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Economic Insights

Some observers believe medical cost increases have begun to abate amid the onset of the Affordable Care Act. The evidence isn’t there yet.

Efforts to bend the cost curve on health care seem to command constant attention. Well, they should, for medical expenses of all kinds have risen to levels that already burden the economy and have impaired its growth potential. Especially with the population's aging, the country's prosperity literally depends on healthcare cost abatement. Analysts, insurance executives, politicians, medical associations, and others have all advanced proposals to curtail costs. President Obama has promoted the Affordable Healthcare Act (ACA) as an answer, in part, to this need. People are so keen to see progress on this front that some have made dubious claims in response to momentary pauses in healthcare inflation. But apart from one or two data points and many hopeful pronouncements, the evidence of cost curve bending is thin at best. If there are good reasons to look for continued economic growth and further market gains, they do not lie in this area, at least not yet.

Given the economic burden imposed by rising healthcare costs, genuine progress on this front surely would give ample reason for optimism. Since 1990, per-capita healthcare spending in the United States has grown more than 250%. The overall cost of health care has risen, from a mere 7.2% of the total economy in 1970 to almost 20% recently. Whatever other merits this diversion of funds offers, it has sapped resources from consumer and capital spending, from the funds available to refurbish the nation's infrastructure, from research and development, from all sorts of economic activity, and it continues to do so. It has also detracted from the country's competitive position internationally. Germany, for instance, diverts less than 11% of its economy to healthcare spending; France, about 11%; Canada 10%; the United Kingdom about 8.5%; and Japan slightly more than 8%. It would be worth the extra expense, if the United States had better health outcomes than these other nations, but as it is, this country has no greater longevity than others, no fewer days of work missed or lower infant mortality or anything superior on any recognized metric of health.1

Since the need for control is so great, many have seen it where there is precious little evidence. When, for instance, the Bureau of Labor Statistics announced last June that healthcare costs fell 0.1% in May (1.1% at an annualized rate), Health and Human Services secretary Kathleen Sebelius seized on the news. Noting that was the first such drop since 1975, she claimed that it was an early sign of the favorable effects of the ACA. But her enthusiasm was never convincing. After all, the legislation had not yet been implemented. In any case, subsequent reports contradicted that single indicator. Following the May decline, June, July, and August saw consumer healthcare costs rise at an annual rate of about 5%, continuing their trend of rising far faster than the core rate of inflation, which during that time rose at about a 2.0% annual rate.

Most who claim that the cost curve is bending rely on two reports, one composed by the Pricewaterhouse Cooper (PwC) Health Institute and the other by the Federation of American Hospitals (FAH). There is some suspicion of these findings, since the sponsors in both cases could avoid government constraints if in fact costs are decelerating. But apart from this concern, the material in both cases is detailed and well-argued. They point to four main factors slowing the rise in healthcare costs:

1) Treatment has migrated from hospitals to less expensive retail clinics and mobile providers, sometimes bringing down costs per visit as much as 33%.

2) Some major employers have begun to contract directly with large health systems, holding down costs both directly and by streamlining medical and administrative procedures.

3) Because the ACA threatens to penalize hospitals for "unnecessary re-admissions," hospital managements have exercised greater care than in the past, and these expensive events have dropped.

4) More employers have turned to high-deductible plans, prompting healthcare consumers to use medical services less and make more cost-effective choices when they do.

It is on the basis of these and other observations that the PwC and FAH forecast a continued declaration in the pace of healthcare cost increases. But especially with the implementation of the ACA, it is not at all apparent that the American consumer and his or her health insurer can count on such trends. To be sure, the ACA has contributed to a drop in expensive re-admissions, but it is also poised to all but abolish many of the high-deductible policies also noted in these analyses as a major cause for cost savings. Since it is probably the high deductibles that have fueled the turn toward retail clinics, coming years may well see an interruption or even a reversal in this cost-reducing trend. Nor is it apparent what will happen to direct contracting under the coming healthcare regulatory regime.


 
Table 1. A Comparison of Healthcare Inflation and Overall Inflation
(% expressed an annual rate)

Source: Bureau of Labor Statistics. *Year to date through August.

 

Even some of the pricing trends, to which these analyses point, raise questions. It is, of course, undeniable that the pace of healthcare inflation has slowed over the last 30 years. Table 1 lays out the relevant figures. The rate of healthcare inflation has dropped from a 7.1% annual rate of advance in the late 1980s to about 4.0% on average during the first decade of this century to a mere 2.3% annual rate of advance during the first eight months of this year. The most optimistic observer, of course, has to admit that most of this improvement simply reflects the general easing in the country's overall inflation rate. To be sure, the abatement in healthcare inflation has been more pronounced than the overall inflation rate. But even this seeming improvement may have more to do with the widely recognized tendency for the dispersion of particular trends to cluster closer to the general rate as inflation becomes less severe.2

Welcome, then, as an improvement in this area would be, whether because of or in spite of the ACA, investors and business people would do well to reserve judgment. Complacency certainly would be misplaced. Of course, if the cost-curve bending were to occur, it would help the economy and so investment prospects. But if this economy is to break out of its present subpar pace of recovery, the source will likely come from somewhere else. If equities and credit-sensitive bonds still offer attractive areas of investment, support here, too, comes from other sources.


1 For more detail, see, for example, Fredric Blavin, "Trends in U.S. Health Care Spending Leading Up to Health Reform," The Urban institute, September 2012, and "Trends in Health Care Costs and Spending," Kaiser Family Foundation Report, March 2012.
2 The explanation of this well-observed phenomenon has to do with uncertainty. Because high rates of inflation leave more doubt about future prices than lower rates, individual price setters inevitably make choices across a wider spectrum when general inflation rates are high than when they are low. Those who are very interested in this phenomena might turn to its early exposition in Stanley Fischer, "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers, No. 2, 1981.

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