Health Care Costs:

Originally published by the Center for Studying Health System Change (HSC). HSC was a nonpartisan policy research organization funded principally by the Robert Wood Johnson Foundation.

Will They Start Rising Rapidly Again?

Issue Brief No. 10, June 1997

News reports had begun speculating that health care costs, after years of remarkably slow growth, were poised to take off again. But a panel convened by HSC concluded that the forces keeping large cost increases at bay were still functioning and premium increases would remain moderate. Based on a health policy seminar held April 10, 1997. Panelists: Paul B. Ginsburg (HSC), Peter Reilly (Milliman & Robertson), Jeff Goldsmith (Health Futures, Inc.), Murray Ross (Congressional Budget Office).

Continued Low Growth in 1996

Health care cost growth had declined steadily since 1990, reaching historic lows by 1994. The Milliman & Robertson index showed costs rising just 2.0 percent in both 1995 and 1996. Private insurance premiums rose only 0.5 percent in 1996 -- below underlying cost growth -- reflecting intense competitive pressure. Employers were willing to switch plans for lower premiums, and plans were restraining premiums to build market share. Speculation about 4-5 percent premium increases for 1997 was plausible, but 3 percent increases seemed more likely. Employers had already been shifting more costs to employees and steering them toward managed care.

A Fundamental Change in Health Care Economics

The relationship between health care spending and economic growth had shifted fundamentally in 1993, according to Reilly. The historical pattern of health care spending consistently outpacing GDP had been eliminated -- health care consumption was actually growing below where economic activity would have predicted. He credited managed care's expansion and improved effectiveness. Low general inflation also helped. Medicare reimbursement had been rising faster than other payer rates, creating favorable cost-shifting for the non-Medicare market -- but that would reverse as budget pressures hit. Plans had been spending surplus to hold market share while setting premiums below cost growth, losing money on an underwriting basis.

Market Forces Reinforce Cost Containment

Goldsmith argued speculation about cost increases was wishful thinking by plans and providers. Cost expectations had changed permanently since the double-digit premium increases of the 1980s, partly the legacy of failed Clinton health reform. The spread of managed care and shifting of risk to providers strengthened incentives to hold costs down. Purchasers who once accepted steep increases now expected lower costs and had no reason to ease up.

Rather than managed competition, the system had produced managed care expansion within unmanaged competition. Employers had narrowed carrier choices -- 50-70 percent offered just one carrier -- but that carrier was forced to offer multiple products with broad, overlapping networks. In mature markets like Portland and Los Angeles, this produced a crisis of differentiation with virtually no price differences between plans and identical provider networks. As providers realized exclusion threats were less credible, panic-driven discounts would be harder to maintain.

Medicare Spending Slows

Medicare spending growth had decelerated from about 10 percent annually in the early 1990s to 8 percent in 1996. Without changes, spending would grow from $190 billion to roughly $314 billion by 2002 -- 8.5 percent annually. With proposed cuts, the rate would drop to 6.7 percent but still outpace private insurance. Large increases were projected for home health, skilled nursing, and hospital outpatient services.

Looking to the Future

The forces restraining costs would largely remain in place. Most major markets still had excess hospital and specialist capacity -- roughly 50 percent more than needed. Provider oversupply left insufficient leverage to reignite inflation. Growing Medicare and Medicaid enrollment in managed care increased plan bargaining power. Over the longer term, major savings opportunities would emerge as managed care grew more sophisticated. Competitive bidding for Medicare could finally remove excess capacity from the delivery system.

The consensus: cost-containing forces would remain operative but might not hold trends at current historic lows. Reilly projected underlying private insurance costs rising from 2 percent to 4-5 percent by end of 1997, climbing slightly in 1998 and leveling off in 1999. Costs would vary across local markets depending on managed care penetration and provider market power.

Sources and Further Reading

CMS — National Health Expenditure Data — Official U.S. health spending data.

Kaiser Family Foundation — Health Costs — Health care cost analysis.

Health Affairs — Peer-reviewed health policy.

Robert Wood Johnson Foundation — Health policy research.

Commonwealth Fund — Research on health care costs.