What this huge US legal decision could mean for your money

The US Supreme Court is set to hand down a crucial decision on president Obama's healthcare law. That could have huge consequences for the sector. Matthew Partridge explains why, and how you can profit.

What is the most pressing political issue in the US today?

The contest for the Republican nomination? High prices at the pump? The question of whether Ben Bernanke will begin printing money again (QE3)?

These are all important. However, they would also be the wrong answer.

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The most pressing political issue in the US today is the US Supreme Court's decision over Obama's healthcare law. By late June, nine people will have made a decision affecting the future of nearly a sixth of the US economy.

And that decision will have major implications for drug and insurance companies. Here's why, and what it could mean for your investments.

The American healthcare crisis

Two years ago, almost everyone agreed that the US healthcare system was a mess. Tax breaks for private insurance led to waste, while those on low incomes could not afford decent coverage.

The state-funded insurance systems, Medicaid and Medicare, are poor-quality and have problems with fraud. And although they cover a much smaller segment of the population, they cost nearly as much as a percentage of GDP as Britain's NHS does.

Indeed, in 2000, the World Health Organisation ranked the US health system 32nd in the world in terms of value for money. This put it between Costa Rica and Slovenia.

It was becoming very clear that unless there was reform, an ageing population would bankrupt the US economy.

Enter 'Obamacare'

To combat this, Congress passed the Affordable Care Act (ACA). This tried to cut costs while increasing coverage. Tax breaks for insurance were capped, while healthcare exchanges were set up to increase competition. There were also more subsidies for low-income groups.

Insurers now had to cover people with pre-existing conditions. To prevent people waiting until they were ill, the legislation also required everyone to buy health insurance.

From almost the minute it was passed, the bill has been under attack from all sides. Many point out that studies have shown that 'single-payer' systems, where the government runs healthcare directly (like the NHS though recent British reforms will increase the role of the private sector), are better value. At the very least, they wanted Obama to expand Medicare to more people ('the public option').

Republicans on the other hand, think that a voucher system would have been simpler. They regard Obama's reforms as a power grab by the government.

However, despite the bill's unpopularity, the US law-making system makes it easy for Democrats to block repeal attempts. More importantly, rhetoric aside, most politicians accept that there is a need to curb healthcare costs. Mitt Romney, the probable Republican nominee, passed a similar law when he was governor of Massachusetts. So even if the Republicans were able to regain the White House, and win both parts of Congress, they would only make minor changes to Obamacare'.

Supreme Court

However, the law has been challenged in the US courts. Its opponents argue that forcing people to buy healthcare violates the US Constitution because it gives the government too much power.

Initially, most experts thought that the case would be quickly dismissed. And indeed, lower courts ruled that it was invalid. But it eventually reached the US Supreme Court. And after those arguing the law's case did badly in oral arguments, most experts now think that there is a good chance that the mandate, or even the entire law (though this is much less likely) could be struck down.

The Supreme Court is split between left and right, with the inconstant Anthony Kennedy widely viewed as the swing vote on the nine-judge panel. Justin Gundlach, an associate at the top Washington DC law firm Crowell & Moring LLP, thinks that "no one knows how this will play out, and by no one, I mean even Justice Kennedy (probably) hasn't decided". Experts agree that if the mandate - forcing people to buy health insurance - were outlawed, this would push costs up, killing the system.

Implications for healthcare and pharma

The end of the mandate and by implication the ACA would move the situation back to where it was two years ago. 'Single-payer' (like the NHS) is one possible solution, as it doesn't involve a mandate. But this is very unlikely to be taken up in the US, so the reality is that healthcare costs will continue to spiral.

This is bad news for US taxpayers. But it could be very good for pharma and healthcare stocks. One way to get broad exposure to this sector is through the US Health Care Sector ETF (LSE: XLVS). This fund tracks the S&P Select Sector Capped 20% Health Care TR (Net) index though the largest holdings are in global drug companies such as Pfizer.

However, one US health insurer that we particularly like is Cigna Corp (NYSE: CI), which is trading at aprice/earnings (p/e)ratio of around ten. It has successfully restructured its prices to anticipate the extra costs of the reforms, so even if the ACA is upheld, there is little downside risk.

While the drug industry is becoming increasingly global, Israel's Teva Pharmaceutical (Nasdaq: TEVA) gets half its sales from North America, yet its p/e ratio of 14.5 is below that of most of the US-focused companies. It has a diversified drug portfolio, with a sideline in generic drugs (drugs whose patents have expired), which should reduce the downside risk if 'Obamacare' survives.

Another interesting play is to consider companies involved in developing new medical technology. If the chances of fixing US healthcare through reform go down the drain, then interest will turn to other potential fixes.

My colleague Tom Bulford has tipped several companies, which are producing potential "game changers" in terms of technology. Tom's biotech newsletter, Red Hot Biotech Alert, is currently closed to new subscribers, but you can stillsign up for his free email Penny Sleuth.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri