Morningstar Advisor - August/September 2010 - 36

Spotlight

After Reform, Narrow-Moat Firms Have Strong Prospects in Diagnostics
Bill Buhr and Debbie S. Wang

More patients will get more medical tests. Quest and LabCorp are well positioned to take advantage.

Even before health-care reform, the $55 billion diagnostics industry was well on its way to stable, long-term growth. An aging population has benefited from a proliferation of new diagnostic tests. As new disease markers and genetic mutations are discovered, patients will undergo even more tests— a trend that is already on the upswing. The average patient older than 75 was subjected to 13 diagnostic tests in 2005, up from six in 1997. Then came reform—another boon for the industry. As with many other health-care industries, reform will bring more volume to the diagnostics business and will bolster topline growth. Diagnostic tests for the 30 million people who are newly eligible for coverage into the health-care system will have a significant impact on the sector. To analyze that impact, we need to consider the diagnostics industry’s unique place in the health-care reform debate.
Early Diagnosis a Keystone of Reform

On one hand, diagnostic testing was also being cited as a major health-care cost driver. Critics argued that doctors, aiming to be thorough and facing pressure to make the correct diagnosis for fear of malpractice lawsuits, were overusing imaging tests, such as CT scans and MRIs. This rush to use imaging, critics said, led to unnecessary tests and increased costs, including malpractice insurance premiums. On the other hand, many reformers argued that the keys to driving down health-care costs were illness prevention and early detection of diseases—two areas in which diagnostics companies play critical roles. This notion was backed by a September 2009 report by the health-care policy firm the Lewin Group. The report recommended that screening and lab tests should be essential components of reform, because testing assists in the early detection and proper diagnosis and treatment of a huge number of ailments. Testing, therefore, saves money and keep patients healthier. The report also focused on a few of modern medicine’s problem areas, including hospital staph infections and diabetes. Hospital-acquired infections kill almost 100,000 people each year, costing the health-care system as much as $45 billion. Using rapid diagnostic tests, hospitals can more effectively identity and cull outbreaks when they occur. With diabetes, early blood glucose

testing could both delay the disease’s onset and increase the success of managing it, helping to reduce complications and overall costs, which the report pegs at $174 billion annually. The questions of which tests are necessary, which are overused, and whether additional testing leads to healthier patients will continue to be hotly debated. Overtesting is a serious issue across the health-care industry, but it is especially prominent in the diagnostic-imaging sector. But we agree that preventive care is a pathway for lowering health-care costs. It seems to be a pretty reasonable assumption that if a disease or ailment can be identified early, the chances are better that it can be treated more effectively and efficiently. Acknowledging these benefits, the health-care reform bill provides funding for preventive care as a way to improve health and lower costs. An increase in patient volume, with the government encouraging wider use of testing, will benefit diagnostic companies and their offerings. But the sunnier revenue opportunities come with a price—the government wants to take a chunk out of the industry on the cost side. For example, the Senate bill originally called for $750 million in annual industry fees for clinical laboratories and $2 billion in fees for the

Diagnostic services range from routine testing of bodily fluids (for blood chemistry, pregnancy, and thyroid function) to far-more-complex testing of specific tissue and genetic signatures for conditions such as cystic fibrosis, cancer, and Down syndrome.

36 Morningstar Advisor August/September 2010

Morningstar Advisor - August/September 2010

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