During the past months, a number of important articles have appeared in the healthcare literature on the subject of the recent slowing of health-spending growth in the U.S. In an article in January’s Health Affairs, economists at the Centers for Medicare and Medicaid Services suggest that the recession, even though officially ending in mid-2009, was the major factor in “extraordinarily slow” spending growth of 4.7 percent in 2008 and 3.9 percent in 2010, down from 7.5 percent in 2007 and double-digit growth in the 1980s and 1990s. Also citing recessionary causes, a report from the McKinsey Center for U.S. Health System Reform specifies declines in the rate of overall spending growth for eight consecutive years, from 9.2 percent in 2002 to 4.0 percent in 2009.

The purpose of this commentary is to suggest—through observations and data analyses—that independent of the recession, other fundamental and structural changes are likely contributing to the flattening of the cost curve, and further, that these changes have the potential to significantly alter the curve’s path into the future. Two independent analyses support this premise.

First, looking closely at use-rates per thousand for hospitals in 20 states covering approximately 50 percent of the nation’s population (listed in Note 1 below), inpatient utilization by Medicare-age patients declined significantly between 2006 and 2010, falling 8.3 percent for those aged 65 to 84 and 3.0 percent for those over age 85. Because their healthcare costs are largely covered by the Medicare program, individuals over age 65 would not be expected to forgo care due to recessionary stresses; other factors must be at play.

Second, healthcare utilization would be expected to decline as unemployment increases, meaning that as people lose jobs and employer-based insurance, their ability to access healthcare services normally declines. Unemployment rates have historically served as a good proxy for recessionary impact. During the recession in the 1980s, for example, unemployment surged from about 6 percent to nearly 11 percent. If unemployment rates were relatively moderate in certain states, but utilization in those states was declining more rapidly than in other states, it would stand to reason that fundamental causes other than recession-linked unemployment were creating the use-rate drops.

Of the nine states that experienced use-rate declines greater than five percent (listed in Note 2 below), six states (listed in Note 3 below) also had 2010 unemployment rates lower than the U.S. national average. This positive correlation of high use-rate drops in states with lower unemployment strongly suggests that other factors are working to reduce utilization, which, in turn, is helping to moderate total health system costs.

More Than Meets the Eye

Described here are five trends we believe are bringing fundamental and structural changes to the healthcare marketplace, contributing to the slowing of the nation’s health spending and potentially significantly altering the cost curve going forward.

1. A New Era of Physicians

Jeff Goldsmith, Ph.D., President of Health Futures, Inc., suggests that the makeup and organization of the nation’s physicians is one source of the slowing cost growth. Physicians of the past 30 years typically practiced in solo or small group practices. Under the fee-for-service system, they were incentivized to work long hours, see as many patients as they possibly could, and buy into labs, ambulatory clinics, and specialty hospitals. As a result, they tended to be high users of inpatient and outpatient services. These more entrepreneurial physicians are now reaching retirement age and many tens of thousands are opting to exit the workforce. Replacing them are physicians of a new generation, which has different work and lifestyle expectations. For many younger physicians, owning a practice is not as important as having time to spend with the family and a steady, predictable income.

One effect is that physicians have sought employment by hospitals. Hospital employment of physicians has increased rapidly, growing 32 percent since 2000 according to the 2012 edition of AHA Hospital Statistics. Additionally, during the 2000s, physicians moved to larger and larger group practices, many of which now employ hundreds of doctors.

The move by doctors away from self-employment represents a sea change in practice patterns and marks the emergence of a “national medical staff.” Increasingly guided by their employers’ point of view about care processes, these physicians are practicing medicine in ways that remove utilization and cost from the system. Protocols to reduce variation in care delivery, chronic disease management, case management, and other approaches are increasingly being adopted by physicians nationwide. Larger practices owned by hospitals and other entities will have the capital and human resources required to successfully reduce care costs through such approaches, slowing health-spending growth going forward.

