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1 Tracking Health Care Costs: Inflation Returns Despite rising trends, the double-digit cost increases of the 1980s are not likely to return. b y Ch r i s t o p h e r Ho g a n, P au l B. G i n s b u r g, a n d Jo n R. Ga b e l Tr e n d s i n health care spending that underlie private health insurance premiums occupy center stage in any debate over the affordability of health care and the future of employer-sponsored health insurance. Premium trends affect employers decisions to offer insurance, the types of plans offered, the level of copayments and other out-of-pocket costs, and employees share of premiums. Ultimately, increases in premiums affect not only employers willingness to offer insurance but also employees ability to purchase coverage when it is offered. The period was a time of record-low rates of growth in health insurance premiums and in the underlying medical expenses that are covered. A robust economy and low premium growth enabled the premium for a typical private health insurance plan to grow more slowly than did gross domestic product (GDP) per capita. This is the fifth in a series of annual analyses that synthesize trends relevant to private health insurance premiums. 1 Here we argue that a return to higher rates of premium growth was probably inevitable. In hindsight, the respite from rapid premium increases during was the result of uniquely favorable conditions: low growth in underlying spending combined with insurers willingness to absorb cost increases to gain market share. In this paper we first review recent trends in medical spending that are relevant to private insurance premiums and then discuss how the relationship between trends in spending and premiums reflects the health insurance underwriting cycle. Study Methods Health care spending can be measured in various ways: (1) using data from insurers and from consumers on payments to providers of care; (2) using data from providers on revenues; or (3) using data from providers on costs incurred in the delivery of care, with labor costs being the most important component. Because we have placed a premium on timeliness in order to discuss the most recent trends, this analysis makes the greatest use of data on provider revenues and on labor costs incurred by health care establishments. We use the Milliman and Robertson (M&R) Health Cost Index to reflect expenditure increases underlying private health insurance premiums. 2 This index, which is intended to assist insurers in forecasting their claims payments and comparing them with those of others, is based on provider revenues (a proxy for spending on services) gathered from a variety of sources, some widely available and some proprietary. 3 It is limited to health services that tend to be insured: inpatient and outpatient hospital services, physician services, and prescription drugs. Since 217 Christopher Hogan is president of Direct Research, LLC, a small health services research consulting firm in Vienna, Virginia, and a consultant to the Center for Studying Health System Change (HSC) in Washington, D.C. Paul Ginsburg is president of HSC. Jon Gabel is vice-president of health systems studies at the Health Research and Educational Trust, also in Washington.

2 218 provider revenue data tend to cover all patients, M&R actuaries subtract data on Medicare payments to providers, to arrive at a series that more closely reflects the population with private health insurance coverage. 4 We use this index because (1) the actuarial work to remove revenues from Medicare is valuable, since that component of revenues has followed trends that are distinct from those of private insurance; and (2) because it is available with a very short time lag. We have compared historical data from an expanded version of this series (which includes Medicare spending) with the national health spending accounts maintained by the Health Care Financing Administration (HCFA) generally recognized as the gold standard for tracking expenditures and found that they track fairly closely. 5 We look at data on payroll costs for nonsupervisory workers in health services establishments (SIC 8000) compiled by the Bureau of Labor Statistics (BLS), to gain insight into providers costs. The sample includes both private and public employers but excludes nonsalaried health professionals. These data also are available with a very short time lag. Trends in provider revenues from M&R and payroll costs from the BLS are reported on a per capita basis. This is the most relevant measure for policymakers and is directly comparable to trends in premiums. Data on premiums in employment-based health insurance come from the Kaiser/Health Research and Educational Trust (HRET) Survey of Employers and its predecessor surveys. The 2000 Kaiser/HRET survey used a stratified random sample of 1,887 private and public firms employing three or more workers. The sample frame is Dun and Bradstreet s listing of businesses that have entered the credit market. Data are from telephone interviews with employee benefit managers conducted from January to May The survey continues the health benefits survey first conducted by the Health Insurance Association of America (HIAA) from 1987 to 1991 and then by KPMG Peat Marwick from 1991 to The core questions in these surveys premium increases, the monthly cost of coverage, employee contributions, self-insurance status, and plan enrollments are virtually identical. For the years 1991, 1992, 1994, and 1997, KPMG sampled only firms with 200 or more workers. We use published data from the U.S. Department of Labor s Consumer Expenditure Survey (CES) to gain additional insight into how spending trends are passing through to consumers. The CES surveys approximately 5,000 households about their spending by category of goods and services over the past quarter. The survey includes separate questions for health insurance premiums, medical services, drugs, and medical supplies. Underlying Spending Trends Provider revenues per privately insured person increased percent in 1999, compared with 5.1 percent in 1998 and percent in 1997, according to the M&R Health Cost Index (Exhibit 1). 6 Components of the 1999 increase followed the same pattern as prior years, with sharply higher drug spending and hospital outpatient costs, but small increases or even decreases in hospital inpatient costs. Drug spending accounted for about 44 percent of the 1999 increase, slightly higher than in About one-third of the 1999 increase in drug spending was attributable to higher drug prices as measured by the Consumer Price Index (CPI); the remainder, to new drugs and increases in use of existing drugs. A recent analysis of claims for of a major pharmacy benefits manager (PBM) by the Schneider Institute of Health Policy, Brandeis University, attributed the increases in spending per enrollee to the following categories: 32 percent, higher costs per day; 15 percent, more days per prescription; 40 percent, more prescriptions per user; and 13 percent, more users per enrollee. 8 Hospital inpatient revenues, by contrast, accounted for only 3 percent of the 1999 increase. This continues the pattern of the last half of the 1990s, during which hospital revenues per privately insured person fell more often than they rose and balanced the effect of other components to restrain overall health H E A L T H A F F A I R S ~ V o l u m e 1 9, N u m b e r 6

3 EXHIBIT 1 Trends In Provider Revenues From Non-Medicare Patients, By Component, a 6.9% % % SOURCE: Milliman and Robertson Health Cost Index ($0 deductible). a Data through March 2000, compared with corresponding months in % % care spending increases. The spending slowdown underlying private health insurance during the 1990s was largely attributable to the behavior of hospital inpatient spending (as measured by revenues). Inpatient care is a large component of services covered by private insurance, so the years of declines in inpatient spending were also years of slow growth in total spending. If inpatient revenues were excluded from the calculation, the average rate of spending growth for the decade would nearly double, and the slowdown of the mid-1990s would virtually disappear. Spending for physician services accounted for 32 percent of the 1999 increase. The trend for this component also dipped in middecade, but by 1999 it had nearly returned to its earlier rate of increase. The mid-1990s were a period of substantial deflation in physician fees paid by private insurers, with many insurers bringing their rates down toward or below Medicare s payment level. 9 By the end of the decade the pullback from intensively managed care and the broadening of insurers physician networks may have limited the opportunities for continued fee reductions. Spending for hospital outpatient services accounted for 21 percent of the 1999 increase. This category grew at a consistently high rate throughout the decade. Since 1992 annual per capita revenue increases for this sector averaged about 8.5 percent. The rate in any year never deviated more than one percentage point from the average. Rates of increased spending for the first quarter of 2000 are very similar to those for the first quarter of 1999 (Exhibit 1). The only difference of importance is a slightly lower rate of increase for drug spending. BLS data on payrolls in health services establishments provide timely insight into the largest cost factor that providers face. (Unlike the M&R index, this series applies to revenues from all payers, including Medicare.) Payrolls increased only percent per capita in 1999 (Exhibit 2). Payroll per capita rose at an annual rate of nearly 5 percent in the first seven months of 2000, returning to the trend seen in the mid-1990s but well below the pace seen earlier in the decade. Insurance Premium Trends The sharp increase in premiums for percent, compared with percent in 1999 was widely anticipated, given the recent discrepancies between cost and premium growth and the behavior of the health insurance underwriting cycle (Exhibit 3). If the trend in spending underlying health insurance premiums in 2000 is similar to that in 1999 (less than 7 percent), this will mark the first year since 1994 that premium increases exceeded underlying spending. The early 1990s were characterized by an 219

4 EXHIBIT 2 Changes In Employment, Hours, And Earnings In Health Services Establishments, c 9.0% % % % SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Employment, Hours, and Earnings database. a Product of second and third columns. b Product of number of production workers (excludes executives and managers) and average hours per week, adjusted for changes in U.S. population. c Data through July 2000, compared with corresponding months in unexpected decline in health care spending growth, resulting in higher underwriting profits and thereby attracting capital into the health insurance industry. Thus, insurers cut premiums to enter new markets and gain market share; as a result, premiums rose more slowly than did spending for services covered by health insurance. This, in turn, led to underwriting losses and insurers withdrawing from selected markets. While employers resistance to premium increases may have delayed the onset of the stage in which premium increases exceed trends in underlying spending for services, this stage of the cycle probably accounts for a portion of the sharp increases for EXHIBIT 3 Annual Increase In Employer-Based Insurance Premiums And Underlying Spending, c 11.5% % % 5.0 SOURCE: Spending data are from the Milliman and Robertson Health Cost Index ($0 deductible). Premiums are from the Kaiser/Health Research and Educational Trust (HRET) survey of employer-based health plans for and from the KPMG survey for a Firms with 200 or more workers. b Not available. c Data through March 2000, compared with corresponding months in H E A L T H A F F A I R S ~ V o l u m e 1 9, N u m b e r 6

5 Data on underwriting gains and losses by Blue Cross and Blue Shield plans support the notion that insurers may just be entering the next phase of the underwriting cycle in 2000 (Exhibit 4). On average, Blues plans essentially broke even on health insurance underwriting in 1999, after having losses in the prior four years. If the 2000 premium increase outstrips cost growth, the industry may move into the initial portion of the profitable phase of the underwriting cycle this year. Another indication that we are entering a new stage of the underwriting cycle comes from a comparison of premium increases for fully insured and self-insured plans, which are identified in the Kaiser/HRET survey. Premiums for self-insured plans reflect Consolidated Omnibus Budget Reconciliation Act (COBRA) mandated rates filed by employers with the Department of Labor, which are based on employers projections of claims costs. In contrast to premiums for fully insured plans, they are unlikely to reflect underwriting practices of setting premium increases above or below projected cost increases. The premium increase for 2000 was 9.6 percent for fully insured plans and 7.1 percent for self-insured plans. In contrast, premium increases for fully insured plans were two percentage points lower in 1995 than were those for self-insured plans. Within plan types, differences in premium increases were equally dramatic. For example, among health maintenance organizations (HMOs), premiums increased 9.4 percent for fully insured plans and 4.5 percent for selfinsured plans. Among preferred provider organizations (PPOs), premiums increased 10.9 percent among fully insured plans and 7.4 percent among self-insured plans. The recent cyclical phenomenon of larger increases in premiums for fully insured than for self-insured plans has encouraged some employers to self-insure. The percentage of employees enrolled in self-insured plans increased from 48 percent in 1999 to 51 percent in This has also stimulated a shift to PPO plans, which are primarily self-insured plans, and away from HMO and point-of- 221 EX H IB IT 4 Blue Cross And Blue Shield Plans, Underwriting Gains And Losses, As Percentage Of Revenue, Percent SOURCE: Authors analysis of data provided by the Blue Cross and Blue Shield Association.

6 222 service (POS) plans, which are largely fully insured. We expect these trends to continue into 2001 and Implications For Consumers Persons with employer-sponsored coverage have largely been insulated from health care cost growth since the middle of the decade. According to the CES, consumers spent 5.5 percent of after-tax income on health care in By 1998 (the most recent year available), that amount had fallen below 5 percent. The only health care item commanding a larger share of income in 1998 than in 1993 was prescription drugs, mainly as a result of an 8 percent increase in out-of-pocket spending in Earlier in the decade, expanding coverage for prescription drugs, related to rising enrollment in m anaged care plans, had sharply limited the total out-of-pocket spending increase. For employees share of premiums, the Kaiser/ HRET survey shows distinctive patterns for employee-only and family coverage. For the former, employers have been willing to pick up an increasing share of costs in recent years. For example, from 1996 to 2000 employees share of the premium declined from 21 percent to 14 percent. However, the employee share of the premium for family coverage was virtually unchanged, declining from 28 percent to 27 percent. 10 The Future The sharp reductions in provider fees negotiated during the mid- or late 1990s appear as a one-time realignment that is now behind us. The most disturbing development over the past two years has been the steep growth in spending for covered medical services. Over the entire underwriting cycle, average premium growth largely reflects this trend. Although some of the jump in premiums reflects the current phase of the underwriting cycle, an important segment reflects the trend in underlying spending. Several factors indicate that future spending increases will continue to be higher than in recent years. (1) In response to the managed care backlash and increased regulation of plans at the state and federal levels, managed care plans are becoming less restrictive and consumers are shifting toward more loosely managed plan types, such as PPOs. (2) Expensive new technologies, especially pharmaceuticals, continue to enter medical practice. (3) Continuing provider consolidation could lead to higher rates for services. Moreover, even without this trend, the sharp reductions in provider fees negotiated during the mid- or late 1990s appear as a one-time realignment that is now behind us. (4) Reductions in spending for inpatient hospital services of the magnitude seen in th e 1990s may no longer be feasible and, in any case, will have a smaller impact on the trend of total spending. In the short run, several indicators suggest that costs and premiums will continue to increase sharply. For the first seven months of the year, health establishments per capita payrolls increased at nearly a 5 percent annual rate, faster than the 1999 rate of increase. For the first quarter of 2000, the Health Cost Index increased at essentially the same rate as in In addition, the California Public Employees Retirement System (CalPERS), one of the nation s largest public purchasers of private health insurance, announced an average premium increase of 9.2 percent for its HMO contracts for 2001, prior to any increases in copayment or deductible requirements. 11 Despite these pressures, the double-digit increases of the late 1980s and early 1990s are not likely to return. Today s health care markets are far more competitive than they were in the past. Price pressure on providers is likely to lead to continuing efforts on their part to cut their costs. However, continued growth in spending even if the magnitude of the increase is less than historical rates has H E A L T H A F F A I R S ~ V o l u m e 1 9, N u m b e r 6

7 implications for the economy as a whole, for state and federal budgets, and for the uninsured. Substantial premium increases mean less consumer spending on other goods and services, lower wage increases, and lower profits. Increased growth in outlays for Medicare and Medicaid would mar the rosy fiscal picture that governments now enjoy. Finally, increases in insurance premiums could lead to an increasing number of uninsured persons. A recent study shows that 20 percent of the uninsured have access to employer-sponsored coverage but have declined that coverage, mostly because of costs. 12 The i nevi ta bl e con clu sion is that U.S. businesses, households, and governments face difficult choices in the immediate future. During the past few years managed care plans and employers have been retreating from managed care heavy. The tightest labor market in three decades has shielded employees from the cost consequences. Whenever the economy softens, employees will be pressed to decide whether to reconsider tightly managed care or to accept more responsibility for health care costs, either at the point of service or in premium payments. The authors thank Jay Thayakaran of Milliman and Robertson for permission to use the Health Cost Index. They gratefully acknowledge the Robert Wood Johnson Foundation and the Commonwealth Fund for their financial support. NOTES 1. P.B. Ginsburg and J.D. Pickreign, Tracking Health Care Costs, Health Affairs (Fall 1996): ; P.B. Ginsburg and J.D. Pickreign, Tracking Health Care Costs: An Update, Health Affairs (July/Aug 1997): ; P.B. Ginsburg and J.R. Gabel, Tracking Health Care Costs: What s New in 1998? Health Affairs (Sep/Oct 1998): ; and P.B. Ginsburg, Tracking Health Care Costs: Long-Predicted Upturn Appears, Issue Brief no. 23 (Washington: Center for Studying Health System Change, November 1999). 2. The term underlying private health insurance premiums is used broadly. Premiums may follow a different trend than underlying spending does because of the insurance underwriting cycle (discussed at length in this paper) and because of changes in benefit structure. We are focusing on how premiums would change prior to these two factors playing a role in determining the actual premium trend. 3. The index that M&R provides to clients simulates trends in claims for a standard private health insurance policy with a $250 deductible. The trend in such an index would slightly overstate the trend in spending underlying private insurance because the standard policy would pay for a slightly higher proportion of expenditures each year. M&R has provided us with a version of the index that reflects a hypothetical policy with no deductible. 4. Ideally, revenues from Medicaid and from uninsured patients should be excluded as well, but data limitations have precluded this. 5. In an earlier paper on tracking health care costs, Ginsburg and Pickreign compared the M&R Health Cost Index ($0 deductible), which they expanded to include Medicare, with data from the National Health Accounts (NHA) from 1975 through The expanded Health Cost Index predicted the NHA series quite well. The mean annual percentage change differed by only 0.4 percentage points, although the expanded Health Cost Index had a larger variance. The mean absolute difference in annual percentage changes in spending was percentage points. See Ginsburg and Pickreign, Tracking Health Care Costs (1996). 6. These data are for the privately insured population only and exclude revenues from Medicare, which generally has a distinct trend. 7. Each category s contribution to overall spending growth was calculated as the change in total spending within category as a percentage of the change overall. This accounts for both the size of the category (share of costs) and the rate of growth of spending within the category. 8. S.S. Wallack et al., Sources of Growth of Pharmaceutical Expenditures (Presentation at Access to Pharmaceuticals: The Seventh Princeton Conference, sponsored by the Council on the Economic Impact of Health System Change, Princeton, New Jersey, May 2000). 9. Physician Payment Review Commission, Annual Report to the Congress, 1996 (Washington: PPRC, 1996), J. Gabel et al., Job-Based Health Insurance in 2000: Premiums Rise Sharply while Coverage Grows, Health Affairs (Sep/Oct 2000): B. Branch and P. Macht, CalPERS Approves Co- Pay Changes, Rates for 2001, California Public Employees Retirement System press release (Sacramento: CalPERS, 17 May 2000). 12. P.J. Cunningham, E. Schaefer, and C. Hogan, Who Declines Employer-Sponsored Health Insurance and Is Uninsured? Issue Brief no. 22 (Washington: HSC, 1999). 223

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