Changes In The Growth In Health Care Spending:
Implicatons For Consumers

Executive Summary

Prepared for
The National Coalition on Health Care

By
Kenneth E. Thorpe
Tulane University Medical Center
Institute for Health Services Research

April 1997

Introduction

      Several recent surveys have documented a moderation in the growth of private health care expenditures. According to the most recent tabulations from the Health Care Financing Administration, private health insurance spending per insured life increased 3.5 percent per year between 1993 and 1995. This contrasts with the 12.5 percent increase per covered life between 1969 and 1995. The reduction in private sector spending is attributed to several factors, including a reduction in the underlying rate of inflation, the threat of a national health plan (which has historically led to a significant reduction in health care spending, see Figure 1) as well as the proliferation of managed care. At issue is whether the recent moderation in health care spending will persist.

      This study examines recent and projected trends in health care spending. The analysis examines several aspects of such spending, starting with national health care expenditures, followed by a more detailed look at employers and consumers. As the results indicate, the growth in health care spending is expected to rise at over twice the underlying rate of inflation. This is lower than observed over the past fifteen years, but perhaps not as low as much of the press attention on the subject might suggest. Indeed, when adjusting for inflation, the projected growth in national health care spending is lower, but only by 1 to 2.5 percentage points compared to the experience of the 1980’s and early 1990’s.

      We also examine how consumers in general, and families in particular, have fared over the past several years. Our analysis focuses primarily on middle class families–those families earning between $20,000 and $60,000 per year. While some major payers of health care were reaping substantial benefits and savings over the past several years from their cost containment efforts, middle class families continued to struggle with persistent rise in health care costs. Health care spending as a percent of the family budget has grown relatively little for upper income families and the lowest income families during the 1990’s. However, this has not been the experience of the middle class as our results indicate.

      We present several key findings in the analysis presented below:

• The health care cost crisis is not over. After a two year hiatus, the projected growth in health care costs is on the rise. Several factors are contributing to the renewed pressure; including the a substantial erosion in operating margins among health plans which is increasing pressure for premium hikes, the persistent growth in out-of-pocket spending, and the continued rise in Medicare and Medicaid;
  
• Middle income families — those earning between $20,000 and $60,00 per year — will be hardest hit by this resurgence;
  
• Consumer spending in health insurance continues to rise. Over the past ten years, the real (inflation adjusted) growth in consumer health care expenditures has increased 2.5 percent per year. The largest component of this increase has been the growth in health insurance, which has increased 6.4 percent per year over the past ten years;
  
• Smaller firms will face substantially higher growth in premiums compared to the the larger firms. Over the next several years, the increase in health insurance premiums among such firms could rise nearly 7.5 percent, compared to less than 4 percent among larger firms.

      The plan of the paper is as follows; the first section presents the recent and projected growth in national health care spending, the second section examines changes in employer and employee spending on health care, and the final section focuses on changes in spending among families in general and the middle class in particular.

I. Trends in National Health Care Expenditures

      Several studies by private benefit consulting firms, as well as recent data from the Health Care Financing Administration (HCFA) have highlighted the recent moderate growth in health care costs (see Figure 2). Between 1983 and 1995, national health care expenditures increased 5.3 percent per year. At issue is whether the recent moderation in health care spending will persist, or will the future look more like the experience of the 1980’s and early 1990’s. Quite simply, the more direct question is whether we have solved the health care cost crisis! Several important factors must be considered to address this question. The first issue is whether the recent moderation can, in part or whole, be traced to the impact of President Clinton’s health care reform proposal. Over the past thirty years, several federal efforts have been advanced that did, or if adopted would, have important ramifications for health care expenditures. These interventions include the wage and price controls adopted during the Nixon Administration, Nixon’s proposed universal health insurance program (an employer mandate), President Carter’s hospital cost containment program followed by the substantial changes in Medicare payment policies introduced in the Reagan administration, and most recently President Clinton’s health care reform proposal. These proposals have three interesting and common characteristics; first, would (the wage and price freeze did) have created substantial changes in the health care delivery system. Second, the growth in inflation adjusted national health care expenditures slowed substantially during and immediately after each major healthcare reform proposals advanced by Presidents Nixon, Carter, Reagan and Clinton! Third, the growth in health care costs resumed to the levels immediately prior to the healthcare reform proposals advanced in each of these administrations. While it may be too early to tell whether the experience from the past thirty years is about to repeat itself, it is certainly worth noting that the current moderation could indeed be temporary and illusory.

      During 1996, national health expenditures will exceed $1 Trillion and will rise to nearly $1.5 Trillion by the year 2002 (see Figure 3). When adjusting for inflation, this amounts to approximately a 3.5 percent annual growth (see Figure 4). Over the past twenty years, the inflation adjusted growth in health care spending has increased between 5 and 6 percent per year. With private sector cost containment efforts leading the way, the inflation adjusted growth in spending decreased to a low of 1.5 percent per year. However, the projected resurgence in private sector spending, along with the renewed growth in Medicaid will result in a real rate of growth of approximately 3.5 percent–about 1 to 2.5 percentage points lower than observed during the 1980’s and early 1990’s.

      A second issue concerns the sustainability of the private sector savings generated through managed care. The increased demand by employers to slow the growth in their spending spawned an impressive increase in managed health plans. To attract market share, some plans underpriced their products. Over the past two years, operating profits and administrative costs among managed care plans have fallen sharply. Operating margins among health plans have decreased sharply, falling from 6.4 percent during the second quarter of 1995, to 1.1 percent during the same quarter of 1996. Moreover, the medical loss ratio (the ratio of claims to premium) among the same plans has increased from 80.2 percent in 1995 to 84.8 percent by 1996. In an effort to regain their profits, there is widespread reporting that the growth in premiums among managed care plans are on the rise. Though most analysts do not believe the growth in premiums will resume the record rate observed during the 1980’s, premiums will rise faster than observed over the past observed during the 1980’s, premiums will rise faster than observed over the past two to three years.

      Though segments of the private insurance industry have enjoyed moderation in cost growth, the growth in public sector spending–Medicare and Medicaid–has largely been unaffected. Both programs are expected to rise at rates over two and one half times the rate of inflation.

      The third issue concerns the persistent growth in public health care spending. Medicaid and Medicare spending is still rising at two and a half times inflation. Medicare spending is expected to rise 8.4 percent and Medicaid 7.8 percent over the next several years. Though slowing the growth in these programs is a central feature of the on-going congressional budget debate, there are no early signs of a consensus position emerging.

      Each of the key indicators presented above leads to the following simple conclusion; despite all the attention directed toward the notion that we have slayed the health care cost growth dragon, costs will continue to rise nearly 3.5 percentage points above the underlying rate of inflation. During 1996, we spend over $1 Trillion on healthcare; this will rise to nearly $1.5 Trillion by the year 2002 (see Figure 5).

• Though the inflation adjusted growth in spending has moderated some, projected health care expenditures are rising at rates only 1 to 2.5 percentage points lower than observed over the past fifteen years (see Figure 5)!

      During 1997, health care is projected to account for 13.8 percent of our gross domestic product, rising to nearly 15 percent by the year 2002 (see Figure 5). The rate of growth could be even higher if the recent moderation in spending is simply an artifact of the Clinton health care reform proposal.

II. Trends in the Components of Health Care Spending: Household Expenditures

      While most media attention has focused on the managed care revolution, and its apparent success in slowing the growth in health care spending, substantially less attention has focused on spending by families. Families incur several types of health care spending, including payments for health insurance, spending on copayments, deductibles, as well as direct spending on services not covered through their health plans. The magnitude of these expenditures can be substantial, is some cases accounting for 15 to 20 percent of the family budget.

      Based on our projections, we expect the typical family will spend approximately $2,000 per year on health care during 1997 (see Figure 6). When adjusting for inflation, this represents an average annual growth of 2.5 percent per year. What is notable about the overall results in the dominant role assumed by health insurance spending for the typical family. In fact, between 1991 and 1994, the period when large purchasers were actively engaged in their cost containment activities, inflation adjusted health insurance spending for families increased by a whopping 6.4 percent per year!

Our analysis indicates that;

• Across all families, direct spending on health insurance increased sharply during the 1990’s, rising at an inflation adjusted rate of 6.4 percent per year (see Figure 6);
  
• The sharp rise in consumer health insurance expenditures were muted by slower growth in spending on medical services and supplies;

      These averages mask important variation in direct spending among families during this period. In general, the growth in direct spending was relatively low among lower income families–those earning less than $20,000 per year, and higher income families–those earning over $60,000 per year. In contrast, there were substantial increases in spending among the middle class–those earning between $20,000 and $60,000 per year (see Figure 7). When examining the experience of middle class families during the 1990’s, we found the following trends;

• After adjusting for inflation, the growth in private health insurance spending increased by a modest amount, 0.6 percent per year between 1993 and 1995. This relatively low rate of growth masked substantial differences in the experiences of two parent families. Families earning between $40,000 and $50,000 saw their health insurance payments rise 8.5 percent per year, and families earning $50,000 to $60,000 faced an average increase of 5.6 percent. In contrast, families earning above $60,000 faced nearly no growth in premiums (see Figure 7).

