Thursday, June 28, 2012

Obamacare - Supreme Court Ruling; What it Means Politically and to Trading and Why It's Not Over

I first wrote about the Health Care bill and pending Supreme Court decision on 6-11-2012. You can read that original post by here:
Obama Care - Why it Matters to Options, How Vols Explode While Industry Correlation to Market Moves Toward Zero .

I'll summarize the prior post and try to make some sense of the option markets with the decision now out and discuss what could happen later.


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Before we go anywhere, let's start with the ground breaking news today. But, I promise, I will get to the vol and stock moves and which sub-sectors within healthcare are affected, and what the vol implications are now and later.

Ultimately I don't believe this is over (from a vol and options trading perspective). More on that conclusion after some background and analysis. But, this analysis does require some background, so... here we go:

WASHINGTON (AP) -- The Supreme Court on Thursday upheld the vast majority of President Barack Obama's historic health care overhaul, including the hotly debated core requirement that virtually all Americans have health insurance.

The 5-4 decision means the huge overhaul, still taking effect, will proceed and pick up momentum over the next several years, affecting the way that countless Americans receive and pay for their personal medical care.

The ruling hands Obama a campaign-season victory in rejecting arguments that Congress went too far in approving the plan. However, Republicans quickly indicated they will try to use the decision to rally their supporters against what they call "Obamacare."

Stocks of hospital companies rose sharply, and insurance companies fell immediately after the decision was announced that Americans must carry health insurance or pay a penalty.

Breaking with the court's other conservative justices, Chief Justice John Roberts announced the judgment that allows the law to go forward with its aim of covering more than 30 million uninsured Americans.

The justices rejected two of the administration's three arguments in support of the insurance requirement. But the court said the mandate can be construed as a tax. "Because the Constitution permits such a tax, it is not our role to forbid it, or to pass upon its wisdom or fairness," Roberts said.

The court found problems with the law's expansion of Medicaid, but even there said the expansion could proceed as long as the federal government does not threaten to withhold states' entire Medicaid allotment if they don't take part in the law's extension.

The court's four liberal justices, Stephen Breyer, Ruth Bader Ginsburg, Elena Kagan and Sonia Sotomayor, joined Roberts in the outcome.

The legislation passed Congress in early 2010 after a monumental struggle in which all Republicans voted against it. House Majority Leader Eric Cantor, R-Va., said Thursday the House will vote the week of July 9 on whether to repeal the law, though such efforts have virtually no chance in the Democratic-controlled Senate.

Source: AP via Yahoo! Finance; High court upholds key part of Obama health law

I think the most important (and most frequently asked) question surrounding this bill is quite simply, what does it all mean? I've included a snippet from the post in early Jun which does a decent job of summarizing the impact of the bill.   Please note the source.

1. Patients Cannot Be Dropped

The first change that will immediately take place is that health insurance companies will no longer end or refuse to renew coverage unless you have misrepresented yourself or your medical situation, or if fraud has been committed.

Likewise, your coverage cannot be dropped suddenly for reasons you may not be aware of. The health car bill mandates the removal of pre-existing condition clauses from all health insurance plans by 2014

2. Immunization and Preventive Care Must Be Covered

Another change is a section of the bill that requires all health insurance companies and all health insurance plans to cover both immunizations and preventive care.

3. Dependents Can be Covered Until Age 26

A third change has to do with dependents. It used to be that unmarried children could be covered under a parent’s health insurance plan until the age of 23.

4. Everyone is Required to Pay for Health Insurance?

The last notable change that goes into affect immediately has to do with limits. Health insurance companies can no longer put an annual or lifetime limit on a health care plan that is not reasonable. A limit is an amount of money predetermined by the insurance company.

Once an individual reaches this limit, they have to pay all other medical expenses out of pocket. This practice was put into place by insurance companies due to the rise of cancer. What is considered reasonable will be based on income, family size, and past usage of medical benefits.

What changes will occur in the long run?

There are many more changes that will go into affect over the next 5 years due to Obama Care. The most significant change for the average American is the removal of pre-existing conditions. For years, pre-existing conditions have caused millions of Americans to be without adequate coverage for diseases. Obama Care requires the removal of pre-existing clauses from all health insurance plans by 2014.

Another significant change is that Americans who do not obtain minimal health insurance coverage by the year 2014 will have to pay a penalty of $95. This penalty will rise every few years.

Source:; What is Obama Care?

There were several questions surrounding the ruling. Here's a quick summary from the last blog post:

The Supreme Court now has to rule on the constitutionality of the law. There is a question as to whether or not the entire bill will be thrown out if there is in fact a ruling against it. In other words, there seem to be three potential outcomes: (1) Entire law goes into effect (2) Entire law does not go into effect (3) A part of the law goes into effect.


