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Elective Surgery
New York: July 06, 2009
By John Stephenson

Last week, economic growth seemed to take a pause with the release of June's U.S. nonfarm payroll report, which showed that the American unemployment rate is set to hit the ten per cent or higher level by year's end. The stock market took note and moved lower as concern began to mount that perhaps the rally has come too far too fast.

Lately, America has been confronting a multitude of challenges, from rising unemployment, to the implosion of the country's automotive and financial services sectors. But one challenge that the Obama administration seems likely to pursue is the reform of the nation's healthcare system.

In spite of spending more than one dollar in every six of national income on healthcare, the system is in need of a major overhaul. But unfortunately, all of the spending on healthcare has not translated into tangible results. More than 49 million Americans are without health insurance and life expectancy, infant mortality and survival rates after heart attacks are all worse than the OECD average.

Most of America's healthcare system is a patchwork quilt of private insurance schemes, with the poor and the elderly relying, in part, on two U.S. government sponsored plans—Medicare and Medicaid. According to the Congressional Budget Office (CBO), the cost for funding just these two plans is likely to soar from 4 percent of GDP in 2007 to more than 12 percent of GDP by 2050.

While the elderly, the very young, the poor and government workers are provided with a basic level of health insurance through the federal government, most private sector employees receive employer-funded health insurance. While the level of care and wide range of consumer choice is often heralded, it comes at a hefty price. Many smaller and mid-sized employers have given up covering employees and some high profile corporate bankruptcies, such as General Motors, can be blamed in part, on soaring health care costs.

Many culprits are suggested as reasons for the soaring cost of delivering health care in America : from greedy drug companies to an aging workforce. But most of these explanations do not stand up to a rigorous examination. Drugs account for only ten percent of healthcare spending in America . And while an aging population surely increases the nation's healthcare needs, America 's demographic situation is no worse than other rich countries. The explanation for America 's surging healthcare costs seems to be a system of incentives that rewards activity rather than results.

One major distortion in the system is that employer-sponsored health plans are tax deductible. That has encouraged many larger corporations to offer their employees gold-plated plans as part of their overall compensation and retention practices. The impact of the tax deductibility of employer-sponsored health plans is to shift the burden of paying for these plans to workers without such insurance, who subsidize this benefit through higher taxes. The other consequence is that it encourages waste, since the true cost of the plan is not transparent to the employee or the employer. The annual tally for this tax break, costs the American government $250 billion—no small sum.

America 's doctors work on a fee-for-service basis. Their incomes are directly linked to the number of tests they perform, the number of pills they prescribe or the procedures they perform. And while patients with gold-plated health insurance plans may take comfort in the fact that they have been given every imaginable test or procedure, there is ample evidence that many of these tests are unnecessary. The Economist believes that by eliminating or cutting back on expensive or unnecessary prescriptions or procedures, America 's health system could save 10 to 30 percent—a massive savings.

With a jammed packed legislative agenda, the Obama administration has its hands full. Reforming the nation's healthcare system would be a massive and perilous undertaking at the best of times. But with a global economic crisis underway and U.S. unemployment rates continuing to climb, now would seem to be an inopportune time to perform elective surgery on the nation's healthcare system. But, a political promise is still a political promise.

It seems increasingly likely that the optimism that we've seen in the stock market in the last three months will give way to realism over the next three months. The most likely scenario is that the stock market and the economy will move forward slowly and in fits and starts for the foreseeable future.

Investors would be well-advised to adopt a more defensive stance in their investment portfolios and to underweight the shares of pharmaceutical companies and health maintenance organizations that may go under the knife in the not-too distant-future.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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