and extending the Affordable Care Act (ACA).

Scrutiny of PBM business practices has been on the forefront of the health care policy debate for some time. In September, the FTC sued the three largest PBMs for "artificially inflating insulin drug prices." The case cited anticompetitive practices, artificial inflation of drug prices, and a lack of transparency, among other factors influencing its decision. Evegan believes this increased scrutiny has served as a "wake up call" to PBM owners that has culminated in recent cost-cutting actions such CVS Health's decision to lay off nearly 3,000 corporate employees. When asked about the future trajectory of the vertically integrated insurers' business model, Evegan said he expects to see an increase in the number of spinoffs and breakaways. He also noted that drug manufacturers are closely following developments in this arena as they carry out ongoing contract negotiations with the PBMs.

Evegan believed that the ongoing controversy with the 340B Drug Pricing Program could have a major effect on companies. Tensions between pharmaceutical manufacturers and hospital systems over implementation of the program remain high, with Evegan noting the "widening gap between what [the two parties] want out of the program." Johnson & Johnson (J&J) recently announced that it would forgo implementation of a new 340B rebate model, which would have required hospitals to pay full price upfront on two products, Stelara and Xarelto, and subsequently receive a rebate following a review, after the Health Resources and Services Administration (HRSA) warned the company that it had violated the 340B statute. Evegan said that J&J has been affected by a "large gross-to-net effect," paying $6.8 billion in rebates to 340B alone, and he expects increased challenges from pharmaceutical companies to HRSA's administration of the program.

Evegan believes the first round of drug price negotiations under the IRA has been manageable for pharmaceutical manufacturers, given the nature of the drugs selected for inclusion on the list (small molecule drugs approved by the FDA for at least seven years without a generic available and biologics licensed for at least 11 years without a biosimilar available). Both political parties have demonstrated an increase in political will to manage drug costs, so Evegan expects price negotiations will begin to weigh heavily on manufacturers' business development decisions, notably the economics of licensing and royalty deals. Evegan also noted that GLP-1s, given their rapid growth in utilization, could be present on the drug list in the next year or two.

CEO Panel: Cross-Sector Perspectives On The Future Of U.S. Health Care

• With affordability and accessibility at the forefront, trends continue to shift toward ambulatory and home care with larger investments being made in these spaces.
• Telehealth remains an important tool in leveraging physician shortages and improving overall patient outcomes, particularly around behavioral health.
• Organizations are using partnerships, joint ventures, and M&A to create unique structures in an evolving health care landscape and can result in cost savings.

As costs continue to rise due to inflation, providers and insurers are leveraging digital solutions such as telehealth and at-home services, as well as ambulatory centers, to help increase access and keep affordability at the forefront. Bob Garrett, CEO of Hackensack Meridian Health System (HMHS), stated that they are at a tipping point, as most revenues are coming from outpatient and ambulatory centers with the system making significant investments in new ambulatory centers as demand continues to rise. Gary St. Hilaire, CEO of Horizon Blue Cross Blue Shield of New Jersey (Horizon), added that the shift toward outpatient settings can prioritize getting the right care, at the right time, in the right setting while keeping costs low. With more investment toward ambulatory, Garett remarked that HMHS is still funding inpatient facilities, but in a more targeted way depending on the services provided at those hospitals.

In addition, both panelists concurred that the trend of moving care closer to home remains a priority. Automation and digitization of services have become a greater focus for both HMHS and Horizon with substantial investments being made in this space. St. Hilaire highlighted the opportunities in home infusion care as patients prefer to receive treatments in safe spaces such as their homes. "The advent of AI and possible implications of that, all are advances that would hopefully make not only the experience better, but give [patients] faster care to hopefully avoid any potential longer-term care outcomes," St. Hilaire explained.

For both HMHS and Horizon, behavioral health has been a focus, with Garrett noting that, "50% of behavioral health patients connected through telehealth [appointments]," and with the current physician shortage this has helped in getting patients seen quicker, resulting in better patient outcomes and physical health as he states these go hand in hand. Furthermore, HMHS has been investing its cash flow in behavioral health services since before and through the pandemic and witnessed overall cost reductions, as early intervention in many cases can avoid hospitalization and free up urgent care space.

Both panelists agree that partnerships are evolving with greater regulatory restrictions, particularly in the insurance industry, that are making them look at different integration solutions as well as leverage cost savings. One such example is between HMHS and Horizon through their Braven Health partnership, which offers Medicare Advantage (MA) plans in New Jersey, that has helped diversify their business lines. They both see this opportunity as a "win-win situation" with aligned incentives and strategies. Although there may be disagreements in other areas of the payor-provider relationship, both are trying to focus on data and early conversations to manage patient care.

In other areas of evolving partnerships, Garett mentioned that HMHS entered into group purchasing organizations (GPOs) with other hospitals in New Jersey, which has made significant headwinds in reducing costs, as well as partnering with One Medical (Amazon) in building out primary service locations. On the other hand, St. Hilaire stated that Horizon is leaning into areas of operational excellence to expand its market in non-insurance products and services, citing NovaWell, the subsidiary that is offering Horizon's behavioral health platform to other payers and employers. Similarly, it has partnered with other Blue plans to leverage GPO capabilities to lower drug costs.

