Family Wealth Conference. September 27-28, 2012

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1 Family Wealth Conference September 27-28, 2012

2 Family Wealth Conference The Rx for Uncertainty: Navigating the Shifting Healthcare Landscape Ryan S. Daniels, CFA William Blair & Company The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of William Blair & Company.

3 Table of Contents Current State of the U.S. Healthcare Market Crossing the Quality Chasm A Dose of Tough Medicine: What s Next for the U.S. Healthcare Space Investing in the Current Healthcare Landscape

4 Current State of the U.S. Healthcare Market

5 The Patient Protection and Affordable Care Act (ACA) will unquestionably expand health insurance coverage, but generally falls short in two other key areas: 1. Reducing Healthcare Costs: Healthcare costs are growing at rates well in excess of GDP, making current trends unsustainable; in our view, this is the root cause of the large uninsured population today. The ACA cost reduction claims are more accounting gimmicks than substantive savings. 2. Improving Healthcare Quality: Despite spending more money, per capita, than any other nation on healthcare, our quality scores trail most developed nations. Put simply: we are the best at providing care, but the worst at promoting health. The ACA takes only minor steps to address the quality issue.

6 So why are healthcare costs the biggest issue we are facing today? Because medical costs drove 60% of personal bankruptcies in the United States last year Because GM spends more on healthcare than steel, Starbucks spends more on healthcare then coffee beans--healthcare costs are making the U.S. less competitive. Because, if nothing changes, healthcare will consume roughly 50% of our GDP by 2082 Because the Medicare Trust Fund is scheduled to be bankrupt in just over a decade Because the present value of healthcare commitments is roughly four times the level of national debt Percentage of U.S. GDP Consumed By Healthcare Expenditures 35 % Of GDP All Other Health Care Medicaid 10 5 Medicare Source: Congressional Budget Office

7 Demographic trends are a major factor impacting the U.S. healthcare spending outlook Number of people (millions) E 0 Source: U.S. Census Bureau

8 Demographic trends are a major factor impacting the U.S. healthcare spending outlook Number of people (millions) The Medicare population in E 5 0 Source: U.S. Census Bureau

9 Demographic trends are a major factor impacting the U.S. healthcare spending outlook Number of people (millions) The Medicare population in E 5 0 Source: U.S. Census Bureau

10 Demographic trends are a major factor impacting the U.S. healthcare spending outlook Number of people (millions) The Medicare population in E 5 0 Source: U.S. Census Bureau

11 Demographic trends are a major factor impacting the U.S. healthcare spending outlook 25 Number of people (millions) Baby Boomers are driving material growth in the size of the Medicare population E 5 0 Source: U.S. Census Bureau

12 Demographic trends are a major factor impacting the U.S. healthcare spending outlook and this age cohort is the largest consumer of healthcare resources in the United States $530 $144 $1,286 $237 $1,879 $381 $2,265 $551 $2,703 $745 $3,583 $959 $3,397 Healthcare spend per capita Drug spend per capita $1,098 Under to to to to to Age Range Source: U.S. Census Bureau

13 Another troubling trend is the growing prevalence of obesity in the United States

14 Another troubling trend is the growing prevalence of obesity in the United States

15 Another troubling trend is the growing prevalence of obesity in the United States

16 Another troubling trend is the growing prevalence of obesity in the United States

17 Another troubling trend is the growing prevalence of obesity in the United States

18 Another troubling trend is the growing prevalence of obesity in the United States

19 Another troubling trend is the growing prevalence of obesity in the United States

20 Obesity and unhealthy lifestyles also are likely to drive growth of costly, chronic diseases at a pace exceeding population growth

21 These trends have led to a significant increase in the per capita cost of healthcare. Let s put this into perspective: If other prices had grown as quickly as healthcare costs since 1945

22 These trends have led to a significant increase in the per capita cost of healthcare. Let s put this into perspective: If other prices had grown as quickly as healthcare costs since 1945 a dozen eggs would cost $55

