Medicare
GIBBS: Welcome to Wall $treet Week with FORTUNE. I’m Karen Gibbs. While it’s not quite a done deal, Congress is on the brink of passing the first major overhaul to Medicare in 38 years. The stakes are huge. More than 40 million people rely on this “Great Society” program. To critics it’s an example of big government run amuck, leading to higher prices and bureaucratic interference in every aspect of health care. To supporters it’s literally a lifeline, providing prescription drug relief to elderly and disabled Americans who may have nowhere else to turn. Will this reform pass? Who are the winners and losers?
Republican Congressman Gil Gutknecht of Minnesota has made a name for himself leading the fight for lower prescription drug prices. Ira Loss, who follows the health care industry for Washington Analysis Corp., says odds favor passage of some form of Medicare drug benefit, but it may not satisfy everyone involved.
Let me start with you, Congressman. What do you think the odds are of this bill passing?
GUTKNECHT: Well, I would have to say, Karen, they’re probably better than 50-50. In fact, there’s an awful lot of very heavy-handed lobbying going on as we speak. And at the end of the day, I think the chances are probably better than 50-50, but not a lot better than 50-50.
GIBBS: Ira Loss, do you agree? Do you think it has a chance of passing?
LOSS: Oh, definitely. But as the Congressman says, there is a lot of last-minute lobbying going on on both sides. For as many groups that seem to be satisfied with what has been done, there are an equal number that are not satisfied. And I’m sure the Congressman is hearing plenty about it from these two sides.
GIBBS: Ira, who do you see as winners and losers in this debate?
LOSS: Well, if this legislation passes, the clear winners in the near term first and foremost would be managed care companies, particularly those that are already involved in Medicare Plus Choice. This legislation significantly increases premiums paid to managed care companies, I think primarily to try to keep the ones that are already offering benefits or alternatives to Medicare recipients to keep them in the program, as well as an attempt to try to lure others back in.
Over the last several years, there’s been a major exodus of managed care from Medicare. And for this program to work in the long term, they need to have a significant number of managed care options available to the elderly. So in order to get that, they provide a major carrot to bring the managed care companies back in. Beyond that, practically every provider in the Medicare system gets some kind of increase in their reimbursement. Hospitals, nursing homes, rural hospitals, they all seem to get something out of this deal. So from the provider standpoint, I think there are a lot of winners to go around.
GIBBS: Congressman, if there are a lot of winners on the provider side, where does the consumer fall in this?
GUTKNECHT: Well, I think the consumer in general is a loser, because ultimately when this is over, the world’s best customers, the United States of America, are still going to paying the world’s highest prices for prescription drugs. And I think that’s a tremendous opportunity lost. I might add to Ira, and I certainly agree with what he just said, that one of the real big winners will be the pharmaceutical industry.
There was one study done by the University of Boston that indicated that they may see their profits increase by $139 billion over the next 10 years just because of the passage of this bill. Now I believe in profit. I’m a Republican. But in many respects there is a very fine but discernible line between profit and profiteer, and that’s why I’ve been arguing that if we’re going to do something like this, if we’re somehow going to bring market forces to bear on the overall issue of Medicare, we ought to figure out a way to bring market pressures to bear on the cost of prescription drugs. Because in almost every, well, in every study that’s ever been done, the conclusions are the same, and that is that Americans pay far and away more than consumers in any other industrialized countries for the same drugs.
GIBBS: Well, no aspect of this debate is more controversial than the question of importing cheaper drugs from Canada, and it’s easy to see why. The popular arthritis medication, Vioxx, sells for $92 in the United States, but costs less than half as much in Canada, where a month’s supply is only $35. The front line of this battle is right around the corner at your neighborhood pharmacy.
Congressman, are your constituents subsidizing unfairly, or unfairly having to subsidize this drug industry?
GUTKNECHT: Well, there’s no question Americans subsidize the pharmaceutical industry in three different ways. First of all, we subsidize them in the tax code. When the pharmaceutical companies talk about how much they spend on research and development, which incidentally they are more and more studies that say they spend more on advertising and marketing now than they do on research and development, what they don’t say is that they are allowed to write off every dollar of that on their federal income tax forms.
