S & P S H E A L T H C A R E C R O S S S E C T O R

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1 S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L S & P S H E A L T H C A R E C R O S S S E C T O R C O N F E R E N C E The outlook for the U.S. economy, the federal budget and the changing economics for healthcare October 2016 Bob Muller Managing Director Credit Strategy J.P. Morgan

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3 S & P S H E A L T H C A R E C R O S S S E C T O R C O N F E R E N C E Agenda Page Macroeconomic Update 1 The Changing Healthcare Environment 11 1

4 M A C R O E C O N O M I C U P D A T E J.P. Morgan now forecasts that the unemployment rate will decline, reaching the 4.6% mark by the second half of 2017 J.P. Morgan expects real GDP growth for 2H16 of 2.0%; revised down from 2.25% after BREXIT vote due to added uncertainty CPI is also anticipated to rise through 2017 Economic Forecast (% ch q/q, saar) Source: J.P. Morgan, U.S. Fixed Income Markets Weekly, September 17,

5 M A C R O E C O N O M I C U P D A T E Jan-91 Oct-91 Jul-92 Apr-93 Jan-94 Oct-94 Jul-95 Apr-96 Jan-97 Oct-97 Jul-98 Apr-99 Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11 Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Oct-15 Jul-16 Unemployment Rate Unemployment rates have been falling steadily insured unemployment is below the lows of the last cycle, and the participation rate has finally stabilized Retirees account for half of the decline in the employment force Unemployment Rate vs. Participation Rate (%) 12.0% Insured Unemployment Rate Unemployment Rate 6.0% 4.0% 2.0% 0.0% Last 3 Months 62.9% 62.8% 62.7% 68.0% 10.0% Participation Rate 67.0% 66.0% 8.0% 65.0% 6.0% 4.0% 64.0% 63.0% 62.0% Participation Rate 61.0% 2.0% 60.0% 0.0% 59.0% Source: U.S. Bureau of Labor Statistics; Federal Reserve Bank of St. Louis 3

6 M A C R O E C O N O M I C U P D A T E The number of job openings has risen faster than hiring, with openings surpassing hires in early 2015 indicating a potential skills mismatch Job Openings and Hires (thousands) 7,000 6,000 Job Openings Layoffs and Discharges Hires Quits 5,000 4,000 3,000 2,000 1,000 0 Source: Jul-05 Bureau of Labor Jul-06 Statistics. Seasonally Jul-07 adjusted. Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Source: U.S. Bureau of Labor Statistics; Seasonally adjusted 4

7 M A C R O E C O N O M I C U P D A T E Demographics will continue to have an important influence on the economy with the retirement of baby boomers U.S. Noninstitutionalized Population Age Distribution (thousands) 25,000 20,000 Employed Unemployed Not in Labor Force Participation Rate % Unemployment Rate % Baby Boomers 21,971 22,106 21,717 21,523 21,055 20,531 19,885 19,815 19,070 19, % 80.0% 70.0% 16,619 15, % 15,000 10,000 11, % 40.0% 30.0% 5, % 10.0% % Source: U.S. Census Bureau, Bureau of Labor Statistics, Labor Force Statistics from the Current Population Survey, February

8 M A C R O E C O N O M I C U P D A T E Real median household income rose 5.2% in 2015 and is approaching levels seen before the recession Wealth of US households also rose to a record $86.8 trillion in Q Main catalyst of the growth is the rebounding home values which totaled $15 trillion in home equity Real Median Household Income $ $60,000 $58,000 $56,000 $54,000 $52,000 $50,000 $48,000 $46,000 Shaded areas indicate recessions Source: US. Bureau of the Census 6

