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Paul and Brett's Alpha

January 2024

Back, to the future

As noted in last month’s missive, the portfolio’s strong performance into the final weeks of 2023 was driven by a combination of more constructive macro (interest rates believed to have peaked and increased optimism around a soft landing) and the ongoing unwinding of negative sentiment during the summer months, regarding the likely impact of increased usage of GLP-1 drugs on other ‘obesity-linked’ areas within healthcare.  

Finally, the sell-side and investors (yes, we are generalising; not everyone fell into this) seem to be willing to re-engage with a broader debate about the positive outlook for procedural volumes in an era of an ageing population, as opposed to a monomaniacal focus on a doom-loop of increased GLP-1 usage negating morbidity and decrepitude, in spite of the modest impact on secondary factors versus inexorable demographic trends.  

Lest we forget – every day, 10,000 people in the US turn 65. Across Europe, it is about 3,500/day (Europe is already older on average). Across the OECD, there are ~240m people aged over 65, around 64m aged over 80 and generally speaking, they desire a more active lifestyle than previous aged cohorts, who seemed willing to accept a degree of functional loss and discomfort with age.  

The next generation (i.e., the current over 50s) is generally sicker and less healthy on average than the previous one. This is due to a combination of lifestyle factors (sedentary behaviour, ultra-processed foods, long COVID, etc.). Our view remains that, whilst losing some weight will be a positive for this population, it is no panacea, and in all likelihood the resultant increase in lifespan (as opposed to healthspan, since much of the damage will have been done) will make them more likely to fall into the net of procedures later in life.  

The previous GLP-1 hysteria seems all but forgotten in recent weeks, amidst encouraging comments around procedure volumes. Although the overall commentary has been constructive, and a focus back towards the positive fundamentals of healthcare is welcome, there are some interesting divergences in views on the drivers of this acceleration in growth, and thus  questions to be asked over its likely duration. This is an important topic and we have highlighted some of the more interesting commentary from recent reporting and conference presentations in the following pages. 

COVID backlog and other COVID effects   

It is undeniable that we had at least two years of serious disruption to the smooth running of hospitals from COVID. Measures to reduce the spread of the SARS-CoV-2 virus limited the ability of patients in many markets to access “non-essential” healthcare procedures (we recognise the definition of non-essential is a very de-personalised one and sadly did include cancer and cardiovascular care for some patients in some markets, resulting in loss of life), and reduced surgical capacity at the same time, resulting in huge backlogs, especially here in the UK.  

These post pandemic backlogs were further compounded by labour shortages as many burnt out medical staff elected to leave the profession for other (often better paid) vocations. Typically, the most frequent users of healthcare services were the elderly and they were also the most at risk from contracting the virus.  

Consequently, there was a reluctance to re-engage with the regular face-to-face interactions with primary care doctors that drove procedural volumes. That fear does look to have subsided, and we are, to a large extent, back to ‘business as usual’.  

With insurance providers and hospitals to some extent seemingly caught unaware by the Q4 demand surge (causing them to respectively miss and beat guidance expectations), it behoves us to consider if this elevated demand is somewhat transitory (i.e., backlog-related) or a ‘new’ normal.  

Med-Tech behemoth J&J, whose activities span general surgery, orthopaedics and cardiovascular commented that COVID disruption was receding but was still being felt in terms of labour shortages and higher costs. They attributed the strong procedural growth in 2023 to the backlog effect and expected this to continue to play out in 2024, but did not suggest its expectations on the structural outlook for key markets (in terms of pre-COVID positive volume growth rate and negative annual price erosion) had changed. In other words, it would be reasonable to assume that trends slow over 2024 and look more typical (i.e., comparable to 2018/19) in 2025+.  

In contrast, ortho-focused peers Zimmer Biomet and Stryker were less inclined to attribute the strong patient volumes to the backlog; Zimmer went as far as to say it did not feel that a COVID-driven backlog made a significant contribution in 2023.  