More importantly, many times they qualify for research and development tax credits. Over the last ten years, pharmaceutical companies have received something like $28 billion in R&D tax credits. The second way we subsidize the pharmaceutical industry is in the prices that we pay for those drugs. We pay, as was indicated by the studies you just showed, far more than the Canadians. And as a matter of fact, the studies I’ve seen, the drugs are actually cheaper in the European Union than they are in Canada. And then finally the way we subsidize the pharmaceutical industry is in the amount that we spend through taxpayers’ dollars on basic research here in the United States. I’m the Vice Chairman of the Science Committee, and I’m proud of the fact that we spend about $27 billion taxpayers’ dollars this year on basic research, much of which will benefit the pharmaceutical industry free of charge.
And let me just talk about one particular drug, Tamoxifen. That drug was developed at taxpayers’ expense. It literally was taken all the way through Phase II trials at the expense of the U.S. taxpayers. Then we licensed it to a pharmaceutical company, and the reward we get as American consumers is that they sell that drug here in the United States for roughly $350 for a month’s supply. You can buy that same drug for about $60 in Canada, and a little less than that in Germany. You know, I think we ought to pay our fair share in terms of the cost for these new drugs. I think we ought to be able to subsidize the people in sub-Saharan Africa. But I don’t think Americans ought to have to subsidize the starving Swiss.
GIBBS: Ira Loss, how come people here in the United States can’t have the advantage of paying cheaper prices even if they have to import them from Canada?
LOSS: Well, I think, you know, I don’t really want to get into a dispute with the Congressman about this. I remember when the laws were passed that prevent re-importation. They were, after significant hearings were held by the House Commerce Committee, where a clear demonstration was shown of bogus drugs being introduced into the drug supply, including hundreds of thousands of birth control pills that were counterfeit, these were coming in by, let’s call them entrepreneurs who were taking advantage of a system that had really no method for keeping them out.
Now they drew the curtain down and they prevent this thing, this re-importation. And until there can be some type of assurance that what is going to be shipped into this country is in fact what the shipper says it is, I understand why the FDA is as adamant as they are about opposing this type of legislation. If we want to impose a price control system in this country, maybe we should do it directly instead of doing it by adopting the Canadian price control system.
GIBBS: But, Ira, isn’t it true that not being able to afford medicine is just as injurious to your health as possibly getting tainted medicine?
LOSS: There’s no question about that, but, you know, I think these are two separate issues. To be able to provide medication for people who are in need and can’t afford it is separate from allowing the drugs to pour in over the border when we can’t be assured of what is coming in.
GIBBS: Congressman, do you see them as two separate issues?
GUTKNECHT: Well, first of all, perhaps back when the law was put into place that literally holds American consumers captives, it may well have been true that we didn’t have the technology then to track these materials. But today we have counterfeit-proof, tamper-proof packaging. And the truth of the matter is, we do this with all kinds of other products. There’s nothing else in America where we literally guarantee the producers that they will have a captive market. And so the technologies exist today to make certain that Americans can be sure that the drugs that they’re getting, whether they get them from Canada or Germany or any of the industrialized countries, we can do that today to make certain that those drugs are both safe and effective, that they are in fact FDA approved drugs from FDA approved facilities.
There will always be people who will take advantage of the system, but the truth of the matter is, we keep records on how many of the millions of Americans who are currently buying their drugs from other countries, how many of them have actually been injured. The CDC and other groups keep records on that, and we know, even though millions of Americans are currently buying their drugs from Canada and other countries, we know that zero have been killed as a result of taking a tampered drug. Now, I think you raised a point, Karen, that a drug that you can’t afford is neither safe nor effective. And it seems to me that we can come up with a reasonable plan that will guarantee that Americans have access to world-class drugs at world market prices.
GIBBS: Congressman, do you think this is a deal-breaker, this idea of re-importation of drugs?