2. A New Approach to Services Offered

Financial pressures since 2008 may be changing how hospitals define their missions and the services they offer in their communities. Prior to 2008, hospitals and health systems experienced strong revenue growth. For all hospitals with debt rated by Moody’s Investors Service, the median total operating revenue growth rate exceeded 7 percent through 2008. Year-over-year revenue increases of this magnitude would suggest that cash flow for hospitals during these years was sufficient to meet the historic community mission of being “all things to all people” by offering a full line of services and using the strong cash flows generated by profitable services to subsidize less profitable offerings.

However, beginning in 2008, revenue growth began to decline in a significant and rapid way, falling to 4 percent median growth by 2010. It’s reasonable to suspect that as revenue growth diminished, hospitals minimized or eliminated services that were no longer financially supportable. A narrowing of service offerings by hospitals would likely remove a significant amount of patient utilization now and going forward. Additionally, as revenue growth has declined, hospitals have been good at reducing costs. Since 2008, growth rates in operating expenses have slowed, closely mirroring the downward-bending rates in operating revenue growth. Hospitals’ success in moderating expenses to cope with slower growth in revenues would be another factor contributing to the observed bending of the cost curve.

3. New Care Models

As U.S. healthcare begins to move from an activity-based business model that incentivizes utilization of services to a value-based model that incentivizes population health management across the continuum of care, thousands of healthcare “science projects” are taking place in communities nationwide. Data emerging from the early initiatives by organizations that are aggressively transforming care delivery and payment should identify whether a “premium” of curve-bending change is occurring through these value-based efforts.

One of the most-watched of the nation’s new-model programs is occurring at Advocate Health Care in Illinois. After more than 15 years of work in aligning the organization’s hospitals and affiliated physicians, Advocate Physician Partners (APP) entered into a value-based contract with Blue Cross Blue Shield (BCBS) of Illinois in 2010. Lee B. Sacks, M.D., Executive Vice President of Advocate Health Care and CEO of APP, comments: “As part of ‘reworking the system’ to align incentives for value-based care, the 3,900 physicians in APP have been encouraged to rethink how they provide care and when and why they admit patients to the hospital.”

The new contract, which began on January 1, 2011, covers inpatient and outpatient care for 200,000 patients “attributable to Advocate” in BCBSIL’s PPO program, which covers approximately 1.2 million Illinois customers. Advocate is held accountable for the population health management of Advocate-attributed patients, while a control group of one million BCBSIL PPO patients receive the traditional volume-based approach to care delivery.

Six months of data for Advocate’s performance under this contract—January through June 2011—are now available. (Data and related comments provided through personal communication with Lee Sacks, M.D., Feb. 2012.) Comparing data for the first half of 2011 to data from all of 2010, the reduction of inpatient admissions per thousand for Advocate-attributable patients exceeded the reduction for the control group by nearly two percentage points, 10.6 percent versus 8.8 percent. Advocate also lowered ER cases per thousand nearly one percentage point more than the control group, 5.4 percent versus 4.6 percent. (Data is not risk-adjusted.)

We propose that the difference between Advocate’s results and the control group results represents the “premium of success,” largely resulting from Advocate’s approach to care delivery, over and above the recessionary effects experienced by the control group. “We attribute the large drop in admit rates to our focus on chronic disease management, which impacts potentially avoidable admissions related to diabetes, asthma, congestive heart failure, and other chronic diseases,” comments Dr. Sacks.

Cost trend data for Advocate under the contract also show significant curve-bending success independent of recessionary effects. “When BCBSIL applied its risk adjustment to data for the first half of 2011, our trend in the cost of care was 6.1 percent below the control group, which declined only slightly by -0.7 percent during this period,” indicates Dr. Sacks. “The overall cost of care is decreasing while quality is improving under our value-based approach,” says Dr. Sacks. With deployment in July 2011 of 62 care managers to primary care physician offices, Advocate expects to see further evidence of improvement in lowering utilization and costs in the data for July to December 2011.

