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Health Care Costs: Why Do They Increase? What Can We Do?

Factors Driving Cost Increases


Kenneth E. Thorpe, Ph.D., Robert W. Woodruff Professor and Chair, Department of Public Policy, Rollins School of Public Health, Emory University, Atlanta, GA.

Paul B. Ginsburg, Ph.D., President, Center for Studying Health Systems Change, Washington, DC.

Health insurance premiums and underlying medical expenses have been rising dramatically since 1998. Factors accounting for rising health care costs include:

  • Growth in pharmaceutical expenses.
  • Expensive new technologies.
  • Aging of the population.
  • Increase in consumer demand.
  • Broader managed care networks.
  • Provider consolidation.
  • Health care labor pressures.

As a result, analysts expect that insurers will be forced to increase health premiums even more over the next few years in order to overcome the rising costs of covered services.

The Centers for Medicaid and Medicare Services (CMS, formerly the Health Care Financing Administration, HCFA) project that continued increases in health care spending from 2002-2010 will include:

  • Hospital care (21 percent).
  • Physician services (19 percent).
  • Outpatient prescription and over-the-counter drugs (21 percent.
  • Nursing home and home health care (10 percent).

According to Kenneth Thorpe, Ph.D., both private and public sectors are affected by the recent dramatic increases in health care costs. With the declining ability of managed care to control cost growth, the private sector is trimming benefits and adjusting cost sharing. Demographic changes and enrollment growth are contributing to Medicare cost increases, and spending is projected to rise from $252 billion in 2002 to $456 billion in 2010.

Medicaid pressures include:

  • Increased growth in prescription drug spending.
  • Increased enrollment of Medicaid and the State Children's Health Insurance program (SCHIP).
  • Pressures to increase payments to physicians.
  • Long-term care spending, including Olmstead decision concerns.

These pressures are expected to continue through at least the next five years, with Medicaid spending projected to rise faster than private insurance increases.

Paul Ginsburg, Ph.D., has been examining health care costs trends through a community tracking study (CTS) that includes 60 randomly-selected communities representative of the entire country. According to Ginsburg, the three major themes in health care costs trends include the underwriting cycle, retreat from tightly controlled managed care, and technological change.

The underwriting cycle includes alternate periods where health care premiums grow faster or slower than underlying health care costs. The current underwriting cycle reflects efforts to recapture profits that were lost in the mid-1990s due to insurers underpricing their competitors to increase local market share. The underpricing ultimately resulted in underwriting losses. In attempts to regain profits, many insurers increased premiums.

This phase of increasing premiums to increase profitability is expected to continue due to expectations that cost increases are likely to continue to accelerate. Ginsburg warned, however, that premium trends are a poor indicator of costs trends, in that premium trends may not necessarily move parallel to costs trends. According to Thorpe, premium changes lag behind cost changes by approximately 18 months, meaning currently rising costs may likely translate into even higher premiums over the next two years.

In response to provider discontent and pressure from employers and consumers, the loosening of managed care has led to decreased use of prior authorizations, decreased use of capitation as a method of payment to providers, increased enrollment in preferred provider organizations (PPOs), and greater direct access to specialists. However, according to Ginsburg, despite the loosening of managed care, the managed care benefit structure remains in place, including little cost sharing inside the network and key developments for pharmaceuticals, such as a tiered co-payment structure.

While there has been a general absence of response to date, employers are beginning to respond to cost increases through increased cost sharing and addressing lifestyle issues, such as smoking or being overweight. According to Ginsburg, directions for Medicaid include seeking flexibility on optional services and working with employers on quality initiatives. Medicaid diverges from employers on care management and cost sharing because of program requirements. He believes that higher cost trends will continue, and added that although the retreat from managed care is a key driver, tighter managed care could re-emerge by the mid-decade.

Thorpe expressed that while new technologies are the key drivers of rising health care costs, and managed care has declined in its ability to control such increases, it remains unclear what will be the "next generation" of cost containment tools.

Additional Resources

Appendix: Average Single Premium for Managed Care by State, 2001. Office of Personnel Management, HMO Premiums, Federal Employee Health Benefits Program.

Berk M, Monheit A. The Concentration Of Health Care Expenditures, Revisited. Health Affairs 2001 Mar/Apr 20(2):9-18. Agency for Healthcare Research and Quality Article Reprint. AHRQ Pub. No. 01-R049.

Bruen B, Holahan J. Medicaid Spending Growth Remained Modest in 1998, But Likely Headed Upward. Kaiser Commission on Medicaid and the Uninsured. The Henry J. Kaiser Family Foundation. 2001 Feb.

Heffler S, Levit K, Smith S, et al. Health Spending Growth Up In 1999; Faster Growth Expected In The Future. Health Affairs 2001 Mar/Apr 20(2):193-203.

Hogan C, Ginsburg PB, Gabel JR. Tracking Health Care Costs: Inflation Returns. Health Affairs 2000 Nov/Dec 19(8):217-23.

Lesser CS, Ginsburg PB. Center for Studying Health System Change, Issue Brief No. 35, Back to the Future? New Cost and Access Challenges Emerge, 2001 Feb.

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