S&P Global Ratings' Cross-Sector Views

• In not-for-profit health care, balance sheets remain solid, with some initial signs of performance improvement in 2024 as demand remains sound and labor pressures ease, though performance is still at lower-than-historical levels amid ongoing sector headwinds.
• For health insurers, two long-term growth segments, MA and Medicaid, represent near-term earnings risk due to revenue and utilization issues.
• Although for-profit health care service providers have been experiencing significant rating pressures from elevated labor inflation and higher cash interest costs, rating pressure should moderate in the first half of 2025. In contrast, prospects for pharmaceutical and medical device company ratings are more balanced, despite evolving regulatory and competitive dynamics.

S&P Global Ratings analysts shared their views for the not-for-profit health care, health insurance, and corporate health care sectors.

Not-for-profit health care

The not-for-profit health care sector view is negative, given the lighter cash flow trends, high percentage of negative outlooks, and trend of higher downgrades to upgrades. Overall, the median operating margin for the sector has been roughly breakeven, although there were signs of incremental improvement in the first half of 2024. That said, operating performance might not return to pre-pandemic levels in the medium term. Patrick Zagar, Director, U.S. Public Finance, also pointed out providers have been working on performance improvement with a host of initiatives including revenue cycle, staffing adjustments, and for some, cutting or reducing select service lines: "they can't be everything to everybody." Despite these challenges, many in the not-for-profit health care sector retain good credit strength. Zagar stated that it is generally a highly rated sector with 90% of organizations carrying investment-grade ratings. "Balance-sheet strength is the key differentiator for not-for-profit providers." He also thinks sustainability of cash flow, however, is important for ratings in this sector, given the need for both operating and capital investments. In addition to a focus on both strategic and operating initiatives to support long-term credit quality, a recent favorable trend is wider adoption of enhanced Medicaid payments by states. "Medicaid rate enhancement programs, direct payment programs--some with average commercial rates, depending on the state where providers operate--could be a game changer for performance." These programs could significantly improve earnings but also pose questions around the dependency for these programs. On the legislative and regulatory front, Zagar thinks that while there will be federal focus in certain areas, state oversight also remains active with focus on providers' M&A activity, and scrutiny on affordability and tax exemption.

Health insurance

The sector view for health insurance remains stable, but with an increasing negative bias. Francesca Mannarino, Associate Director, North America Financial Services, said that despite it being a highly rated sector, year-to-date, health insurance currently has the highest percentage of companies with a negative outlook, at 25%, in several years. Most negative rating actions have been associated with S&P Global Ratings' revised view of capital following its updated capital adequacy criteria "Insurer Risk-Based Capital Adequacy - Methodology And Assumptions," published Nov. 15, 2023. The remaining negative actions reflected earnings, capital deterioration, and pending M&A activity. Most of the earnings pressure arises from government-sponsored products (MA and Medicaid) because of weaker MA rates, elevated utilization trends, MA Star rating volatility, and Medicaid rate pressure. She raised a question to track for the coming year: "How will insurers balance between choosing membership growth in MA versus margins?" The preliminary MA rates for 2026 that come out in early 2025 will set the tone for future operating performance. In Medicaid, the population that remains in the program post-redeterminations is exhibiting higher acuity. Medicaid earnings pressure will be sustained in 2025 or even bleed into 2026 because insurers might need more than one rate cycle for rates to be actuarially sound. In terms of legislative and regulatory risks, health insurers that own PBMs face the potential for PBM reform legislation, which appears to have bipartisan support. She thinks that the PBM legislation will likely focus on transparency measures, but also could change PBM's revenue models. That said, she believes that PBMs may have sufficient lead time to adjust their revenue models and ensure stable margins. On a separate matter, she said that the upcoming presidential election will affect the ACA exchange market, which has been a strong growth segment. The election results may decide the fate of the ACA enhanced subsidies (implemented in 2021), which are currently set to expire at the end of 2025.

Corporate health care: Sector view varies by subsector

The sector view for all subsectors is stable except for for-profit health care services, which remains negative. David Kaplan, Director, Corporate Ratings, said that the sector view for for-profit health care service providers is negative, in part due to high labor inflation among health care professionals, and by higher interest rates exacerbated by high leverage, as about two-thirds of these companies are owned by private equity. The sector view for pharmaceuticals is stable, as the sector's revenue outlook is strong and its appetite for M&A has moderated, as growth from new products outpaces products coming off patent. Moreover, generic drugmakers are benefiting from an improved pricing environment and good prospects for revenue growth from biosimilar products. Medical devices is currently a stable sector, albeit with some risks, including the long-term effect of GLP-1 drugs on cardiac and other procedures and a tough business environment in China.

Corporate health care: Key operating trends

In the for-profit health care services subsector, reimbursement rates vary among service lines, with favorable rate increases for some, such as behavioral health, and unfavorable for others, like home health. Volume trends for services overall have improved, supported by more utilization as the population is aging. However, this is being partially offset by the unfavorable shift in payor mix, as "Medicare and especially MA are generally less generous payers than commercial health plans." On the regulatory front, the FTC's increased scrutiny of M&A could help bring down companies' leverage by suppressing debt-financed M&A, but, on the other hand, it also reduces companies' growth prospects and therefore, valuations, increasing refinancing risk. For the pharmaceutical industry, Kaplan thinks U.S. legislators appreciate the value pharmaceutical companies create for society and that drug price reform initiatives are unlikely to reduce profitability drastically.