23 These trends have led to a significant increase in the per capita cost of healthcare. Let s put this into perspective: If other prices had grown as quickly as healthcare costs since 1945 a dozen eggs would cost $55 a gallon of milk would cost $48

costs since 1945 a dozen eggs would cost $55 a

24 These trends have led to a significant increase in the per capita cost of healthcare. Let s put this into perspective: If other prices had grown as quickly as healthcare costs since 1945 a dozen eggs would cost $55 a gallon of milk would cost $48 a dozen oranges would cost $134

25 But doesn t healthcare reform lower overall spending and reduce the federal deficit?

26 But doesn t healthcare reform lower overall spending and reduce the federal deficit? The Congressional Budget Office reported that, if enacted, the latest health care reform legislation would, over the next 10 years, lower federal deficits by $138 billion. (NYT, March 21, 2010) President Obama: If you have health insurance, this reform just gave you more control If you don't have insurance, this reform gives you a chance to be a part of a big purchasing pool This reform is the right thing to do for our seniors. It makes Medicare stronger and more solvent It will reduce our deficit by more than $100 billion over the next decade and more than $1 trillion in the decade after that. (March 23, 2010) House Speaker Nancy Pelosi (D-CA): It makes it more accessible to many more people It holds insurance companies more accountable It [is] fairer to the middle class... Overall, we save over $1.3 trillion for the taxpayer We protect Medicare and make it solvent for nearly a decade longer

27 We are not so sure, rather, creative accounting is likely at work here: The 10/6 Differential 10 years of revenue, but only 6 years of expenses Much of the tax revenue collected immediately, but the cost does not begin until 2014 Medicare Physician Fee Schedule Fix NOT included on the cost side: Nearly $300 Billion over 10 years; this is TWICE the $138 billion budget deficit reduction projected for the bill Medicaid Expenditure Support (Two Issues) Increased Enrollment (16m on a base of ~50m) paid for 100% by Feds at first, but scales down after 2017; this has emerged as a major issue post the SCOTUS decision in June 2012 Medicaid physician rates increased to Medicare levels, paid for by Federal funds, but stops after two years CLASS long-term care insurance CBO Score assumes revenue is collected for ten years, but cost only incurred for five Scored to contribute $70B in savings, but offsetting cost not considered Using Social Security taxes to offset health care spending Expected to contribute $53 billion Student Loan Provision expected to generate $19B in savings Answers the question Why is there a student loan provision in a health care bill?

28 We are not so sure, rather, creative accounting is likely at work here: The 10/6 Differential 10 years of revenue, but only 6 years of expenses Much of the tax revenue collected immediately, but the cost does not begin until 2014 Medicare Physician Fee Schedule Fix NOT included on the cost side: $280 Billion over 10 years; this is TWICE the $138 billion budget deficit reduction projected for the bill State Medicaid Expenditure Support (Two Issues) Increased Enrollment (16m on a base of ~50m) paid for 100% by Feds at first, but scales down after 2017 ; this has emerged as a major issue post the SCOTUS decision in June 2012 Medicaid physician rates increased to Medicare levels, paid for by Federal funds, but stops after two years CLASS long-term care insurance CBO Score assumes revenue is collected for ten years, but cost only incurred for five Scored to contribute $70B in savings, but offsetting cost not considered Using Social Security taxes to offset health care spending Expected to contribute $53 billion Student Loan Provision expected to generate $19B in savings Answers the question Why is there a student loan provision in a health care bill?

