• [WEBCAST] Rickards: How To Protect Your Wealth (When This Bubble Bursts)

    Outspoken author and investor James Rickards has a pro-to-pro discussion with Hedgeye CEO Keith McCullough live Friday, July 26th at 10:30am ET. Replay available after the interview.

The Hedgeye Risk Management research team continues to focus on important long-term issues not yet in the EYE of the MANIC MEDIA. 

The flowing note below was recently published by Christian Drake of the Hedgeye Healthcare team.  The genesis of the note is a follow on to a note we published on 2/24/2010 called “Domestic Pigs,” which focused on state pension liabilities.

Fiscal Conservatism, at least rhetorically, is garnering more headlines as politicians and state officials attempt to right size state budgets operating increasingly at a deficit.  Political and fiscal motivations look to be coalescing around a same objective as mid-term elections approach and politicians address a growing base of discontent from a populous who, over the past year, have been forced to face their own ghosts of leverage past and are now seeing the canonical kick-the-can approach to public debt management for the financial malfeasance that it is.

Current estimates peg state budget shortfalls for 2010 & 2011 as high as $350B and as state governments look to reorder their fiscal house, Medicaid allocations, at 21% of state revenues for FY2009, will continue to be a principal target for prospective offsets. 

Collectively, NASBO, the Kaiser Foundation, and the U.S. Census Bureau provide some interesting data as it relates to the condition of State budgets and the historical and prospective effects on Medicaid eligibility and reimbursement.  

Roughly 60M people receive Medicaid support in the U.S. with rolls continuing to swell as unemployment persists and payrolls continue to decline.  As stated above, Medicaid made a new high in FY2009 as the state entitlement program absorbed an average of 21% of all state revenues - coming in just behind education as the single largest budget allocation.  Total Medicaid Spending growth averaged 7.5% against a budgeted average of 3.6%, as enrollment grew by the largest amount since the program was first implemented back in the 60’s. 

In an attempt to keep individuals insured and support State’s Medicaid funding obligations, the American Recovery & Reinvestment Act (ARRA2009) allocated some $87B to increase the federal matching percentage.  Prior to 2009, federal support, by way of FMAP (Federal Medical Assistance Percentage), averaged a matching rate of ~57% nationally.  With the ARRA2009 subsidy, the matching range increased ~6% to a range of 61% to above 84% with support totaling $44.1B as of Jan. 31st. 

An important stipulation in the ARRA legislation was that states could not restrict Medicaid eligibility or enrollment if they wished to qualify for enhanced FMAP matching.  When the ARRA program ends, so does the incentive for maintaining broad eligibility.   The enhanced FMAP has 12/31/10 end date and represents a huge budgetary trapdoor for states who expect Medicaid enrollment to continue rising in the face of economic stabilization & improvement.  Indeed, enrollment increased 9.3% in 2002 following the 2001 recession. 

The Kaiser Commission’s February update on Medicaid & the Uninsured (Here) found that halfway through FY2010, forty-four states are again seeing Medicaid enrollment and spending growth in excess of their budgeted projection.  Almost every state implemented some new policy measure to control Medicaid spending in FY2009 with the balance of measures coming in the form of provider cuts and benefit limits.  Moreover, 29 states reported that additional mid-year cuts in FY2010 are likely and 15 others indicated further reductions are under consideration but that it remained too soon to tell.   

Analysis by The Center on Budget and Policy Priorities, who updated their analysis of the current & projected state fiscal positions last week, tells a similarly bleak story.  You can find the updated report Here but the relevant takeaways surround the projected budget shortfalls for the FY’s 2010, 2011, & 2012.  As it stands, newly identified mid-year 2010 budget shortfalls equal $38B while projected shortfalls for FY 2011 & 2012 total 130B and 120B, respectively. 

Aggregate state budgets, defined as the sum total of state’s general funds, totaled $686.5B for FY2008.  Using this 2008 total as a budget baseline, the projected FY 2011 & 2012 deficits equate to 19% and 17.5% budget shortfalls, respectively.  Moreover, without continued Federal support such as an extension of ARRA2009 stimulus monies (which is slated to end Dec. 31, 2010/mid FY 2011), the FY2011 shortfall could move more towards $180B, or 26.5% of budget. 

