For the third year in a row, national health spending in 2011 grew less than 4 percent, according to the CMS Office of the Actuary.  However, the report said modest rebounds in pharmaceutical spending and physician visits pointed toward an acceleration of costs in 2012 and beyond.  CMS’s analysts make much of the cyclical character of health spending’s relationship to economic growth and also forecast a doubling of cost growth in 2014 to coincide with the implementation of health reform.

This non-economist respectfully disagrees and believes the pause could be more durable, even after 2014.   Something deeper and more troublesome than the recession is at work here.  As observed last year, the health spending curve actually bent downward a decade ago, four years before the economic crisis. Health cost growth has now spent three years at a pre-Medicare (indeed, a pre-Kennedy Administration) low.

More Than The Recession Is At Work

Hospital inpatient admissions have been flat for nine years, and down for the past two, despite compelling incentives for hospitals to admit more patients. Even hospital outpatient volumes flat-lined in 2010 and 2011, after, seemingly, decades of near double-digit growth.  Physician office visits peaked eight years ago, in 2005, and fell 10 percent from 2009 to 2011 before a modest rebound late in 2011 — all this despite the irresistible power of fee-for-service incentives to induce demand.

The modest rebound in pharmaceutical spending (2.9 percent growth) in 2011 appears to have been a blip.  IMS Health reports that US pharmaceutical sales actually shrank in 2012, for the first time in recorded history, and that generic drugs vaulted to the high 70s as a percent of prescriptions!

There is no question that the recession’s 7-million increase in the uninsured depressed cost growth.  But the main reason health cost growth has been slowing for ten years is the steadily growing number of Americans — insured or otherwise — that cannot afford to use the health system.  The cost of health care may have played an unscripted role in the 2008 economic collapse.  A 2011 analysis published in Health Affairs found that after accounting for increased health premium contributions, out-of-pocket spending growth and general inflation, families had a princely $95 more a month to spend on non-health items in 2009 than a decade earlier.  To maintain their living standards, families doubled their household debt in just five years (2003-2008), a debt load that proved unsustainable.  When consumers began defaulting on their mortgages, credit cards and car loans, the resultant chain reaction brought down our financial markets, and nearly resulted in a depression.

By sucking up consumers’ income since 2008, the rising cost of health benefits has weighed heavily upon the recovery.  According to the 2012 Milliman Cost Index, the cost of health coverage rose by 32.8 percent from 2008 to 2012, while family income did not grow at all in real terms.  The total cost (employer and employee contributions plus OOP spending) of a standard PPO policy for a US family of four was $20,700, almost 42 percent of the US household median income in 2012.

2014 And After

CMS actuaries already see health costs rising, but expect the rate fully to double in 2014 (to 7.8 percent).  One worrisome 2011 datum:  the 6.2 percent rise in Medicare spending, sharply higher than the 3.8 percent increase in private insurance costs.  Medicare saw 1.1 million new beneficiaries and experienced a 3.6 percent increase in per-beneficiary expense in 2011.  If these trends continue or accelerate through 2014, CMS might be close to the mark.

But as to how the rest of US health costs will behave after the 2014 coverage expansion, to paraphrase Hollywood producer William Goldman, “Nobody knows anything”.  (Goldman’s comment was about the profound lack of clarity about how a movie will open).  Among the larger unknowns:  how much Medicaid expansion states will ultimately agree to after the surprising Supreme Court decision rendering the expansion “optional”.

A post-election analysis of state plans to participate in the ACA Medicaid expansion found the entire sunbelt except California either undecided or leaning against. Since then, Arizona and New Mexico have decided to participate in the Medicaid expansion.  More troubling, however, such rust belt stalwarts as Pennsylvania, Michigan, Indiana, Ohio and Wisconsin are listed as “on the fence

States experienced a bracing 22 percent increase in state Medicaid spending in 2011 (1.7 million new beneficiaries plus expiration of the temporary bump in the federal matching rate (FMAP) contained in earlier economic stimulus legislation). That explosive growth, plus the fact that Medicaid enrollment continued growing briskly two years into the alleged “recovery,” as well as the  ten million or more people presently eligible for Medicaid and not enrolled (and thus not covered by the generous 90 percent-plus FMAP for newly eligible) — all would give a responsible state finance officer pause, regardless of how much Earl Grey tea is being served in the legislature or Governor’s Mansion. If enough states opt out, then many fewer people would be newly covered, and demand growth would be correspondingly muted.