We are not so sure, rather, creative accounting is likely a work here: The 10/6 Differential 10 years of revenue, but only 6 years of expenses Much of the tax revenue collected immediately, but the

29 We are not so sure, rather, creative accounting is likely a work here: The 10/6 Differential 10 years of revenue, but only 6 years of expenses Much of the tax revenue collected immediately, but the cost does not begin until 2014 Medicare Physician Fee Schedule Fix NOT included on the cost side: $280 Billion over 10 years; this is TWICE the $138 billion budget deficit reduction projected for the bill State Medicaid Expenditure Support (Two Issues) Increased Enrollment (16m on a base of ~50m) paid for 100% by Feds at first, but scales down after 2017; this has emerged as a major issue post the SCOTUS decision in June 2012 Medicaid physician rates increased to Medicare levels, paid for by Federal funds, but stops after two years CLASS long-term care insurance CBO Score assumes revenue is collected for ten years, but cost only incurred for five Scored to contribute $70B in savings, but offsetting cost not considered Using Social Security taxes to offset health care spending Expected to contribute $53 billion Student Loan Provision expected to generate $19B in savings Answers the question Why is there a student loan provision in a health care bill?

30 Going back to the original question: So why are healthcare costs the biggest issue we are facing today? If we do nothing to slow these skyrocketing (healthcare) costs, we will eventually be spending more on Medicare and Medicaid than every other government program combined. Put simply, our health care problem is our deficit problem. Nothing else even comes close. Nothing else. - President Obama, September 9, 2009

31 Going back to the original question: So why are healthcare costs the biggest issue we are facing today? Rapidly rising health care costs are not simply a federal budget problem; they are our nation s number one fiscal challenge. Addressing the unsustainability of health care costs is a societal challenge that calls for us as a nation to fundamentally rethink how we define, deliver, and finance health care in both the public and private sectors. -David Walker, Former Comptroller General of the United States "The healthcare problem is the No. 1 problem of America and of American business. Healthcare accounts for about 18% of the U.S. economy, compared with 10% in some countries. There s only 100 points in the dollar, and to have a 7 or 8 point disadvantage is huge. In terms of cost, it s going to require a huge change. -Warren Buffet

32 Crossing the Quality Chasm

33 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care. Health Expenditure as a Percentage of GDP, Public expenditure on health Private expenditure on health Source: OECD Health Data 2011

34 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care: Percent of Adults Who Had Healthcare Access Problems in Past Year Because of Costs, Note: Problem accessing is defined as did not get medical care because of cost of doctor's visit; skipped medical test, treatment, or follow-up because of cost; or did not fill Rx or skipped doses because of cost. Source: Commonwealth Fund National Scorecard on U.S. Health System Performance, 2011

35 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care:

36 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care:

37 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care: Life Expectancy at Birth The United States falls behind many industrialized nations in life expectancy at birth Source: OECD Health Data 2010

38 Crossing the Quality Chasm Despite spending more, per capita, on healthcare than any other developed nation, the U.S. lags behind in the quality of care: 36.0% Health Crisis Index ( ) 34.0% % Uninsured + Health % of GDP 32.0% 30.0% 28.0% 26.0% 24.0% 22.0% Year

39 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space

40 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space First a quick review of the next steps of the ACA:

41 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space First a quick review of the next steps of the ACA:

42 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space First a quick review of the next steps of the ACA:

43 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space First a quick review of the next steps of the ACA:

44 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space The upcoming elections will also play a large role in the outlook for the U.S. healthcare market If President Obama wins the election, the blueprint will largely remain the same Only potential change would be a pushback in the insurance expansion date (gives states more time to plan for exchanges, would be a large budget windfall, could gather bipartisan support, etc.) This would be a much easier way to deal with the budget than major tax increases or other entitlement (e.g., Social Security) reforms (and Republicans would likely be willing to agree with this) Even if Obama loses the election, it will be very hard to repeal the health reform legislation, as Republicans are unlikely to hold 60 seats in the Senate Mostly likely outcome would also be for Romney administration to attempt to delay the legislation (perhaps for a very long time), create more implementation hurdles, etc.

45 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space The upcoming elections will also play a large role in the outlook for the U.S. healthcare market Romney administration, however, would begin to push more of Paul Ryan s reform ideas: Similar to recent Social Security reform, the Ryan plan will not impact anyone currently over age 55; rather, the plan gradually increases the eligibility age of Medicare from 65 to 67 by 2034*. The largest change is that the Ryan plan would cap Medicare spending growth at GDP + 0.5%, effectively ensuring that Medicare spending growth remains in check. For those under 55, the largest change would be Medicare Premium Support, which would provide seniors with a fixed amount of money to either buy traditional Medicare or private coverage. All plans would include a minimum set of benefits equal to the value of those in the traditional Medicare program. The government payment to individuals would be set at the same level as the full cost for the private plan charging the second-lowest premium or the premium set by the government for traditional Medicare, whichever is lower. If beneficiaries desire a higher-priced plan, they would merely have to pay the difference out of pocket. * Life expectancy in 1965: 66.8 years for men, 70.2 for women (outliers get Medicare) Life expectancy in 2012 averages years (most people get Medicare)

46 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space The upcoming elections will also play a large role in the outlook for the U.S. healthcare market An example of how premium support would work: 1. Insurers would submit bids for what they would charge to provide seniors with the same benefits as Medicare 2. The government will establish a base rate equal to the lower of: 1) the second-lowest bid, or 2) Medicare s current rate. 3. Seniors would then receive this exact amount of money to either buy traditional Medicare or a private plan. Private plans could also charge more money and offer additional benefits (vision, gym memberships, alternative medicine, etc.). The senior would be required to fund any difference between the base rate and the cost of his/her insurance. 4. The base fee would then be capped at GDP +0.5%, so if insurance costs rose greater than this amount, seniors would incur more costs to buy insurance 5. The hope is that when in a competitive market, health insurers will have more incentive to keep costs down to make their plans attractive relative to the competition

47 A Dose of Tough Medicine What s Next for the U.S. Healthcare Space Other longer-term ideas: Easier Solution: Value-added tax (VAT): A VAT is one of the last easy deficit reduction tools that Congress has at its disposal Per WSJ: every percentage point in VAT tax would bring in roughly $100 billion per year. European-level rates of 20% would net the U.S. Treasury $2 trillion Look for this discussion to heat up in the future Broader means-testing also likely Harder Approaches: Tort reform Viewed as a large mechanism to reduce costs Estimates ranging from $50 billion in annual savings to as much as a 25% reduction in care delivered Pilot Programs (such as those linking payment to improved outcomes) could be a way to bend the cost curve More investment in preventive care and primary care physicians Comparative effectiveness- better information and increased transparency (price and quality) for payers and consumers Value-based reimbursement for providers- pay for outcomes & quality, not volume of services provided Healthcare rationing (extremely hard to sell this idea to the public)

48 Investing in the Current Healthcare Landscape

49 Investing in the Current Healthcare Landscape From an investment standpoint, the key message is that reform is just beginning and a lot of uncertainty remains. One thing we are fairly confident saying, however, is that Medicare payment rates have probably topped out; we also know mix shift is not in providers favor over the long term (shifting from profitable managed care patients/procedures into less profitable Medicare patients/procedures). One of our healthcare investing rules-of-thumb is to avoid entities with heavy Medicare exposure and high gross margins these providers are most at risk, in our view. We look for innovative, differentiated providers with a proven value proposition and/or broad political support (e.g., Healthcare Information Technology), or for providers with lower-cost/high-quality solutions (they will win out in a more consumer-centric environment) We also try to find peripheral plays on healthcare investment areas (e.g., medical waste management, linen and laundry services, veterinary health care, private pay senior housing, etc.)