Advocate’s results in materially reducing utilization and costs through use of new care-delivery approaches and value-based systems can be replicated and perhaps already are being replicated in other initiatives taking place all over the country. These efforts will likely have a significant positive impact on reducing the nation’s health spending going forward.

4. Prescription Drugs

The growth in spending on retail prescription drugs has slowed dramatically during the past decade, falling from a remarkably robust 11.6 percent in 2000 to 1.2 percent in 2010. This rapid deceleration of growth is attributable to the leveling-off of enrollment in the Medicare Part D prescription drug program and the increasing use of generic drugs, reported the IMS Institute for Healthcare Informatics last year; the Institute’s just-released review of 2011 prescription drug spending confirms the trend of slowing growth in prescription drug spending. Generics comprised 80 percent of total prescriptions in 2011, up from 63 percent in 2006. Continued loss of patent protection for high-volume branded drugs—to peak in 2012 and remain significant through 2015—will also continue to lower the growth of health spending.

5. Marginal Utility

Uwe E. Reinhardt, Ph.D., suggests another fundamental force behind the slowing of healthcare spending—a force embodied in the microeconomic principle of marginal utility.

Marginal utility is defined by Arthur Thompson as “the change in total utility resulting from a 1-unit change in the consumption of a commodity (or service) per period of time. In the case of an increase in consumption, marginal utility refers to the extra satisfaction obtained from the extra unit of consumption per period of time. In the case of a decline in consumption, marginal utility refers to the amount of the decline in total utility associated with the decline in the consumption rate.” According to the principle of diminishing marginal utility, if a consumer increases his or her consumption rate of a good or service beyond some point, the marginal utility (or extra satisfaction) which is obtained from successive units becomes smaller and smaller.

Professor Reinhardt describes the healthcare application of these principles as follows: “As the fraction of (the nation’s) GDP devoted to healthcare increases, the added satisfaction, or utility, that people derive from added healthcare is likely to diminish relative to the added satisfaction derived from consuming more of other things.” Marginal utility also gets at the notion of “crowding out” noted by Elliott Fisher, M.D., M.P.H., of Dartmouth Medical School, meaning that healthcare costs are reducing the available federal and state funding for other important social programs, including education and job creation.

The concepts of marginal utility and crowding out could be contributing to the decline in healthcare spending growth. Perhaps we have reached a point where consumers—and employers and other healthcare purchasers (including public payers)—are spending such a large proportion of their dollars on healthcare that  purchasing one more unit of a healthcare service becomes less attractive than spending their money elsewhere. In other words, might we be at a point where we’ve given our nation just as much healthcare as it can possibly stand, moving the marginal utility of one more unit of healthcare from positive to negative?

The McKinsey Center’s report shows that U.S. health spending has grown nearly five times as much as GDP since 1960, and, when compared with member countries of the Organization for Economic Cooperation and Development, “The U.S. spends considerably more on healthcare than would be expected based on expenditures in other developed countries, even accounting for difference in income.” The Center indicates that about 23 percent of total U.S. healthcare spending—or $572 billion in 2009—exceeds “estimated spending according to wealth.”

Concluding Comments

The forces described here— a new era of physicians, a new approach to service offerings in hospital communities, value-based care models, pharmaceuticals market trends, and the diminishing marginal utility for healthcare—are changing the nation’s healthcare cost curve. The impact of these forces is likely more permanent in nature than could be expected from recessionary effects. In coming years as the U.S. recovers from the recession, we will be tracking these and other important emerging trends impacting the nation’s healthcare providers.

The author extends a special thanks to Jeff Goldsmith, Ph.D., for reading a draft of this commentary and making important contributions to many of the points raised here.

Note 1. Arizona, California, Colorado, Florida, Hawaii, Iowa, Kentucky,  Maryland, Minnesota, Missouri, Nebraska, Nevada, New York, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, and Wisconsin

Note 2. Hawaii, Iowa, Kentucky, Minnesota, Pennsylvania, South Carolina, Tennessee, Utah, and Wisconsin.

Note 3. Hawaii, Iowa, Minnesota, Pennsylvania, Utah, and Wisconsin.