Equally unclear is how rapid the uptake of exchange-based coverage will be in 2014 and after, and how much “pent up demand” there will be among the newly covered.  Despite the ACA’s laudable intention to cap cost sharing as a percentage of family income, those receiving subsidized coverage under the exchanges will still carry an amount of family financial responsibility that could retard demand growth.  Demand growth from the newly covered could also be offset by the continued explosive increase in privately insured folks covered by high-deductible plans (which quadrupled from 5 percent to 19 percent of all workers from 2007-2012).

It is also not clear how much capacity the health system, particularly the primary care part, will be able to absorb if there is a significant demand spike.   If the Massachusetts experience is any guide, we can expect sharp increases in waiting time for primary care physician visits and in hospital ER volumes to accompany the ACA coverage expansion.   There will certainly be lots of empty hospital beds, but people have to pass through a clotted primary care system to get to them.

Finally, there is the nasty issue of the sustainability of the recovery. A renewed economic downturn would crush state finances, as well as push more Americans into high-deductible health plans or out of coverage altogether.

Cost Reduction, Not Merely Reduced Cost Growth, Is Needed

As previously argued, the real problem is that health care simply costs too much. Both directly through cost share/premium share and indirectly by suppressing wage growth, health costs weigh heavily on present economic growth.  US society might finally have reached an ugly and poorly distributed equilibrium of demand and ability to pay.

This isn’t an “entitlement problem.”  It’s about a gold-plated health system we can no longer afford. Until the $5,000 CT scans, $10,000 ER visits, $60,000 joint replacements, and $120,000 ICU stays begin to disappear from the American landscape, we’re likely to remain in the economic doldrums.

To restore economic growth will require marked reductions in health costs, not shaving a point or two off of future growth. Both Medicare DRGs and RBRVS-based physician payment remain “cost-based” methodologies, which grandfather in unnecessarily high costs. Medicare’s administered prices form the benchmark in many private insurance plans.  Even if it worked,  a “bolt-on” incentive system tied to administered prices, like the ACO, can only moderate the rate of increase in costs, not markedly reduce them.  In other words, a more sophisticated administered price model with a “rate governor” on it isn’t going to get the job done.

Reference Prices, Not Administered Prices

The urgent need, both for private and public payment, is to move from administered to reference prices, where consumers have multiple provider choices, and benefit from selecting less costly options.  This seems to be the direction major purchasers are headed, to judge from the recent activity of Catalyst for Payment Reform.

Even as payer and provider markets consolidate to narrow consumer choice, there still remains two- to four-fold variation in the prices of many elective services — imaging, surgical procedures, obstetrical deliveries, etc. — in local communities.  Even though elective care may comprise less than half of providers’ total business, it is strategically important because it produces the lion’s share of most provider profits.

Benefits designs that help families save money will produce a lot of positive feedback because so many families remain cash-strapped.   If we give consumers a meaningful incentive and good outcomes information so they can choose high-value alternatives, high-cost providers will be forced to reduce their expenses or lose business.  At present, there is no reward for being the high-value producer of health services.

To switch from administered to reference pricing will require a lot of changes.  Patient cost sharing under conventional private insurance will have to be restructured to enable shared savings for intelligent, high=value choices.  In high-deductible plans, mechanisms already exist to pay bonuses to peoples HRAs or HSAs if they choose less costly options.  In regular plans, it must be possible to eliminate cost sharing if people make intelligent, cost conserving choices, or to share savings with them through premium reductions or cash bonuses.

Adapting Medicare to a reference pricing model would be much messier because so many beneficiaries are insulated from cost pressure by first-dollar MediGap coverage, their own employer-based coverage (if they are still working), or by many Medicare Advantage plans.  Consumer savings options through restructured cost sharing needs to be a part of any meaningful Medicare reform.   It’s worth noting that the ACE (Acute Care Episode) demonstrations recently concluded by CMS did provide fee-for-service Medicare beneficiaries significant incentives to choose a “bundled payment” participant.

Leverage Docs, Don’t Drive Them Into Employment

We will also need to leverage what remains of the physician-based infrastructure in many communities.   Private medical practice is collapsing into hospital employment.   Independent physicians are not wedded to using the hospital’s expensive imaging, surgical, and lab services, and could compete effectively with hospitals in elective care if more of them organized to do so. Putting independent practitioners and freestanding ambulatory services providers with their low unit costs out of business is counterproductive, as is paying hospitals more for services their physicians provide than we pay for comparable services in the community setting.

Payment reform needs to be built around enhanced consumer choices and sharing cost savings with them.  Consumers need to be active agents in a reformed health system, not inert “passengers” statistically attributed to ACOs.   We will know we’ve begun the turn when health care employment begins falling, rather than rising at 30,000 a month as it has for this entire “recovery”.   Maybe then there will be enough free cash flow in household budgets to spend on something besides health care.