Tracking Health Care Costs: Hospital Spending Spurs Double-Digit Increase in 2001

The 2001 Cost Surge: Private Health Spending Hits Double Digits

Originally published as Data Bulletin No. 22 in September 2002 by Bradley C. Strunk, Paul B. Ginsburg, and Jon R. Gabel, this analysis documented one of the most significant turning points in American health care spending during the early 2000s. After nearly a decade of relatively stable growth, spending on health care for privately insured Americans surged by 10 percent in 2001 -- marking the first double-digit annual increase since the early 1990s.

The acceleration was not driven by any single factor but rather by a convergence of forces that had been building throughout the late 1990s. The loosening of managed care restrictions, a severe shortage of hospital workers, and growing consumer demand for services all contributed to what became a defining period for health care economics. The data bulletin, adapted from a Health Affairs web-exclusive publication of the same year, drew on multiple data sources including the Milliman USA Health Cost Index, the Kaiser Family Foundation/Health Research and Educational Trust survey of employer-based health plans, and the Bureau of Labor Statistics employment series.

Hospital Spending Was the Primary Engine of Growth

The most striking aspect of the 2001 cost surge was the outsized role hospital spending played. Taken together, inpatient and outpatient hospital services were responsible for more than half of the total increase in health care expenditures that year. Total hospital spending climbed 12 percent, powered by a combination of higher utilization and rising prices.

Greater use of hospital services accounted for roughly two-thirds of the hospital spending increase. This reflected a broader pattern of loosening health plan restrictions on care -- a retreat from the tightly managed care arrangements of the mid-1990s. As managed care organizations relaxed prior authorization requirements and referral rules, patients and their physicians gained more freedom to pursue hospital-based treatments, and utilization rose accordingly.

Higher prices played a supporting but significant role. Hospitals, having consolidated and gained more bargaining leverage, were successfully negotiating higher reimbursement rates from health plans. The combination of volume growth and price increases created a feedback loop that pushed hospital spending far above its trajectory from just a few years earlier.

Outpatient Care Overtakes Prescription Drugs as the Fastest-Growing Category

Outpatient hospital services emerged as the single largest contributor to overall health spending growth in 2001. Expenditures for outpatient care jumped 16.3 percent, and that category alone accounted for 37 percent of the total spending increase across all health care services. This was a notable development: outpatient hospital care displaced prescription drugs as the fastest-growing component of health spending for the first time in several years.

The shift toward outpatient settings was part of a broader structural change in how hospitals delivered care. Advances in surgical techniques, diagnostic imaging, and minimally invasive procedures allowed many services that had previously required overnight stays to be performed on an outpatient basis. While this was often presented as a cost-saving measure, the sheer volume of outpatient procedures and the prices hospitals charged for them drove spending sharply higher.

Inpatient Hospital Spending Reversed Years of Decline

Spending on inpatient hospital care rose 7.1 percent in 2001, which represented a dramatic turnaround from the mid-1990s. As recently as 1997, inpatient expenditures had actually declined by 5.3 percent. The 2001 growth rate was nearly triple the pace recorded in 2000, contributing 14 percent of the overall health spending increase.

A key factor behind the inpatient surge was rising hospital payroll costs, which grew 8.6 percent in 2001 -- more than double the 3.7 percent increase recorded the year before. This reflected both higher wages and more hours worked by hospital employees.

Average hourly wages for hospital workers climbed 6.1 percent, roughly double the 2000 rate. The wage acceleration was a direct consequence of the severe shortage of nurses and other skilled clinical staff that had gripped the hospital industry. Facilities competed aggressively for experienced workers, bidding up wages, offering signing bonuses, and relying heavily on temporary staffing agencies -- all of which added to the cost base.

Total hours worked by hospital employees rose 2.4 percent in 2001, a sharp jump from just 0.4 percent growth in 2000. The increase in staffing hours tracked closely with the rise in hospital utilization, as more admissions and more complex cases required additional labor.

Prescription Drug Spending Growth Slowed but Remained Elevated

While hospital spending commanded the headlines, prescription drug expenditures continued to grow at a brisk pace. Drug spending rose 13.8 percent in 2001, contributing 21 percent of the total spending increase. However, this actually represented the second consecutive year in which drug spending growth had decelerated -- a departure from the explosive increases of the late 1990s when new brand-name medications, direct-to-consumer advertising, and broader insurance coverage for prescriptions had driven annual spending growth well above 15 percent.

The slowdown in drug spending growth was modest, and prescription medications remained the second-fastest-growing component of health care costs behind outpatient hospital services. The moderation suggested that some of the forces driving earlier drug spending growth -- such as the initial wave of blockbuster medications entering the market -- were beginning to stabilize, though the underlying trend was still well above general inflation.

Physician Services: No Clear Pattern Emerged

Unlike the hospital sector, where the trends in prices and utilization pointed clearly upward, physician services presented a muddier picture. Spending on physician care increased 6.7 percent in 2001, accounting for 28 percent of the overall spending increase. But the data did not reveal a consistent trend in either physician pricing or the volume of services delivered. The physician market was influenced by its own set of dynamics -- including the growing administrative complexity of practice, changing specialty mix, and ongoing negotiations with managed care plans -- that made it harder to identify a single dominant driver.