Instead, both cited more secular trends from the growing population of elderly patients (many of whom want and expect to be more active at any given level of age than the previous generation were and so are more amenable to surgery), and increasing use of robotically assisted placements and surgical planning tools that can augment physician capacity.  

These comments are more in line with our own base case view. Hospital operator HCA also indicated that it did not attribute higher procedure volumes to COVID backlog effects but rather to higher utilisation and capacity.  

Patients are coming in younger and earlier, unwilling to wait for issues to become serious or life-limiting before seeking surgery. Moreover, doctors can now cope with the resultant higher workload, having adopted various new tools. This overall picture is supportive of enhanced short-to-medium term procedure growth, and a more demanding patient cohort will absorb that growing capacity, with an expectation of maintaining a more active lifestyle.  

At some point though, this higher capacity and demand will reach an equilibrium, and growth will slow down from its currently elevated level. Whether or not it returns to pre-pandemic norms or settles a little higher remains to be seen. There are certainly persuasive arguments as to why the long-term growth rate may remain higher, at least while the overall size of the higher acuity (i.e. over 65) population continues to grow in absolute terms. 

What about future seasonal COVID disruptions? Although there is forever a new ‘variant of interest’ popping up to supersede the last one as the prevalent strain in circulation (principally monitored these days from waste-water testing, which gives localised population-level data), few of these become ‘variants of concern’ and hospitalisation data is not worrisome.  

UnitedHealth did note that initial 2024 ‘per case’ costs for COVID hospitalisations were running a little higher than expected, but that it was not a material impact and none of the quoted payors really called out COVID as a contributory factor to the elevated Medicare Advantage medical cost trend widely seen in Q4 23, nor did hospital operators cite it as a driver of higher patient intake over that same period. Continuing to presume that COVID is no longer a material factor on overall patient behaviour and admission patterns seems a reasonable assumption.  

The broader category of community-acquired respiratory infections is worth mentioning. This is the second winter season after the pandemic ended and people fully embraced typical holiday season behaviours. As a consequence, there was another notable spike in those background infections that typically impact paediatric and elderly populations (e.g., RSV, flu, rhinovirus, enterovirus, strep A). This was largely anticipated and factored into the guidance scenarios of both payors and providers.  

There was a higher-than-anticipated uptake of RSV vaccinations, which was widely cited by several payors as driving additional costs latter in the quarter, but this should be a longer-term positive for them as higher vaccination rates should translate into lower background hospital admissions over the following two seasons.  

Site-of-care shift 

Long-term holders will be aware that the so-called ‘site-of-care shift’ has long been one of our key themes for the development of healthcare. The idea here is that facilities operators segment care, physically separating procedures into low acuity elective day cases carried out in walk-in hospitals (Ambulatory Surgical Centres or ASCs) and siting these in population dense regions, offering truly convenient care.  

Because they are not managing complex, high risk cases, these centres require much lower levels of equipment and staffing and can consequently be run at lower cost and profitably charge lower prices. In high population densities, care can even be segmented into disciplines, e.g. a centre specialising in ortho or gastrointestinal (GI).  

The other side of the ASC coin is that removing day cases from fully functioning hospitals reduces bed blocking, which allows them to deal with more trauma cases and complex surgical admissions. These are more profitable for the hospital operators, so it is something of a win-win for those networks that can segment their business in this manner.  

Perhaps there is something for the NHS to learn from this approach; we are not aware of any plans to move NHS provision in a similar direction, beyond continuing to contract out some procedures to private providers to reduce the current backlog.  

Stryker specifically called out the ASC trend as being a positive for their business: convenience is breaking down the barriers to uptake. US hospital group Tenet Healthcare has been at the forefront of the ASC trend. It reported teens growth in both orthopaedic and gastrointestinal procedure volumes during 2023, and continues to add additional ASC capacity at a substantial rate, in the expectation that patient demand for safe and convenient surgical care options will continue for many years to come. 

GLP-1 impact? 

What about GLP-1? According to the most ebullient sell-siders during the summer sell-off, the impact of increased usage of these drugs would be both profound in its reach and imminent in its arrival. We have already noted comments from companies supposedly directly impacted (e.g., dialysis, sleep apnoea, type 1 diabetes management) noting their much more modest expectations.  