9 M A C R O E C O N O M I C U P D A T E The Fed prefers to use the PCE to measure inflation; relative to the CPI, the PCE under-represents healthcare and housing cost inflation Medical Care as a Component of Inflation Reconciliation of PCE and CPI price indexes (Aug. 2016) The CPI only measures prices of goods and services paid for out-of-pocket by consumers Average %ch, ar present Last 12 months Last 6 months The PCE deflator measures prices of expenditures made by households and those made on the behalf of households The medical PCE deflator sources from the PPI, where the trend in healthcare prices is muted relative to the CPI However, medical care has a higher weight in the PCE index Medical care prices increased 1.0% in August 2016, the largest monthly gain since Using Core CPI Fed would have exceeded their inflation mandate in 1Q by 0.7% and 0.4% over the 1H16. Source: BLS, BEA, J.P. Morgan Markets Measures of Core Inflation PCE price index (-) formula effect (-) weight effect (-) scope effect (PCE out of CPI scope) (+) scope effect (CPI out of PCE scope) (-) other effects CPI CPI less PCE inflation Source: BLS, BEA, J.P. Morgan Markets Measures of Medical Care Inflation %12m, sa CPI - medical care services, sa PCE - medical care deflator Source: BLS, BEA, J.P. Morgan Markets 7 Source: BLS, BEA, J.P. Morgan Markets

10 M A C R O E C O N O M I C U P D A T E Median Expectations for Fed Funds by the Federal Reserve Board vs. Forward Curve (September 2016) FOMC Target Rates vs. UST Forward Curve 5.00% UST FOMC Median of Dots 4.00% 2.90% 3.00% 2.60% 2.23% 2.00% 1.90% 1.10% 1.00% 0.60% 0.60% 0.78% 0.91% 0.27% 0.00% Longer Run Source: Federal Reserve Board, 9/21/2016, U.S. Department of the Treasury, 9/12/2016 8

11 M A C R O E C O N O M I C U P D A T E J.P. Morgan Research expects the UST curve to flatten in 2017 The Street s 3-Month LIBOR Forecast JPM U.S. Treasury Interest Rate Forecast (%) 2.00% 1.75% 1.50% JPM Range Current Median 9/23/16 10/23/16 12/31/16 3/31/17 6/30/17 9/30/17 Current 1m ahead Forecast 4Q16 Forecast 1Q17 Forecast 2Q17 Forecast 3Q17 Forecast Fed Funds 0.40% 0.40% 0.65% 0.65% 0.90% 0.90% 1.25% 1.00% 0.75% 0.50% 0.25% 4Q 16 1Q 17 2Q 17 3Q 17 Source: Bloomberg as of 9/23/2016. Includes the forecasts of 34 institutions; J.P. Morgan Research, US Fixed Income Strategy, US Interest Rate Forecast, 9/23/2016, jpmm.com The Street s 10-Year Treasury Forecast 3M LIBOR 0.85% 0.85% 1.10% 1.10% 1.35% 1.35% 2Y UST 0.75% 0.80% 0.95% 1.00% 1.15% 1.25% 5Y UST 1.15% 1.20% 1.35% 1.40% 1.55% 1.65% 10Y UST 1.61% 1.65% 1.75% 1.80% 1.85% 1.90% 30Y UST 2.34% 2.35% 2.40% 2.40% 2.45% 2.45% Source: J.P. Morgan Research, US Fixed Income Strategy, US Interest Rate Forecast, 9/23/2016, jpmm.com JPM Tax-Exempt Yield Forecast (%) 3.00% JPM Range Current Median AAA MMD 9/23/16 10/23/16 12/31/16 3/31/17 6/30/17 9/30/17 Current 1m ahead Forecast 4Q16 Forecast 1Q17 Forecast 2Q17 Forecast 3Q17 Forecast 2.50% 2Y 0.80% 0.80% 0.85% 0.85% 0.95% 1.05% 2.00% 1.50% 1.00% 4Q 16 1Q 17 2Q 17 3Q 17 Source: Bloomberg as of 9/23/2016. Includes the forecasts of 64 institutions; J.P. Morgan Research, US Fixed Income Strategy, US Interest Rate Forecast, 9/23/2016, jpmm.com 5Y 1.04% 1.10% 1.15% 1.15% 1.25% 1.35% 10Y 1.52% 1.60% 1.55% 1.65% 1.60% 1.70% 30Y 2.30% 2.35% 2.30% 2.35% 2.25% 2.35% 10Y MMD/ UST Ratio 94.17% 96.97% 88.57% 91.67% 86.49% 89.47% 30Y MMD/ UST Ratio 98.29% % 95.83% 97.92% 91.84% 95.92% Source: Thomson Reuters Municipal Market Data; J.P. Morgan Research, J.P. Morgan Fixed Income Strategy, US Fixed Income Markets Weekly - Municipals, 9/23/2016, jpmm.com 9

