Despite the lingering "fog" surrounding U.S. Medicaid reform, Bank of America has recommended Encompass Health (EHC.US) as a "policy haven" for investors.

U.S. Bank Securities released a research report to analyze the current changes in medical policies and their impact on the U.S. healthcare facilities industry. The report stated that the possibility of a significant cut in Medicaid is low, as governors may oppose such measures before the midterm election, especially considering the negative Medicare margins in the hospital industry. Non-profit hospitals, in particular, rely heavily on Medicaid, and some residents in Republican-led states also rely on these benefits. Moreover, Republicans have a slim majority in Congress and cannot afford too many dissenting votes.

However, the report noted that a combination of small cuts to Medicaid, Medicare, and the exchanges is expected to save $350 billion for the federal budget over the next decade, including implementing work requirements, extending Medicare automatic cuts, and repealing some regulations. Moreover, provisions related to the exchanges may also be used to combat abuse, such as the estimated cost of up to $15 billion to $26 billion in 2024 due to the lack of income verification, according to Paragon Institute.

Notably, the report mentioned that industry insiders are more concerned about the policy direction after the expiration of the exchange subsidies, as for-profit hospitals rely more on these subsidies, which will expire at the end of the year, and Congress needs to decide quickly whether to extend them.

On the cost side, commercial insurance rates show low single-digit growth, and nursing costs are stable. Although large hospital chains have reduced the use of contract workers, costs are still higher than before the pandemic due to inflation. Meanwhile, professional fees have grown much faster than inflation, prompting hospitals to seek higher commercial insurance rates.

On the market dynamics, policy uncertainty is expected to continue until the summer. Although the House budget resolution calls for $880 billion in spending cuts, the Senate is inclined towards smaller cuts, and the different positions make it difficult to reach a consensus. UBS expects the final bill may not be ready until June or July.

Based on this background, hospital stocks may fluctuate due to policy news, and UBS is more bullish on acute post-acute care services, preferring Encompass Health with a target price of $125, as the company has better defensive characteristics in the current industry environment.