      Based on these data, we have projected the average annual growth in health care spending among middle income families between the years 1990 and 1997. Among these families we find (see Figure 8):

• The largest increase in consumer expenditures among middle class wage earners were for families–both the single head of household as well as families with both parents at home;
  
• Even after adjusting for inflation, the average annual growth in consumer spending was 5.5 percent annually for two parent families, and nearly 10 percent per year for families with a single parent earning between $30,000 and $40,000 per year;
  
• Middle class families with two adults and no children faced a similar, though slightly slower, increase in inflation adjusted out of pocket spending–5.2 percent per year among families earning $30,000 to $40,000 per year;

      The analysis indicates that even as the growth in private health care expenditures were slowing, they continued to rise for middle class families, even as their after- tax income increased at a slower rate than those with greater earnings. In effect, the crunch on families–higher health spending and lower growth in wages– imposes a regressive tax on middle-class American families (see Figure 9). Indeed, if wage growth among middle class families lags behind those with higher incomes, the percent of pre-tax income devoted to health care spending will continue to rise.

      Another way of measuring the impact of the growth in consumer spending on the family budget is to estimate the dollars that would be available to the family had health care spending increased at the same rate as other types of household expenditures (see Figure 10). In fact:

• Had health care remained a constant share of family expenditures during the 1990’s, families with children would have between $500 and $1,000 in additional yearly income to spend on other goods or services or save.

III. Trends in the Components of Health Care Spending: Business Expenditures

      Our projections presented in Figure 3 indicates the growth in health insurance premiums will rise by 5 percent per year for active workers, and nearly 8 percent annually for retirees. Out-of-pocket spending–copayments, deductibles, and spending for services not covered by health insurance–will rise 5.5 percent per year. In each case, these elements of private health care spending will rise faster than wages, and will continue to consume a larger share of total payroll (see Figure 11). During 1996, health insurance accounted for 8.3 percent of payroll among firms that contributed toward the cost of insurance. Based on our projections, health insurance will account for 9 percent of payroll by the year 2002.

      While the larger, Fortune 1000 firms that have invested heavily in cost control and quality enhancement systems may sustain some of their lower costs, the picture remains cloudy for smaller firms. Data from the early 1990’s indicate that the growth in health insurance premiums among smaller firms systematically increased faster than larger firms. We expect this historic relationship to continue into the future. Based on these trends, the growth in spending among smaller firms (those under 100) is likely to rise at slightly faster rates than larger firms (see Figure 12). Across all firms, health care expenditures will continue to rise faster than wages. As a result, employer expenditures on health care will continue to account for an increased share of total worker compensation.

      In sum, after two years of moderate growth, business spending on health care is expected to rise. We see the following trends:

• Overall, we expect health insurance premiums will rise 5 percent per year, traced in part to the continued rise in retiree health care spending. The experience across firms will differ substantially however;
  
• The growth in spending among small firm owners will rise faster than observed among larger firms. Over the next six years, the smallest firms could see annual increases in premiums of nearly 7.5 percent per year;
  
• The largest firms, those with established cost containment programs, and newly acquired tools to measure health plan performance, are likely to continue to generate savings over the near term. However, even among these firms, health care spending will increase slightly as managed care plans attempt to recoup revenue to shore up shrinking operating margins;

Conclusions

Several key findings result from the data presented above:

• Health care cost inflation is back.
  
• Middle income American families, especially single parents and couples with kids, are hardest hit by the current escalation of health care costs.
  
• The current health care delivery system in the U.S. imposes a regressive income tax on middle-class families.
  
• Single parents (primarily women) and couples with children are hardest hit.
  
• Small business has already suffered from the resurgence in health cost inflation.

Though the growth in private sector health care spending slowed due to the shift from fee-for-service to managed care, a dramatic reduction in inflation, and the potential implementation of President Clinton’s health care reform proposal, several forces have combined that will fuel future growth in health care expenditures. Fundamentally, these trends indicate that the basic issues facing the health care system–cost shifting and higher premiums linked to the growing number of uninsured, failure to develop broader approaches to controlling costs, continued difficulties in measuring and assessing quality and value persist. A long term solution to the underlying problems of cost growth, the uninsured, and quality require broader reforms–those involving all payers. (Click here if you would like to read the press release or keyfindings about this survey.)