Health Care Costs Rise Sharply

When the California Public Employees Retirement System (CalPERS), representing more than 1 million state employees and retirees, recently agreed to let health insurers boost premiums by an average of 9.7 percent for the year 2000, the handwriting was on the wall for employers and consumers throughout the state. This huge organization with its tremendous buying power sets the trend, and in approving such a large increase—especially following a 7.3 percent premium increase in 1999—it has acknowledged that employers, who have kept their health insurance costs contained for a number of years, must expect to meet the demands of insurers for dramatically higher premiums.

A number of factors are contributing to the increases now in the pipeline and on the horizon, including consumer demand for greater flexibility, costly new medical technology, rapidly rising prescription costs and the consolidation of the health insurance market. While these factors contribute to the problem in differing proportions, there is no indication that they will be contained in the immediate future.

New prescription drugs and medical devices

By far the greatest cost increases in the health care system in the last few years have come from the introduction of new medicines. Prescription drug expenses among insurers are rising as much as 20 percent annually. These costs reflect both the high research and development expenses of pharmaceutical companies and their desire to recoup these expenses with substantial profits while drugs remain under patent.

Naturally these expenses are eventually passed on to consumers in the form of higher insurance premiums, but in the mean time they have had the effect of distorting co-payment schedules. When inaugurated, these schedules were set at cost-sharing levels proportioned to other medical expenses, typically 20 percent. Over the last few years, however, a $5 to $15 co-payment has shrunk to perhaps 10 percent of the prescription cost. Insurers are making changes to keep up in this area.

While much has been written about Viagra prescriptions at $10 a pill, as well as other "lifestyle" drugs for hair loss, weight loss and smoking cessation, these are only one factor in a complex picture. Equally significant has been the FDA's decision to relax restrictions on consumer advertising. Increased advertising has sent many consumers to their health care providers demanding a medication by name. Not surprisingly, highly advertised name brands are usually synonymous with higher prices.

Paralleling new pharmaceutical developments have been advancements in medical technology, some as simple as an improved blood pressure cuff and others as complicated as a system for keeping a patient's heart beating during open heart surgery. Naturally both doctors and patients are anxious to have the newest and best treatments despite the huge price tags, and so far insurers have been unsuccessful at creating and implementing ways to measure cost-effectiveness in approving purchases.

Increased demand for flexibility and quality

In an era of low unemployment and strong competition for quality workers, human resource managers have looked for an edge by offering higher quality health plans with more benefits. The popularity of HMOs has waned while PPOs and other less rigid arrangements have increased. Naturally, these benefits also come with a significant price tag.

In response to popular demand, many health care plans have adopted "open access" to specialists, dropping the cost-saving measure— preauthorization by a primary care physician—that practically defined HMO delivery. Some plans have dropped all preauthorization requirements and are letting doctors make all final decisions. Further popular features in competitive plans include coverage for alternative treatments such as acupuncture, either as direct benefit or through discounted providers, and Internet access to health information, enrollment forms and personal benefit records.

On a related note, employers, used to rating insurers on the basis of preventative services and size of provider network, have also begun to rely on the National Committee for Quality Assurance, a nonprofit organization partially funded by health plans, for accreditation of HMOs. This organization will soon be reviewing and accrediting PPOs as well. Presumably the effect of such review will be to push insurers toward greater expense.

Shrinking vendor markets

The last three or four years has witnessed a profound change in the face of health insurance through a wave of mergers and acquisitions. Fueled by the competitive atmosphere in the wake of the failed Clinton health care initiative, insurers, HMOs and PPOs have fought for market share, profits, negotiating leverage and the power to attract business through multisite facilities.

The remaining players are now taking advantage of this reduction in the levels of competition with many choosing to only offer plans that meet predetermined levels of profitability. In addition, insurers have tightened their reimbursements to the point of bankrupting providers. The press abounds with accounts of individual doctors mortgaging their homes to pay business debts and stories of provider groups disbanding. In California the problem is complicated by the widespread presence of medical networks representing a large number of physicians. These networks often negotiated "capitation" fees—a contracted pay schedule for covering a certain number of patients per month—without a proper actuarial basis. Not only have these fees proved to be inadequate, but the networks subtract their management costs from these fees leaving physicians' revenues so low that it no longer pays them a competitive income.

According to Bill Scheuber, a trustee of CalCPA's Group Insurance Trust and, for 35 years, the executive secretary of the Alameda-Contra Costa Medical Association, "as a solution to containing medical costs, capitation has always been hopeless." He points out that two of California's largest medical groups declared bankruptcy this year, victims of underpayment, bureaucratic hindrances and managerial incompetence.

How consumers are affected

Where are all these factors leading? For the moment, the system is clearly out of balance. Consumers want more, costs are way up and will probably rise further, and employers are getting hit with health insurance hikes of a sort they haven't seen since the early part of the decade. On the Medicare side, HMOs are getting a 2.5 percent increase from Washington but are seeing a 6.5 percent rate of inflation. The net effect will likely be that Medicare recipients will be hit with higher co-payments for services.

Are we headed for a another period in which health care costs grow at two or three times the general level of inflation? No one is venturing a guess. In the near term employers will have to make some hard decisions about how generous they can afford to be with health benefits, while an increasing number of consumers may have to choose between some combination of improved benefits and higher out-of-pocket fees.

What about quality?

With all of the attention the press has given to the recent rapid cost increases in health care coverage, relatively little has been written about a veritable revolution that has taken place in the quality of care available. Technology has, indeed, increased the nation's total healthcare budget, but it has also produced a steady stream of miraculous treatments that offer people longer, healthier more productive lives. According to the University of California's "Wellness Letter," life expectancy in the preceding century increased by 30 years, and it is continuing to increase by one to two percent per year. The Census Bureau currently projects that life expectancy will increase about seven years by the year 2050. While future health trends are, of course, speculation, the "Wellness Letter" suggests that those who are currently in their eighties are "far more vigorous and healthier than their parents were at the same age."

Contributing to these improvements are remarkable advances in cardiac bypasses, angioplasty, non-invasive diagnostics, hip and knee replacements and even mental health interventions. Charles R. Morris, in an Atlantic Monthly article titled, "The Health-Care Economy Is Nothing to Fear," offers the following vivid example. "Cataract surgery used to be a dangerous operation, requiring as long as a week in the hospital for only marginal improvements in vision. Now it's a virtually painless hour-long outpatient procedure that usually restores near-normal sight." He then adds, "not surprisingly, the pool of potential customers is vastly larger."

It's a good point to keep in mind. Health care doesn't cost more because it has become less efficient but because it has consistently offered a variety of ever more effective treatments.