GUTKNECHT: Well, I don’t know whether it’s a deal-breaker, but I do know this, that markets are more powerful than armies, and as Victor Hugo said so many years ago, that more powerful than an invading army is an idea whose time has come. And I think the idea of opening up markets, creating a competitive marketplace for prescription drugs, just as we do with virtually every other product, will ultimately result in enormous savings for American consumers. And let me just say, I don’t want Americans going to Canada or Germany to buy their drugs, but once you open up the markets, you will see prices level so that we in the United States will see savings of anywhere from 30 to 50 percent, and while countries in places like Germany and Canada may see their prices go up a little, the truth of the matter is markets have a way of leveling prices. And we think that we should pay our fair share, but right now Americans are getting a very bum rap on the whole deal in terms of how much we pay for prescription drugs relative to the rest of the industrialized world.
GIBBS: Congressman, as the bill is now, what do you see as the best aspect of it?
GUTKNECHT: I think the best aspect is that we do begin to create what are called health savings accounts. I think long term this represents a huge opportunity. It essentially uses the doctrine of enlightened self-interest to get people to get more involved in the decisions about their health. And I think health savings accounts represent an enormous opportunity, not only for savings, but ultimately to improve the quality of health here in the United States.
But beyond that, I think this is opening up a huge new entitlement, and frankly I think that the leadership has mis-framed the issue from the very beginning. They have talked about this issue as if it’s only about coverage. The bottom line is, when you talk to seniors, the real issue is affordability. And I’ve always said that if you deal with affordability, it makes it much easier to deal with the issue of coverage. If you don’t deal with affordability, you will never be able to catch up with coverage. Unfortunately, the bill that’s going to be before us in the next couple of days does little to deal with that affordability and the prices that Americans pay.
GIBBS: Ira Loss, I’ll pose the same question to you. What do you think is the best aspect of this bill?
LOSS: Well, I think that 10 years from now or seven years from now when the competitive aspects of this legislation go into effect, you’re going to have a whole new group of beneficiaries in Medicare who are more familiar with managed care. To some extent, this is a more enlightened approach than what I’ve seen from Congress in the past, in that they’re not trying to change the existing Medicare population, not trying to ram them into managed care.
By the time the baby boomers come into retirement, this will be a population that is very familiar with managed care, so these choices won’t be quite as daunting as they might be to a 90-year-old person who’s never dealt with it before. So leaving a large period of time for people to get prepared for what’s coming I think is a good thing. You know, with regard to the affordability aspects of it, that’s always been a big problem with Congress. There’s a reluctance to put tight price controls on our markets in all areas, not just health care.
GIBBS: Ira Loss, Congressman Gutknecht, thank you very much for joining us.
LOSS: Thank you.
GUTKNECHT: Thank you.
Luxury
COLVIN: Well believe it or not there are some sectors of the economy in which American consumers are actually delighted to pay a little more than they have to. Consider this bottle of wine. There are many ways to open it -- aside from the $2 corkscrew you get at the supermarket; you can buy a fairly cool looking one at Target for $14.99 or a gold Rabbit model for $165. But this item, which sells for $49.95 at Crate and Barrel, is more than just a corkscrew. Although it is a corkscrew, let’s give it a try right here. That’s supposed to put the corkscrew in, that’s supposed to take the cork out – look at that – it works.
Along with Viking ranges, Victoria’s Secret underwear, and Callaway golf clubs, this represents a major trend in consumer marketing that will affect the fortunes of many companies this holiday season and for years into the future. Or so says Michael Silverstein, a consumer expert at the Boston Consulting Group. He joins us from New York. Kristin Bentz is a market analyst at Northeast Securities, where she covers many of the companies cashing in on this trend. She’s also in New York. Michael Silverstein what is the larger significance of this bizarre looking corkscrew.
SILVERSTEIN: Well the corkscrew is one of the new luxury products. It’s part of a $400 billion business in 2003. It’s growing at 15 percent. Its middle market consumers, deciding that they are going to invest their hard-earned dollars against a group of products that deliver technical, functional and emotional benefits.
