The health care debate continues to dominate the headlines, but little clarity has emerged; investors remain divided about the implications for earnings. Some analysts argue that reform could result in greater profits; others worry that private enterprise won’t be able to compete with Big Brother. For an expert’s take, we turned to Leefin Lai, lead portfolio manager of DWS Heath Care (SUHAX) and a managing director at DWS Investments. Lai has followed the sector for over 18 years and is firm in her belief that long-term fundamentals will win out over a watered-down bureaucratic intervention. She remains sanguine about the sector’s prospects.

Health care reform has been a major topic of conversation lately. What’s the likelihood that we’ll actually see a package approved, and what form do you think it will take?

If you asked me a month ago I would have pegged the likelihood of health care reform passing at 60 percent, but right now I think there’s a 50 percent chance that a package passes this year or early next year. This issue is a top priority for President Obama, and there’s been a lot of back and forth between the House and Senate–four different committees are working on it.

In terms of what the framework will be, compromises needed to secure passage will likely make the package more moderate and benign than alarmists expect.

President Obama and the Democrats have lost some political capital since the initial package was unveiled in February. To date, the stimulus package hasn’t had the promised impact; I think voters are less willing sit back and accept what comes through the system–legislators are getting more pushback than anticipated. That leads me to believe that compromise will be a key component of any health care reform bill. This dynamic is at play in the Senate Finance Committee, and whatever emerges from those discussions should provide a good proxy of what the final legislation will look like.

I don’t think anyone is really opposed to an individual mandate, but the employer mandate is a sticky issue–especially in the case of small businesses. Any public option will probably be more along the lines of the co-op group proposal floated by the Senate Finance Committee. I really don’t see the government being an option–that strikes me as unrealistic.

The bottom line is that Washington realizes that it’s easier to expand coverage than rein in costs. And any changes will be phased in. Reforms won’t take root immediately after the legislation is passed. For me, the takeaway message is that expanding coverage isn’t the issue; trying to make the plan affordable and not add to the deficit will be the biggest challenge.

Given your take on how the reform efforts are likely to shape up, how much of a challenge would these changes pose to insurers?

I think it’s an opportunity. Take Medicare Part D as an example; everyone thought government control of pricing was going to be a disaster, but Part D actually turned out to be very lucrative for the pharmaceutical companies. Under a proposal that’s freighted with compromises, the impact will be modest. Companies will benefit from increased volume but might take a bit of a hit in terms of pricing; in that case, reform legislation would have a slightly negative impact.

Are any there any other particular subsectors at risk?

If there is a public option, the perception is that the insurers stand to lose the most.

If legislation doesn’t pass, the market would perceive that failure as a negative for hospitals. Hospital stocks have performed quite well this year; the perception is that an expansion of coverage would address the bad debt expense–a big issue for names in that space. That is, with fewer uninsured there would be less bad debt expense–an overall positive. If hospitals feel margin pressures, they’ll likely shift some of that burden to medical device companies.

I just don’t see health care reform being a real game-changer for the industry as a whole, though there are incremental positives and negatives for different subsectors. I haven’t made any major structural changes to the portfolio in anticipation of health care reform.

What’s your outlook for the industry over the next year?

One thing the economic weakness has shown us is that health care stocks aren’t as defensive as initially thought. The credit crunch had a negative impact on hospitals’ purchasing power, which trickled down through the system. But a lot of these companies have rationalized their costs and are well positioned as the economy begins to improve. Demographic trends also favor the sector; an older population tends to consume more health care products and services than the younger generation. Overall, conditions are still quite positive for the US health care industry.

I do have one caveat regarding health care stocks going into next year. When reform legislation is finalized and the market sees that it’s not the worst-case scenario, you might see a sector rotation toward areas that offer better exposure to an improving economy. In that context, health care stocks might not perform as well.

Are there any subsectors that offer more opportunities than others?

I don’t have any positive or negative biases toward any particular subsector. At this point, I’m a little nervous about hospitals just because the shares have staged a phenomenal recovery, suggesting that the easy money has been made. But the biotech group, especially the large-cap names, have underperformed year to date–there are opportunities in that area. In terms of themes that will work over the long term, there are selective opportunities in health care information technology (IT) and life science tool companies.

Investors should still focus on companies that are fundamentally strong and have a good business model, attractive positioning in the industry, capable management and solid balance sheets.

What are some of your favorite names right now?

Health care IT companies should benefit handsomely from any reform; the stimulus package passed back in February injected $35 billion into this relatively small subsector. Not surprisingly, tech giants like Google (NSDQ: GOOG) and Microsoft (NSDQ: MSFT) see opportunities in the space and have expressed an interest in becoming involved.

To qualify for government support, health care IT must meet the criteria for “meaningful use.” A committee has until the end of 2009 to define exactly what this term constitutes; once that definition is in place, hospitals and medical practices will accelerate their implementation of these systems.

And through 2014, there are incentives to encourage practitioners to move towards electronic health records. If hospitals and medical practices don’t have qualified systems in place by 2015, penalties will start to kick in. That carrot-and-stick approach should also help convince physicians and hospitals to adopt electronic health records.

Within the health care IT space, Cerner Corp (NSDQ: CERN) is one of the larger players and will likely be one of the main beneficiaries of stimulus-driven spending.

In the current environment, hospitals need to manage their cash flows carefully. MedAssets (NSDQ: MDAS) is a smaller company that provides revenue cycle and supply chain management systems to hospitals. This technology helps hospitals to maximize revenue per patient from admission to discharge.

Another name that I think has been neglected is Shire Plc (LON: SHP, NSDQ: SHPGY). Its key franchise treats attention-deficit hyperactivity disorder (ADHD). The market has focused on blockbuster drug Adderall XR, which went off patent in April and represents a big part of the firm’s revenue base. But the company is really ramping up its human genetics therapies business; the focus will eventually shift away from the loss of its ADHD franchise to these new opportunities.

What’s your best piece of advice for investors over the next year?

Always focus on the long term, especially when the market is this volatile. You really need to do your homework, which will increase the strength of your conviction and limit panic selling and other rash moves.