Buy Insurers Like UnitedHealth, Sell Hospitals Like HCA

NEW YORK ( TheStreet) -- Amid all the business changes surrounding the Affordable Care Act, the most obvious lesson for investors is being lost.

Buy the insurers. Sell the hospitals.

Companies such as UnitedHealth ( UNH) have been building toward this day since the late 20th century.

Back then, the primary means of controlling costs was the health maintenance organization. The idea was to keep people inside a network, punishing them financially for going outside it, and limit network costs.

The idea died because people could go outside networks, they did go outside them, and doctors outside networks did what they wanted and charged what they wanted.

What has changed now? Groups such as the Mayo Clinic and Intermountain Healthcare of Utah have developed integrated care management and data systems that work. They keep patients inside their networks. They collect fees per patient, rather than per procedure. They have incentives to keep people well and limit expenses.

They are called accountable care organizations. Over the last decade they have been spreading like wildfire in Medicare and Medicaid. With Obamacare they're poised to take over the general market.

UnitedHealth's Humedica unit is just one of the insurance units working directly with Mayo, a nonprofit, on the best practices necessary to make this work.

Over the last four years, all the insurers have been buying Medicare ACOs using this economic model. For example, UnitedHealth bought XLHealth, completing the purchase in 2012.

By controlling both income and expenses, insurers have learned to generate big profits. From 2009 through 2012, UnitedHealth's annual revenue increased 27%, from $87.14 billion to $110.62 billion. Annual net income rose 45%, from $3.82 billion to $5.53 billion.

UnitedHealth and other insurers will now bring ACOs into the general market through the insurance exchanges, in areas where they have the facilities to deliver it profitably. Small wonder that UNH stock is up nearly 190% over the last five years (adjusted for dividends) and has a 28 cent-per-share dividend to boot.

By contrast, consider what all this does to a large hospital chain such as HCA ( HCA).

Hospitals are like hotels. The profits come from utilizing their capacity. The incentives under the Affordable Care Act are geared toward keeping people out of hospitals as much as possible, by guaranteeing wellness services and using data to make sure best practices are followed.

For-profit hospitals like HCA also face competition from nonprofits such as Mayo that deliver complete care solutions. Control over the money, and the patients, moves from doctors to insurers, who have incentives to keep costs down.

This is already affecting HCA's results. From 2009 through 2012, its annual revenue rose just 10%, from $30.05 billion to $33.01 billion. Net income for 2012 was $1.60 billion, down about one-third from $2.47 billion in 2011.

Hospitals don't go away under the Affordable Care Act. By buying front-line clinics, by using automation so that data can deliver integrated care, and by maintaining best practices to limit mistakes, they can still make money.

In Massachusetts, where something like Obamacare has been the law since 2006, Steward Health Care's hospitals regularly lose money, but they make up for it with front-line doctors' practices, outpatient clinics and insurance units. (Steward is owned by Cerberus Capital Management.)

The aim of their turnaround is to build the brand and limit "leakage" to more-expensive teaching hospitals, according to the Macadamya blog, which follows the space. They're trying to become an ACO, in other words, but finding it difficult with patient control.

Cost controls change the incentives in the health space. That was their intent. By marrying the companies that provide care to those that collect money, you create a virtuous rather than a vicious cycle. The place to invest is with companies that marry these incentives best, the insurance companies.

At the time of publication, the author owned no stock in companies mentioned here.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Dana Blankenhorn has been a business journalist since 1978, and a tech reporter since 1982. His specialty has been getting to the future ahead of the crowd, then leaving before success arrived. That meant covering the Internet in 1985, e-commerce in 1994, the Internet of Things in 2005, open source in 2005 and, since 2010, renewable energy. He has written for every medium from newspapers and magazines to Web sites, from books to blogs. He still seeks tomorrow from his Craftsman home in Atlanta.

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