COLVIN: So what’s the difference between new luxury and old luxury?
SILVERSTEIN: Well let me start with your corkscrew. Your corkscrew is actually better designed, it actually works better. It leaves no cork in the bottle. So that for a consumer who cares about their wine, who has spent $15 or $20, they don’t won’t cork particles in the bottle. Now new luxury is about product that middle-class consumers could afford. Old luxury is about aristocracy and the top one-half of one percent. New luxury or goods for 40 million households in America.
COLVIN: 40 million, so what kind of income level are we talking about?
SILVERSTEIN: We’re talking about incomes between $50 and $150,000; we’re talking about the vast bulk of middle-class in America. And we’re talking about everyone of those households – 96 percent according to the research of the Boston Consulting Group, are consuming one, two, three, four categories of goods where they trade up.
COLVIN: So this is not an interesting niche, this is a huge phenomenon?
SILVERSTEIN: This is an explosion. It’s about a migration of the consumer to buying better quality goods, balancing their budget by trading down on a wide variety of goods.
COLVIN: I want to get to some other examples, but Kristin first I want to ask you you cover a lot of retailers does this all ring true to you?
BENTZ: Absolutely. Absolutely rings true. It is a phenomenon that let’s say in the 1980’s for instance, it was all about being served -- being served the best. I think now it’s more about taking care. Taking care of oneself, taking care of one’s family treating yourself a little bit more gently.
COLVIN: So this is a response to what? Economic times? The security situation of the world? Stuff like that?
SILVERSTEIN: There are four or five phenomenon that are really important to get out on the table quickly. The first one is between 1970 and 2002 the real income per capita of the middle-class family in America doubled. That’s not a well-known fact. The media doesn’t cover that, the media talks about year upon year upon change where there’s up and down fluctuations. But in that time period you had a doubling of real income. All that real income is because women went to work.
There are now 70 percent of women with young children working. Only the households that have a workingwoman had growth of real income. The third factor is that all that growth and income only occurred in households that were educated, and you therefore have a vast middle-class with larges amounts of disposable income who are living stressed, time-compressed lives and they are saying to themselves there are a few categories of good where I am going to have the very best.
COLVIN: Well Kristin, you don’t cover Wal-Mart and discounters like that but they are thriving. How’s the explanation? What’s going on?
BENTZ: Well, if I can actually take a portion out of Mr. Silverstein’s book, if you can talking about rocketing, you might want to explain that a little better Mr. Silverstein, but I will put it in layman’s terms very simply. The consumer that is out there right now, for instance, luxury consumer – she might be shopping at Neiman-Marcus for Jimmy Choo shoes but she is also willing to cut back in other areas and shop at Costco or Wal-Mart or Target for other items.
COLVIN: In order to help pay for the luxury products?
BENTZ: Exactly.
SILVERSTEIN: That’s one of the facts that we found. Inside the American middle-class family, there’s a value meter. And in that value meter they are making choices. They are deciding what categories they’re going to buy good things in. They’re investing against their homes; they’re investing against kitchens and bathrooms. They’re buying luxury cars, in tremendous quantities. That’s were all the growth is in the car market. They’re going to sit-down restaurants, they’re going to P.F. Chang and they’re going to Cheesecake Factory, they’re going to Panera. They’re spending a premium on the things that are important to them. And then in large quantity goods, they are going to Target and to Wal-Mart and to Costco and they are buying private labels and they are trading down.
COLVIN: Trading down as well as trading up. To learn more about this phenomenon, we actually took our cameras one of the retailers that you have identified as an excellent purveyor of new luxury – which is Crate and Barrel, where we got the corkscrew and we just talked to some of the consumers and asked them what was going on from their point of view. Here’s what they said.
COLVIN: Now Michael those are just consumers we happened to find when we visited that Crate and Barrel store. They sound like a commercial for the company. What is really going on here?