12 M A C R O E C O N O M I C U P D A T E What does all of this data mean for this expansion s future? A Rising Recession Risk? The tightening labor market conditions usually portend an ultimate recession The unemployment rate and gap have been the best indicators that an expansion is nearing its end Our economists recently noted an up to 37% chance of recession within 12 months Other areas of focus: Lower long term growth potential due to lower productivity and labor force growth supply side issues The lack of more consumption stimulus from lower energy prices Very erratic global growth Historical Probabilities of Recession, by Unemployment Rate Probability of recession 100% 80% 60% 40% 20% 0% 9 8 Source: NBER, BLS, J.P. Morgan Within 4 years Within 3 years Within 2 years Within 1 year Unemployment rate Historical Probabilities of Recession, by Unemployment Gap Probability of recession 100% 80% 60% 40% Within 4 years Within 3 years Within 2 years Within 1 year Current U rate % J.P. Morgan estimate 0% Unemployment gap (unemployment rate NAIRU*) Source: NBER, BLS, CBO, J.P. Morgan *NAIRU - non-accelerating inflation rate of unemployment

13 S & P S H E A L T H C A R E C R O S S S E C T O R C O N F E R E N C E Agenda Page Macroeconomic Update 1 The Changing Healthcare Environment 11 11

14 With the ACA, health expenditures rose to 17.5% of GDP in 2014 Manufacturing Employment / Total Non Farm Payroll 18% 17% 16% 15% 14% 13% 12% Shaded areas indicate recessions Source: Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Group; U.S. Department of Commerce, Bureau of Economic Analysis; and U.S. Bureau of the Census. 12

15 Inflation in healthcare prices has significantly outpaced general price increases, although medical care inflation is near historic lows, we have seen an uptick in the past year. The trend in healthcare inflation may be important for Fed policy Yearly Change in Consumer Price Index (%) 9.5% 8.5% 7.5% 6.5% 5.5% YoY Growth, Last 6 Months 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Mar Apr May Jun Jul Aug General Medical Care Medical Care Services 4.5% 3.5% 2.5% 1.5% 0.5% -0.5% -1.5% -2.5% Source: U.S. Bureau of Labor Statistics Note: Yearly change represents July to July change of each year. 13

16 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Healthcare employment growth has almost doubled general employment growth and has generally been counter-cyclical during recessions Healthcare employment is now 10.8% of nonfarm payrolls, however, this total underrepresents the total share of employment in healthcare dependent businesses such as pharma and medical device manufacturing. Employment YoY Growth, Last 12 Months Total Nonfarm Healthcare Ambulatory Hospitals % 2.80% 1.80% 0.80% -0.20% Source: U.S. Bureau of Labor Statistics. The base period in 1990 = 100. Reflects January data of each year and is seasonally adjusted. Note: Ambulatory employment includes Home Health Services, Hospitals include residential facilities 14

17 The number of job openings in health care has risen significantly faster than hiring indicating potential for wage escalation Job Openings and Hires Health Care and Social Assistance (thousands) 1,200 Job Openings Hires 1,000 Layoffs and Discharges Quits Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 15

18 The Healthcare Employment Cost Index has caught up to the overall ECI, indicating that wage and benefit growth is rising in the healthcare industry Employment Cost Index for Total Compensation (Seasonally Adjusted) Civilian Workers Percent Changes for 3-months ended Indexes ECI Change (Seasonally Adjusted) 14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4 16Q1 16Q Q Q1 All Workers Healthcare Hospitals Nursing and Residential Care Facilities % All Workers Healthcare Hospitals Ambulatory 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Source: U.S. Bureau of Labor Statistics, Employment Cost Index. Dec = 100, Moody's MFRA: All Hospitals and Systems--Ba3 and above 16

19 Yet hospital and ambulatory employee earnings remain at growth rates far below the prior decade. YoY Change in Hospital and Ambulatory Employee Earnings 8.0% Hospitals Ambulatory 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Source: U.S. Bureau of Labor Statistics. The base period in 1990 = 100. Seasonally adjusted. Earnings represent average hourly earnings of production and nonsupervisory employees 17

20 Unlike in past periods, Medicaid enrollment and outlays have jumped during an expansion as a result of the ACA Medicaid Spending and Enrollment are Affected by Changes in Economic Conditions and Policy Source: Kaiser Family Foundation: Medicaid Enrollment & Spending Growth, Oct 15,