50 Investing in the Current Healthcare Landscape If we had to rate the healthcare services universe based solely on federal policy, we believe the various subsegments would fall into different buckets: Strongest Outlook Positive Outlook Neutral Outlook Negative Outlook Weakest Outlook Healthcare IT Acute-care Hospitals Overall Physicians Durable Medical & Medicare Advantage Medicaid HMOs Clinical Labs Hospice Home Oxygen Home Health PCPs Dialysis Providers Surgery Centers SNFs Specialty Hospitals Preventive Care & Psychiatric Hospitals Managed Care Disease Mgmt. Imaging No Impact Dental Veterinary Healthcare Outsourcing Medical Waste Private Pay Seniors Housing Value-added devices Generic devices Low-tech devices Imaging equipment Me-too devices Diagnostics Aesthetics

51 Thank You for Your Time Happy to Address Any Questions

52 Disclosures Current Rating Distribution (as of 8/31/2012) Coverage Universe Percent Inv. Banking Relationships* Percent Outperform (Buy) 61% Outperform (Buy) 9% Market Perform (Hold) 34% Market Perform (Hold) 2% Underperform (Sell) 1% Underperform (Sell) 0% * Percentage of companies in each rating category that are investment banking clients, defined as companies for which William Blair has received compensation for investment banking services within the past 12 months. Ryan S. Daniels attests that 1) all of the views expressed in this research report accurately reflect his/her personal views about any and all of the securities and companies covered by this report, and 2) no part of his/her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed by him/her in this report. We seek to update our research as appropriate, but various regulations may prohibit us from doing so. Other than certain periodical industry reports, the majority of reports are published at irregular intervals as deemed appropriate by the analyst. Stock ratings, price targets, and valuation methodologies: William Blair & Company, L.L.C. uses a three-point system to rate stocks. Individual ratings and price targets (where used) reflect the expected performance of the stock relative to the broader market (generally the S&P 500, unless otherwise indicated) over the next 12 months. The assessment of expected performance is a function of near-, intermediate-, and long-term company fundamentals, industry outlook, confidence in earnings estimates, valuation (and our valuation methodology), and other factors. Outperform (O) stock expected to outperform the broader market over the next 12 months; Market Perform (M) stock expected to perform approximately in line with the broader market over the next 12 months; Underperform (U) stock expected to underperform the broader market over the next 12 months; not rated (NR) the stock is not currently rated. The valuation methodologies used to determine price targets (where used) include (but are not limited to) price-to-earnings multiple (P/E), relative P/E (compared with the relevant market), P/E-to-growth-rate (PEG) ratio, market capitalization/revenue multiple, enterprise value/ebitda ratio, discounted cash flow, and others. Company Profile: The William Blair research philosophy is focused on quality growth companies. Growth companies by their nature tend to be more volatile than the overall stock market. Company profile is a fundamental assessment, over a longer-term horizon, of the business risk of the company relative to the broader William Blair universe. Factors assessed include: 1) durability and strength of franchise (management strength and track record, market leadership, distinctive capabilities); 2) financial profile (earnings growth rate/consistency, cash flow generation, return on investment, balance sheet, accounting); 3) other factors such as sector or industry conditions, economic environment, confidence in long-term growth prospects, etc. Established Growth (E) Fundamental risk is lower relative to the broader William Blair universe; Core Growth (C) Fundamental risk is approximately in line with the broader William Blair universe; Aggressive Growth (A) Fundamental risk is higher relative to the broader William Blair universe. 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Biography Ryan Daniels, CFA, Partner William Blair & Company Ryan Daniels, CFA, partner, joined William Blair & Company in 2002 and focuses on healthcare information technology and healthcare

53 Biography Ryan Daniels, CFA, Partner William Blair & Company Ryan Daniels, CFA, partner, joined William Blair & Company in 2002 and focuses on healthcare information technology and healthcare services. Previously, he worked with Deloitte Consulting s M&A Advisory Services Group. Mr. Daniels was recognized by The Wall Street Journal s Best on the Street for his coverage of healthcare providers in 2009, ranking No. 3 overall. Mr. Daniels holds a B.A. in economics from Northwestern University and earned an M.B.A. from the Kellogg School of Management.

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