SILVERSTEIN: We did research with 44,000 consumers and BCG and our research basically says that consumers are stressed and they are time-crazed and they are looking for outlets. They are trying to protect themselves and part of that protection is designing a home that is more satisfying. That’s why they are spending $50,000 on a kitchen, that’s why they are putting in new bathrooms. That’s why this Christmas you’re going to see in fact Christmas overall will be called by the media a B-minus but there are going to be some winners out there.
There’s going to be some companies that are like the Home Depots and the Lowes that are providing pure product that is high value to consumers that allows them to change their homes. And you’re going to find that there are going to be people that are going to be taking care of themselves, buying themselves a massage, getting themselves some wonderful bath products, changing their lives.
COLVIN: Kristin, for the holiday season and beyond, there’s got to be some big winners in all of this from an investors point of view who do you like?
BENTZ: Absolutely, we’re very bullish on the luxury sector. And one of our favorites is Coach. And talk about an aspirational yet attainable American luxury brand. They have product items that fit across all “demos.” So something for your mother, your daughter, your girlfriend, your father.
COLVIN: Who else?
BENTZ: We love Neiman-Marcus. For pure play luxury, you want to talk about treating yourself gently that’s the place for you.
COLVIN: Michael, it strikes me that this is a lot about emotion, right? This is not just mechanical, there’s a certain magic here yes?
SILVERSTEIN: Absolutely. What we have found is that there is this thing called the new luxury winner. And the new luxury winner is actually like Zeus on top of the mountain with a lightning bolt and sending the lightning bolt onto the emotional meters of American women. Eighty-five percent of these discretionary purchases are controlled by women. They are talking about questing, they are talking about taking care of me, they are talking about emotional space.
COLVIN: Michael, do you have any relationship with any of the companies we’ve talked about.
SILVERSTEIN: The preface of the book is written by Leslie Wexner, one of the most brilliant retail innovators out there in the world and so we do have a relationship there.
COLVIN: And he’s Victoria’s Secret as well as several others.
SILVERSTEIN: He is the inventor of Victoria’s Secret.
COLVIN: And Kristin, what about you.
BENTZ: I have no conflicts.
COLVIN: Great, Kristin, Michael thanks so much for being with us.
FOLIOfn
GIBBS: In case you’re keeping score in the fast paced world of mutual fund scandals, the well known founders of the Pilgrim Baxter fund were charged with fraud this week. And prosecutor Eliot Spitzer is now warning that he may soon bring criminal charges against other financial institutions. While there are still many good mutual funds out there, there are also new ways to play the game. Steve Wallman left his job at the SEC to start FOLIOfn, a whole new way of owning stocks.
Well, Steve, FOLIO investing simply offers investors a basket of stocks. Now, how does that differ from mutual funds?
WALLMAN: It differs in some significant respects. It also is similar in some respects. Part of what mutual funds have offered for three quarters of a century is diversification and affordability, which are two of the principles of really better investing.
Diversification is critical. What we offer is a way for people to both diversify, to do it affordably, and to do it in a very transparent way. So they can actually see what they own, they can control what they own, it can be personalized for them, and they actually have, they control the underlying securities themselves. So it’s not like a fund at all. There’s no fund mechanism. You’re not in a common fund with other investors. It’s your own account, and you control the securities that are in that account.
GIBBS: Who picks the stocks that are in the Folios?
WALLMAN: It can be one of three different ways. We have a lot of advisors who are using our system, and they actually pick the stocks for their clients, and they actually manage baskets of stocks for their clients. For individual investors, we have a whole series of tools on the site. You can either do what we call ready-to-go Folios, which are 75 prepackaged portfolios that you can start with and use and customize as you wish. You can use stock screeners. You can create your own list of stocks from what you read or from newspapers or from what you get off of this show or others and create your own package and basket of portfolio stocks.
GIBBS: Steve, is this basket just limited to stocks?
WALLMAN: No. We actually increasingly are offering mutual funds on the site. We also offer ETFs, a whole package of ETFs, ADRs, closed-end bond funds, and over time we’ll also be offering individual bonds and other kinds of asset classes, as well.
GIBBS: Well, how does this differ from just going to any other financial advisor?
WALLMAN: The most important thing that investors need to recognize is that they need to diversify. If you can diversify, if you can own 20, 30, 40 securities at once, you get the magic of being able to lower your risk and increase your expected returns. People have to diversify. What has happened for so long is that in brokerages people have understood that the best way to invest, which is the wrong way to invest, is to buy one or two stocks and hope they got the winners. That doesn’t give you a diversified portfolio. It basically puts all of your eggs in one basket. What you need to be able to do is buy 40 stocks, 50 stocks, all at once. We’re unique in being able to offer that service to investors.
GIBBS: Forty to 50 stocks, it’s got to be kind of expensive.
WALLMAN: Actually that’s part of our uniqueness, which is we’ve not only provided an opportunity for people to buy it so that it’s very low cost – we actually charge a monthly fee of under $20 for basically unlimited trading, up to 200 trades per month, so you can buy a portfolio of 50 stocks, 100 stocks, reinvest twice a month, and you’re still paying only the $20 – but we also have mastered the ability to buy fractional shares, so that you can have ownership of, for example, a tenth of a share of Berkshire Hathaway or a tenth of a share of Microsoft. So even somebody who only is investing $1,000 every couple of weeks or $1,000 a month building a portfolio can still buy 50 stocks all at once. They buy fractions of shares of 50 stocks all at once.
GIBBS: Suppose I have some problem with one of those 50 stocks that’s in the Folio?
WALLMAN: That’s also part of the magic of our system, which is you can actually customize it. You can take out a stock, you can add in your own stocks. We have many customers, for example, who are following indices because they want to just compare themselves to the Dow or to the S&P or some other index. And what they will do is they’ll buy the index, but they’ll subtract out a stock, such as a tobacco stock that they may not want, so they can have socially responsible investing. They can tilt the portfolio a little bit to make it a little bit more risky or a little less risky, depending on what they would like to get out of the portfolio.
GIBBS: And how do I follow and measure performance?
WALLMAN: We actually provide real-time performance on the site. You can see it instantly when you go on. It shows you exactly what your performance is. It actually will allow you to graph it against another stock, against a mutual fund, against an index, and you can see it in real time right on the site.
GIBBS: It almost sounds like one size fits all, and I know that that doesn’t work in clothing. I don’t understand if it will work in investing. Is it for everyone? What’s the risk involved?
WALLMAN: It’s for a lot of people. It’s not necessarily for everyone. The ability to use the site requires an investor who understands some of the basics of investing, somebody who has also at least $5,000, maybe $10,000 to invest. Someone who really only has a few hundred dollars to invest, they’re still better off in a mutual fund. Somebody who has a lot of money to invest still can use our site, and we have an awful lot of people who are using our site with quarter-million, half-million-dollar investments in it, because of the beauty of what we offer, which is the ability to buy a whole diversified portfolio.
We also provide other benefits, as well, such as we keep track of all tax lots. So one of the concerns, if you own 50 stocks or 75 stocks and you’re buying every month is you may have 500 tax lots at the end of the year. We keep track of that automatically for every investor, and we provide actual gains and loss on a real-time basis on the site, so you can see that, as well.
GIBBS: But the investor still has to do their homework to provide the funds. What’s the downside? What’s the risk here?
WALLMAN: Compared to the alternative investment vehicles that are in the marketplace, this is clearly superior. It’s lower cost. It provides the benefits of diversification. It provides transparency, because you can actually see what you own and you don’t have somebody else who is able to play any games with what’s in your account. It’s in your account and you control your account. So there really is no risk along those lines, accept for the ordinary risk of being in the marketplace. The last three years have been tough for a lot of investors and it’s been a bad place to be for a lot of investors. But one of the benefits of our system is that if you diversify, the risk that you assume is much less than if you put all of your eggs in one basket.
GIBBS: Steve Wallman, thanks for joining us.
WALLMAN: Thank you very much.
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