21 Medicaid and CHIP Enrollment has risen in States joining the ACA Across the 49 states (including DC) that provided enrollment data, approximately 72.7 million individuals were enrolled in Medicaid and CHIP as of June 2016 Among states that adopted the Medicaid expansion and whose expansions were in effect in June 2016, enrollment rose by over 36% compared to the July-September 2013 baseline period States that are not expanding Medicaid reported a 12% increase over the same period 16 of the 28 expansion states (as of May 2016) experienced an enrollment increase of 30% or more % Change in Total Medicaid and CHIP Enrollment from Pre-ACA to June % 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 102% 83% 73% 65% 65% 62% 59% 59% 54% 55% 47% 49% 42% 40% 37% Average = 37.5% 25% 26% 27% 28% 28% 31% 12% 13% 14% 18% 18% 18% 19% 20% 6% 3% LA DE DC NY VT IL MN HI PA MI IA OH MA AK ND IN NJ AZ MD NH RI AR CA WA MT WV OR NM CO NV KY Source: Centers for Medicare & Medicaid Services, Medicaid & CHIP: June 2016 Monthly Applications, Eligibility Determinations, and Enrollment Report Connecticut is excluded because of missing data. Pre-ACA period reflects average of July through September 2013 data. 19

22 The ACA s impact on health insurance coverage has been substantial The ACA Has Resulted in Approximately 20 million People Gaining Coverage Since million uninsured people have gained coverage since the beginning of open enrollment in October, 2013 this includes 2.3 million young adults aged Since the enrollment period in 2013, the uninsured rate has dropped by 43% Between 2010 and the beginning of 2013 open enrollment, 2.3 million young adults aged gained coverage as a result of the ACA s provision allowing young adults to remain on a parent s plan until age 26 Health Insurance Coverage Growth Following ACA's Provisions in October, 2013 Increase in Total Coverage Uninsured Rate 20,000,000 18,000,000 16,000,000 14,000,000 12,000, % 18.1% 10,300,000 14,300,000 15,300,000 17,700, % 20.0% 18.0% 10,000, % 16.0% 8,000,000 6,000,000 4,000,000 2,000,000 4,300, % 12.6% 11.5% 14.0% 12.0% - Q Q Q Q Q Q Q % Source: US Department of Health & Human Services: ASPE Analysis of Gallup-Healthways Well-Being Index survey data through 3/03/2016 Increase in total coverage includes adults over 25 years of age 20

23 2015 uninsured rate by state indicates the impact of the medical expansion on states that joined the ACA Source: U.S. Census Bureau, Year American Community Survey. 21

24 All age groups have seen the percent uninsured decline but young adults remain the highest cohort of uninsured Source: U.S. Census Bureau, 2013, 2014, and Year American Community Surveys. 22

25 And private exchanges have not matched expectations Private Health Exchange and Enrollment for Employer Benefits 8 Source: Accenture 2015, Calculation includes pre-65 employees and dependents, US Department of Health and Human Services Source: Accenture 2016; calculation includes pre-65 employees and dependents. 23

26 Billions $ The Federal Government has become the biggest purchaser of healthcare services National Health Expenditures by Type of Sponsor $900 $800 $700 Private Business Household Federal State and Local $600 $500 $400 $300 $200 $100 $ SOURCE: Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group. 24

27 The impact of the ACA is very evident in the divergence of federal and state healthcare spending. Federal vs. State and Local Health Expenditures (annual % change) 20.0% Federal State and Local 15.0% 10.0% 5.0% 0.0% % SOURCE: Centers for Medicare and Medicaid Services, Office of the Actuary, National Health Statistics Group. 25

28 The ACA is pushing up Federal healthcare spending despite some near term slow down in the growth of Medicare. However, the aging population will drive up Medicare spending in the next decade. Historical and Projected Healthcare Outlays $bn 2,500 Health Insurance Subsidies and Related Spending ($) Medicaid ($) Medicare ($) % of GDP 6.0% 2,000 Medicare (% of GDP) Medicaid (% of GDP) % 1,500 1, Health Insurance Subsidies and Related Spending (% of GDP) ,018 1,052 1, , , % 3.0% 2.0% 1.0% % Source: CBO 26