Nationally, payments to Medicaid average 16-17% of total outlays from state’s General Funds.   Applying this percentage to the projected budget shortfalls for fiscal year’s 2010-2012 yields the projected Medicaid shortfall for the respective years.  Calculated in this way, the shortfall in Medicaid dollars as a percentage of the state’s Medicaid budget is 5.5%, 15%, & 17.5% for the balance of FY2010, FY2011, & FY2012, respectively.



Consensus commentary from Medical Directors interviewed in the Kaiser survey foreshadows significant reimbursement and/or eligibility cuts as 2011 budgets are contemplated. 

“Many governors’ proposed budgets for state fiscal year 2011 include drastic cuts to Medicaid as well as other state programs and state employees… Medicaid directors see the prospect for widespread program cutbacks in 2011, including eligibility cuts that would affect millions of Medicaid beneficiaries as well as the hospitals, doctors and other providers who

depend on Medicaid to pay for health care they provide to Medicaid enrollees.”

In varying proportions, States General Funds source the bulk of their revenues from income & sales tax.  While employment will continue to recover, tax revenues should remain under pressure as consumer’s continue to delever and wage inflation remains muted alongside continued excess capacity. 

Below we’ve highlighted Florida & New York as examples of the similar but different means by which states generate funds.  The principal sources of revenue for each come from income and sales tax, followed to a lesser degree by tariffs on tobacco, alcohol, insurance & other corporate taxes.    As can be seen below, Personal Income tax (73%) + Sales tax (14%) represent  87% of revenue for NY.   Similarly, income & sales tax represent 81% of Florida state revenues.  However, in contrast, Florida, which has a corporate income tax but no personal income tax, generates 74% and 7% of revenues from Sales tax & Corporate Income tax, respectively – almost the mirror opposite of NY.






Rainy day funds have been highlighted as a means of offsetting declining tax revenues.  Rainy day funds, which essentially represent the cumulative budget surpluses allocated to savings during feasting years, can be used to subsidize budget gaps during short-term periods of economic weakness.  While balances grew through the first half of the decade, finishing FY206 at 11.9% of expenditures, states drew heavily from these budget stabilization funds during 2008-2009 dropping that balance to 4.8% of expenditures.  Furthermore, NASBO reports that if Texas & Alaska are excluded from the calculation, total rainy day funds would amount to only 2.7% of expenditures.  Balances have likely dropped further since the December survey and, at this point, probably offer little in the way of budgetary support.

Healthcare reform measures passed through Reconciliation and resulting in an increased Federal shouldering of insurance coverage costs has the potential to significantly reduce state budget pressures, specifically as it relates to Medicaid.  Passage of any major reform initiative, however, remains a big “IF’ and clarity on the range & magnitude of measures that actually emerge in the final iteration of the legislation is still somewhat of a tossup. 

Passage or no-passage, Understanding State’s fiscal positions helps contextualize the pressures likely to be faced by healthcare providers & others levered to State & Medicaid reimbursement.   Indeed, cost pressures faced by states could preview fiscal problems and actions taken at the national level – future cost containment actions, an eventuality we’ve dubbed Health Reform II, implemented at the Federal level as our nation’s P&L & Balance sheet begin to drown in healthcare liabilities under expanded government control.



From an equity perspective, the most obvious follow through is to names directly levered to Medicaid reimbursement and eligibility decisions, namely Medicaid HMO’s.   Medicaid insurer’s are cyclical in so much as they are levered to state tax revenues.  In turn, given that the state coffers are singularly levered to the consumer, the group’s strong longer term correlations to indicators such as consumer sentiment and chain store sales isn’t particularly surprising.

Given the set-up, the fate of Medicaid HMO’s remains tied to the health of state budgets over the longer term while reform legislation will continue to dominate the immediate term. While no candidate can explicitly campaign on an agenda of alienating the uninsured in favor of fiscal austerity, on the margin, a general shift over the intermediate term towards fiscal conservatism would be a negative for provider’s and insurer’s levered to Medicaid.

Looking beyond the HMO’s, our initial screen returned 160 companies with a market cap over $500M who reference Medicaid in their 10K’s.  Some companies in the screen have minimal leverage to pressure on Medicaid spending while others hold more definite risk.  We’ll be working to narrow the candidate list to target those names most directly impacted by Medicaid reimbursement and those most likely to be targeted as offsets to prospective legislation which aims to add an expected $450B in additional costs to the State entitlement program.    

Christian B. Drake