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5 Forward-Looking Trends in Healthcare

Posted on: October 2, 2008 - Email Article - Printable Version

Allen Lutz

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The healthcare sector is going through significant changes and many investors are worried about how a change in administration will affect healthcare companies. While the future of managed care and Medicare spending are uncertain, there are a few subsectors that should continue to experience rapid growth regardless of politics. Here is an introduction to 5 trends that could make you big returns.

1. Generics

The Generic Utilization rate for the United States was about 60% in 2007 and both candidates have expressed support for raising the utilization rate over the next few years. With the large amount of branded drugs going off patent being offset by an increase in spending on specialty drugs, savings from substituting cheaper generics is a trend I believe will continue to grow stronger. Pharmacy Benefit Managers like Medco Health Solutions [MHS: 44.21, +1.48 (+3.46%)] and Express Scripts [ESRX: 57.12, +0.43 (+0.76%)] have been adamantly encouraging the use of generic drugs which has led to a significant reduction in year over year drug trend for the two companies. Some of the big players in the generics industry are Teva Pharmaceuticals [TEVA: 42.82, +0.17 (+0.40%)], Mylan Inc [MYL: 9.86, -0.16 (-1.60%)], Watson Pharmaceuticals [WPI: 25.19, -1.11 (-4.22%)], and Ranbaxy Labs.

2. Personalized Medicine

Personalized Medicine, also known as pharmacogenomics is the study of how drugs interact with the individual human genotype. After the 25,000 genes of the human genome were identified, many were unsure how this achievement could aid and prolong human life. Since 2003 doctors have worked to identify genetic variations in different persons that could increase the efficacy of treatment. According to the 2008 Medco Drug Trend Report, “the [top] five drug categories for which the current approach of trial-and-error prescribing can lead to relatively poor response to medications” resulted in $17.5 billion or 37% of money used to be wasted due to poor therapeutic response. Reducing the inefficiencies in drug interactions can help reduce healthcare costs. Some of the players in this industry include Ilumina [ILMN: 27.48, +0.63 (+2.35%)] and Affymetrix [AFFX: 3.16, +0.04 (+1.28%)].

3. Electronic Prescriptions/Electronic Health Records

Senators John Kerry (D-Mass.) and John Ensign (R-Nev.) introduced legislature for Electronic prescribing this past March which immediately gained bipartisan support. Electronic prescribing allows general practicioners to send prescriptions to pharmacies online, helping to minimize errors. Handwriting errors and misplacement of papers have caused problems, but one of the best features of the electronic prescriptions software is that it will alert a doctor if one medication a patient takes will react with another medicine. Medco’s Drug Trend Report cites “A recent review of several studies by researchers at the University of Minnesota concluded that illegible handwriting and transcription errors account for 60% of medication errors. They also found that
medication errors can be reduced by up to 66% in hospitals that switch to an e-prescribing system.” Now the government is incentivizing the use of electronic prescription software by actually reducing Medicare reimbursements in 2010 if the software is not installed. Electronic health records are also receiving a big push as they would significantly reduce the inefficiencies caused by paper charts. One benefit of EHR’s is that two physicians could theoretically look at the same chart at one time, reducing costs associated with time. Some of the big players in the industry include Allscripts Healthcare Solutions [MDRX: 9.99, +0.02 (+0.20%)], Eclipsys Corp [ECLP: 14.75, +0.08 (+0.55%)], Quality Systems [QSII: 42.12, -1.49 (-3.42%)] and Cerner Corporation [CERN: 39.34, +0.16 (+0.41%)].

4. Specialty Drug Trend

Specialty drugs are scientifically engineered medicines that are used to treat a relatively small amount of people, but cost a lot of money. The top three types of drugs based on the number of compounds in development are cancer with 561, infections with 229 and Central Nervous System (CNS) with 224. As of the end of 2007 Medco Health Solutions reported there were 1752 compounds in development. Medco predicts heavy spending in specialty drugs will more than offset the cost savings from generic versions of branded drugs off of patent. CMS estimates the cost increase of pharmaceuticals year over year was 6.7% in 2007 and will increase to a CAGR (Compound Annual Growth Rate) of 8.4% over the next 10 years. Spending for specialty drugs grew at 12.3% in 2007 and is expected to see double digit growth over the next few years. That is some serious growth! Growth in spending on specialty drugs will pose cost management problems for Medicare and employers.

5. Biogenerics

One of the trends that has not gained traction in the United States is biogenerics, also known as follow-on biologics or biosimilars. Biogenerics are, in layman’s terms, generic versions of biotechnology drugs. One major difference between a normal pharmaceutical compound and a biologic compound is that the former can be easily duplicated without complication. Biologic compounds are based on cells and independently developed biotechnology medicines are not identical. In fact, biotechnology companies have had compounds disapproved because they were not manufactured in the same plant. In April 2006 the first biologic was approved in the European Union. The U.S. government is working toward making biogenerics a less costly alternative in the near future. The Congressional Budget Office projects the widespread use of biogeneric drugs would save the U.S. $25 billion from 2009-2018. However, near term regulatory issues remain and the U.S. should not see widespread generic biotech drugs gain a large amount of market share until at least 2010.

These are some of the strongest trends in the healthcare industry over the past few years. Not all of the trends have led to big gains in the leaders in these markets. For example, Mylan Inc is down roughly 20% year to date and Allscripts is down about 38% year to date. In the future I will be breaking down each of the trends to see if a good trend can lead to a great investment.

-Allen Lutz

Disclosure: The mutual fund the author is associated with is long MYL

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