Employer-Sponsored Insurance Premiums Soared

The rapid escalation of underlying health care costs translated directly into higher premiums for employer-sponsored health insurance. By 2002, the average cost of employer-based coverage had risen by approximately 15 percent. That figure encompassed a 12.7 percent increase in premiums themselves, plus a further 2 to 3 percent reduction in the value of benefits through increased cost sharing -- a practice known as a "benefit buy-down."

The benefit buy-down reflected a deliberate strategy by employers to contain their own costs. Rather than absorbing the full premium increase, many employers shifted more financial responsibility onto workers by raising deductibles, increasing copayments for office visits and prescriptions, and adjusting coinsurance rates. The expectation was that if employees bore a greater share of costs at the point of service, they would become more price-conscious consumers and use fewer services.

This marked the second consecutive year of double-digit premium growth, a trend that raised serious concerns about the future of employer-based coverage. Each successive year of large premium increases put additional pressure on employers -- particularly smaller firms -- to consider dropping coverage entirely or limiting eligibility.

The Uninsured Population and Coverage Erosion

The sustained rise in premiums threatened to reverse modest gains in insurance coverage. According to U.S. Census Bureau data, approximately 38.7 million Americans lacked health insurance in 2000 -- roughly 550,000 fewer than in 1999. That small improvement in coverage, however, was fragile. With premiums rising at double-digit rates for two straight years, analysts anticipated that more workers and their families would lose coverage as employers dropped plans or priced workers out through higher premium contributions.

The uninsured population was already heavily concentrated among low-wage workers and those employed by small businesses -- precisely the groups most vulnerable to premium increases. Any erosion of employer-sponsored coverage in this segment would translate almost directly into more uninsured Americans, since affordable alternatives were scarce in the individual insurance market.

Early Signs of a Possible Moderation

Despite the alarming headline numbers, there were early indications that cost growth might be decelerating by mid-2002. Several factors pointed toward a potential easing of the trend.

First, the increased cost sharing being imposed on employees was expected to dampen utilization. As consumers faced higher out-of-pocket expenses, economic theory predicted they would reduce discretionary health care use -- postponing elective procedures, choosing generic drugs over brand-name alternatives, or forgoing care altogether.

Second, much of the utilization increase was likely a one-time correction. The retreat from tightly managed care had released pent-up demand for services, but once that backlog cleared, the rate of utilization growth was expected to normalize. The managed care backlash of the late 1990s had produced a burst of spending that was not sustainable over the long term.

Third, the national economic slowdown that began in 2001 was expected to exert downward pressure on health care costs, though the effects would be spread over time. Economic recessions tend to reduce health care utilization as unemployed workers lose insurance coverage and employed workers become more cautious about discretionary spending.

The Insurance Underwriting Cycle and Premium Outlook

The health insurance underwriting cycle -- the recurring pattern of profitability and pricing in the insurance industry -- also held the prospect of slowing premium growth. In the years leading up to 2001, insurers had restored profitability by raising premiums faster than underlying costs warranted and by withdrawing from unprofitable markets. Having rebuilt their financial reserves, many insurers were approaching a point where competitive pressure would push them to shift strategy from margin protection to market share growth.

When insurers pivoted to competing on price, premium growth would slow even if underlying medical costs continued to rise. This dynamic -- in which premium trends overshoot and undershoot underlying cost trends in a cyclical pattern -- was well established in the insurance industry and suggested that the 15 percent premium increases of 2002 might represent a peak rather than a new baseline.

Data Sources and Methodology

The analysis drew on several complementary data sources. The Milliman USA Health Cost Index, which used a $0 deductible methodology, was designed to reflect claims cost increases faced by private insurers and served as the primary measure of health care spending trends. Employer-based plan cost data came from the Kaiser Family Foundation/Health Research and Educational Trust survey for 1999 through 2002 and the KPMG survey for earlier years (1991-1998). Hospital labor market data were drawn from the Bureau of Labor Statistics Employment, Hours and Earnings series, while hospital pricing was tracked through the Hospital Producer Price Index.

The bulletin was adapted from "Tracking Health Care Costs: Growth Accelerates Again in 2001" by Bradley C. Strunk, Paul B. Ginsburg, and Jon R. Gabel, published as a Health Affairs web-exclusive in September 2002. The Center for Studying Health System Change, led by President Paul B. Ginsburg, produced the analysis as part of its ongoing effort to monitor trends in health care spending and their implications for coverage and access.

Sources and Further Reading

CMS National Health Expenditure Data -- Official national health spending statistics and historical trends.

Kaiser Family Foundation -- Health Costs -- Research and data on employer health benefits and premium trends.

Health Affairs -- Peer-reviewed journal publishing the original research this bulletin was adapted from.

Robert Wood Johnson Foundation -- Health policy research and health system improvement.

Commonwealth Fund -- Research on health care coverage, access, and system performance.