29 Federal healthcare spending is projected to represent 6.7% of GDP in 2026 During the next recession, healthcare will represent the largest target for expense reduction Spending and Revenue Projected in CBO s Baseline, Compared with Levels in 1965 and 1990 (% of GDP) Source: CBO. Note: Major health care programs consist of spending on Medicare (net of premiums and other offsetting receipts), Medicaid, and the Children s Health Insurance Program, as well as outlays to subsidize health insurance purchased through the marketplaces established under the Affordable Care Act and related spending. 27

30 Workers have increasingly been absorbing the growth in premiums such cost shifting may get harder as the labor market tightens Cumulative increases in health costs, amounts paid by insurance, amounts paid for cost sharing and workers wages, Source: Kaiser Family Foundation analysis of Truven Health Analytics MarketScan Commercial Claims and Encounters Database, ; Bureau of Labor Statistics, Seasonally Adjusted Data from the Current Employment Statistics Survey, (April to April). 28

31 However insurers still account for the largest share of benefit costs 2014 Share of Benefits Costs 6.9% 3.0% 4.7% Paid by insurers Deductibles Copayments Coinsurance 85.4% Source: Kaiser Family Foundation analysis of Truven Health Analytics MarketScan Commercial Claims and Encounters Database, *Includes enrollees with total spending (including claims paid by the insurer and out-of-pocket costs) in the top 15% in each year. In 2014, enrollees in the top 15% had total costs that exceeded $6,

32 Average monthly worker premium contributions paid by covered workers for single and family coverage have risen sharply over the past decade Share of Benefits Costs Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits,

33 For Commercially Insured patients, utilization is declining both on an inpatient as well as an outpatient basis, while drug utilization and professional services have been relatively flat. Utilization per 1,000 Insureds (indexed to 100 in 2011) 104 Prescriptions Inpatient Outpatient Professional Procedures 102 Prescriptions 100 Professional Procedures Outpatient Inpatient Source: Health Care Cost Institute, 2014 Health Care Cost and Utilization Report. Data represents the total population of insureds younger than 65 and covered by ESI. Actuarial completion was performed on data from 2013 and All per capita dollars calculated from allowed amounts. 31

34 Professional services were the largest expenditure category in 2014, and room still exists to shift additional costs away from the inpatient setting Share of Total Per Capita Expenditure by Major Service Category Prescription 18% Professional 34% Inpatient 20% Outpatient 28% Source: Health Care Cost Institute, 2014 Health Care Cost and Utilization Report. Data represents the total population of insureds younger than 65 and covered by ESI. Actuarial completion was performed on data from 2013 and All per capita dollars calculated from allowed amounts. 32

35 Hospital inpatient Medicare admissions (per 1,000 beneficiaries) Inpatient Medicare admissions have been declining steadily too Inpatient Medicare Admissions Total Medicare Benefit Payments, 2014 = $597 billion Total Aged <65 years Aged 65 years and over Source: CCW (CMS) ; Medicare Administrative Data (CMS) Source: Kaiser Family Foundation analysis of data from Congressional Budget Office, 2015 Medicare Baseline (March 2015) 33

36 Children and young adults led all healthcare spending increases in recent years Young adult increases may reflect the impact of the ACA coverage requirement, however, pharmaceutical expenses have risen sharply for year olds Spending by Age Group in 2013 Spending Growth by Age Group (% change from prior year) and Under 10% % % % % Source: Health Care Cost Institute, 2014 Health Care Cost and Utilization Report. Health Care Cost Institute, 2014 Children s Health Spending. Data represents the total population of insureds younger than 65 and covered by ESI. Actuarial completion was performed on data from 2013 and All per capita dollars calculated from allowed amounts. 34

37 Drug prices have increased, but there is a wide disparity between brand name and generic drugs Year over Year Change in Price Paid per Filled Day of Prescription Drugs All Drugs Brand Name 25.6% 28.1% Generic 21.2% 7.6% 5.3% 3.2% 2.3% 3.3% -0.4% Source: Health Care Cost Institute, 2014 Health Care Cost and Utilization Report. Data represents the total population of insureds younger than 65 and covered by ESI. Actuarial completion was performed on data from 2013 and All per capita dollars calculated from allowed amounts. 35