J&J noted that weight is generally not a factor in osteoarthritis, even if it might compound joint pain in those afflicted by it. The company said it continues to see an increased volume of procedures in orthopaedics and does not see any change in any of the segments in which it competes. Zimmer has been more direct, stating that GLP-1 was “not going to kill this market”.  

In response to questions from analysts, Intuitive Surgical noted on its Q3 call that it had seen some slowdown (i.e. a deceleration in growth, not a decline) in bariatric procedures on its DaVinci surgical robotics platform that it was attributing to GLP-1 usage.  

Tenet stated that it has been growing and expanding its bariatrics capability in the ASC setting and usage has been “reasonably stable, despite the GLP hoopla”. Its overall GI surgical volumes grew 15% year-on-year and the company expects growth to remain robust. HCA didn’t call out GLP-1 at all in Q4, but did say at Q3 that “we think it's way too early for any of that to have an impact on demand in the near term or even the intermediate term”. 

Labour shortages   

For facilities operators, the road back to normal post-pandemic was complicated by severe labour shortages. Like airlines, hospitals are one of those businesses where you simply cannot run short-staffed due to safety risks, so capacity must be curtailed to match staffing levels. Many people left the healthcare industry out of exhaustion and frustration in the aftermath of the pandemic. Some left because they could earn more money elsewhere.  

In a perverse circularity, the providers fall back on contract labour to bridge critical shortages and these same agencies were offering premium rates to those same staff leaving direct employment. This caused significant short-term margin pressure. Over time, this has ameliorated since procedural reimbursement rates reflect labour force cost inflation. The acceptance of higher wages has also allowed operators to hire new employees directly.  

Although higher wages represent a like-for-like cost increase, it is a cost saving versus using contract labour and the combination of a falling total wage bill and rising procedure rates has allowed for robust margin expansion during 2023, driven by a combination of lower unit wage cost and higher capacity utilisation, owing to a reduced capacity impact from labour shortages (although it is important to point out that labour shortages are still widely cited as a constraint for facilities operators).  

We do not expect this margin expansion to continue at pace, but operators seem confident they can maintain current margins while investing in additional capacity.  

All major operators cited reduced usage of contract labour as a significant profit driver in 2022 vs 2023. Does this increased capacity utilisation count as “COVID catch-up/backlog effects”? One could see how it might be considered part of this and thus why J&J might have taken a slightly different view on what drove the market in 2023 versus some of its peers.  

Another factor to consider is what the industry refers to as ‘patient activation’. You may well have a non-urgent medical issue that is in some way life-limiting, and it may well be that your insurance coverage would allow you to seek authorisation for an elective procedure to address this. Sometimes though, for whatever reason, patients do not follow up with doctors despite having a diagnosis. 

Medical device companies within our portfolio, especially in the cardiology, sleep apnoea and incontinence categories have been investing heavily in patient outreach and support to drive this patient funnel toward treatment, and this is increasing the market penetration of some product categories. It is not so much that any of this is new, but rather expanded use of social media channels and smart phones is making it easier to reach these people in a targeted fashion and drive them toward physicians who undertake that company’s intervention. 

Why is Medicare Advantage causing so many issues for payors? 

One of the notable things about the managed care providers generally disappointing Q4 23 results and FY24 outlook is that the incremental problems were mainly attributed to a single business line – Medicare Advantage. However, the reality is that cost trend accelerated across all categories during 2023, for all the reasons outlined in the previous comments.  

As a reminder, American retirees (the over 65s) are entitled to government-funded care through the Medicare programme. This $900bn/year scheme consists of three parts: A, B & D. Part A (hospital insurance) helps to cover inpatient care in hospitals, skilled nursing facilities, hospices and some home health care services.  

Part B (medical insurance) helps to cover outpatient care including physician appointments, durable medical equipment that patients might need (such as wheelchairs, walkers, breathing apparatus) and some other types of home health care services not covered under Part A.  