The expected impact given the different possibilities is summarized below:

NEW YORK (TheStreet) -- Investors will soon realize not all health care stocks are equal as the Supreme Court prepares to decide Obamacare's fate.

The good is for companies like Aetna(AET), Cigna(CI) and Coventry(CVH), which profit across the three major segments of Medicare, Medicaid and commercial health insurance. The bad is for the Medicaid HMOs like Amerigroup(AGP), Molina(MOH) and Centene(CNC).

"The companies that would be worst affected if the law were thrown out entirely ... you'd expect probably the Medicaid players, which would be Molina, Amerigroup, Centene, to fare poorly, given that they were hoping to take advantage of Medicaid expansion, which almost certainly wouldn't be resurrected if the law were thrown out," said Matthew Coffina, senior health care analyst at Morningstar.

Some estimates have found that between 16 million to 20 million new Americans would be eligible to enroll in Medicaid if the Supreme Court upholds Obamacare.

Obamacare as a whole gets thrown out, Medicaid HMOs would lose a large revenue opportunity they had expected to begin in 2014.

Medicaid enrollment would rise in 2014 because the law stipulated a shift in income eligibility; simply, the government would extend its low-income health insurance program to earners with a higher annual income than what is currently allowed.


"So that's not currently in their earnings -- they're not going to benefit today in their actions -- but come 2014 it would be a tailwind to revenue growth and profit," said Chris Rigg, senior health care analyst at Susquehanna Financial Group. "In the investment community there's a discounted value of that future revenue stream in the share prices today, and that discounted value goes away ... if health reform is overturned."

Source: via Yahoo! Finance; Health Care Poised to Weather Obamacare's Fate, written by Joe Deaux.

So there we go. Now let's actually look at what happened and so some analysis. Let's start with the Livevol® Pro Summaries from today and from 6-11-2012 for three sub-sectors within health care -- managed care, Medicaid HMO's and hospitals.

Managed Care
6-28-2012 6-11-2012

Medicaid HMO's
6-28-2012 6-11-2012

Hospital Stocks
6-28-2012 6-11-2012

Let's start with the stock reactions:

1. Bad news for managed care:
This is a tough one. I'm guessing the increased reach of Medicaid (16-20 million more people) could mean some of those people that once paid for managed care, will now switch for the government subsidy. The argument for managed care though is opaque beyond the Medicaid issue. I'm not sure we really know what impact the new rules on policy limits, pre-existing conditions and other "stuff" will have. I do note that the move down in managed care is less (in absolute value) than the move up for the other two sectors.

2. Good news for Medicaid HMOs:
Medicaid HMO companies should see somewhere in the range of 16-20 million new customers as the bill expands the reach of Medicaid by raising the minimum income level needed to qualify. More customers means more money.

3. Good news for hospitals:
Hospitals should see more customers -- more people insured means more people getting treatments, means more money.

The vol reaction is much easier to analyze:
The news is out, that means the unknown is now known, that means risk is down and thus vol has dropped significantly.

Using the small portfolios above to represent the individual sub-sectors in healthcare, the stock and vol moves summary stats are:

Many analysts posed the hypothesis that the market was pricing in a pre-decision expectation. I think the numbers above do actually point to a pre-decision expectation (IMHO). The fact that vol is down the most in the managed care companies by a fairly large amount while the stocks are all down, points to an expectation that the bill would be overturned (ruled unconstitutional). In many ways, this decision was a "surprise."

Further evidence of this expectation can be seen in the vol and stock comps for the managed care companies as of the first note (6-11-2012).

In English, the vols of these managed care companies had been exploding since 5-18-2012, while the stock prices had been rising. In that same time period, the vol for the overall market (SPY) was down significantly. This is a wonderful example of two phenomena that make option trading so interesting:

1. When vol rises, it doesn't mean that stock is dropping.
2. When industry specific news overhangs an entire industry, the correlation to the overall market (in terms of vol and / or stock) becomes almost meaningless.

--- SUMMARY --
Ultimately, the Supreme Court's ruling is groundbreaking in the political spectrum and has far reaching impact on the healthcare industry as well as in each of our own lives. From a trading perspective, I'm not convinced that the impact is fully understood, but a chunk of this bill doesn't get implemented until 2014. In between then and now lies a Presidential election.

I believe the impact of the bill if it were to go into effect will be much better known in six months with more research and analysis (and you can bet some firms crying foul and others praising it, strictly from the perspective of their own net income), and the vol will rise in all of these firms again -- by a lot. Why?... Because if Obama is re-elected, this becomes law. If he isn't, then it may just be "that thing we talked about that one time."

The vol has come in today, but I don't think this is done.

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This is trade analysis, not a recommendation.

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