Part D helps cover the cost of prescription drugs and vaccines. Parts A&B are standard elements and Part D is an additional paid-for option. Part A is free for everyone who is eligible. Part B incurs a monthly cost, but is not mandatory. However, there are premium penalties if you choose to join the B scheme at a later age than 65.  

Since the programme will not cover everything and has out-of-pocket co-payment elements, you can also buy separate “Medigap” insurance to cover these costs. Government data suggests that the traditional A&B scheme typically covers around half the total costs for seniors healthcare.  

Medicare Part C is an alternative scheme that allows patients to choose their own plans offered by third party providers with different benefit structures. It provides the same services as Parts A and B, but almost always with additional benefits (such as vision, dental or physio). Part C is also known as Medicare Advantage (MA) and approved plans always include an annual out-of-pocket expense limit in an amount between $1,500 and $8,000 of the beneficiary's choosing (the lower the limit, the higher the premium).  

Because of this catastrophic coverage cap, around 50% of eligible seniors elect to enrol into a Part C plan. However, it is interesting to note that many wealthier seniors opt for the ‘A&B + Medigap’ route as opposed to the Part C route. Typically, wealthier means healthier, so there may be some adverse selection in the MA marketplace.  

Many companies offer support for Part C or D plans as a component of their employees’ retirement packages. Part C has been the fastest-growing insurance market for many years now and has been dominated by UnitedHealth and Humana. Other companies have sought to gain market share by offering competitive pricing and, from time to time, this has backfired in terms of financial results, since operating margins in this market are already thin. 

Typically though, it is one player who has seen this adverse impact and it is rare to see such widespread reports of a negative outlook in this segment. UnitedHealth, CVS, Cigna, and notably Humana (who warned) called it out and CVS announced that they were exiting the business, despite being the 8th largest player by covered lives. Elevance reported an in-line outlook for Part C medical costs, but only because it has shrunken back its book of business and the uplift from exiting smaller, loss-making markets is offsetting the higher costs in core ones. 

Broadly speaking, everyone priced for a worsening claims trend, but it looks like it will come in higher than those assumptions predicted (it’s very early in the year and things may yet change, especially for Humana, who in our experience tend to guide less accurately on cost trend than some of the peers).  

The one thing we can be certain of at this stage is that all of these operators will look for a significant plan changes in 2025 vs. where they priced in 2024. If everyone is disciplined, this should allow the marketplace to remain an attractive and profitable growth segment (albeit one where growth is slowing because we are coming to the end of the boomer retirement bolus).  

Some of the operators indicated that the higher costs were not only in the core Part A and B categories but that supplemental offers such as dental and vision had seen higher uptakes in Q4 than anticipated. Perhaps it was a case of people who had reached their deductible limit for the year taking advantage of that before the plan rolls over to the next period and the deductible resets. 


In our view, there was not anything special or one-off about Q4 2023, nor is the broad acceleration in procedure volume trend all that surprising when viewed against the “easy comps” of 2022, where people were still a little COVID wary and not behaving in line with pre-pandemic norms and hospitals were still constrained by significant labour shortages.  

The hospital/provider market has continued to evolve into one that is better structured to serve the needs of an increasingly large and demanding cohort of over 65s. This should support trend growth that is above that seen in the pre-pandemic period, at least until capacity utilisation caps out and the demographic expansion of this cohort slows markedly.  

These are the very factors that we have long discussed as being the positive secular growth drivers for the wider healthcare industry and, whilst this may not be a supportive environment to own Managed Care companies in the short-term (at least until they can talk more confidently about what the underlying trend is and price their future book of business appropriately), it serves to highlight why healthcare should be a core part of any growth equities portfolio. Life has few certainties, but ageing and increased consumption of healthcare as a consequence of age are definitely two of them.  

We always appreciate the opportunity to interact with our investors directly and you can submit questions regarding the Trust at any time via:  

As ever, we will endeavour to respond in a timely fashion and we thank you for your continued support during these volatile months.  

Paul Major and Brett Darke