Game Changer: Health-Care Spending Defies Almost Everyone

The five most common words in forecasting may be "no one saw this coming." Forecasters tend to look for patterns of the past and extrapolate them into the future. But the future doesn't work that way. Things change, and trends that once looked unbreakable break.

For years, every long-term federal budget forecast and projection of income growth has painted a dire view of America's future based on one key assumption: Health-care costs would continue to rise precipitously, as they have for decades.

But something incredibly important has happened lately: They haven't. Growth in health-care spending across the board -- from the private market to Medicare -- has slowed dramatically, well below even the lowest projections.

As Annie Lowrey wrote in this weekend's New York Times, nationwide growth in health-care spending hit a five-decade low in 2009 and 2010. "After years of taking up a growing share of economic activity, health spending held steady in 2010, at 17.9 percent of the gross domestic product," she wrote.

Much of the decline is due to the recession, as workers lose employer-provided health insurance and falling incomes hit families' ability to shoulder costs. But there's more to it than that. "The recession just doesn't account for the numbers we're seeing," Lowrey quotes Harvard health economist David Cutler as saying.

Spending on government health programs like Medicare should be immune from the effects of a recession, for example. Yet growth in per-enrollee costs have plunged. Over the last four decades, Medicare's per-enrollee costs have outpaced broader economic growth by an average of 2.6 percentage points a year, according to a recent report in the New England Journal of Medicine. In 2010 and 2011, however, cost growth roughly matched economic growth. That's the lowest Medicare growth rate on record. Five years ago, the Congressional Budget Office forecast the government would spend $587 billion on Medicare in 2011. The actual number was $485 billion -- one of only a handful of times in history the government has overestimated its ability to spend.

"On the whole, we do not believe that the recent slowdown in Medicare spending growth is a fluke," the Journal wrote. "There has been a long-term trend toward tighter Medicare payment policy, and policy changes that began in the middle of the 2000s have continued that tightening."

There can be dozens of other explanations for the broader decline in health-care spending. One of the biggest is that fewer businesses offer health insurance to employees. According to the Kaiser Family Foundation, 69% of businesses offered workers health insurance in 2000. By 2009, only 60% did. The growing popularity of high-deductible insurance plans also discourages unnecessary treatment. Health-care providers are becoming more accountable for errors and waste. With big pharmaceuticals like Pfizer (NYSE: PFE  ) and Merck (NYSE: MRK  ) facing patent expirations, generic drugs have surged to nearly 80% of all prescriptions filled, from 63% in 2006, according to the IMS Institute. Add it all up, and the forces that most analysts predicted would keep health-care spending on the rise are waning fast.

So what's it all mean?

One of the biggest changes falling health-care growth could bring is falling deficits.

The Congressional Budget Office has for years warned that out-of-control growth in health-care spending would derail the federal government's finances. Indeed, health-care spending was virtually the only factor worth paying attention to in the debate over long-term deficits. Of the massive increase in real government spending forecast over the next 75 years, CBO estimated in a 2009 report that "almost all" was due to Medicare, Medicaid, and Social Security. Of those three, "Medicare and Medicaid are responsible for 80 percent" of the projected growth between now and 2035, and 90% of the growth between 2035 and 2080.

Part of the growth is due to the demographics of an aging population. But by far the largest projected contributor to the growth is per-enrollee Medicare costs growing faster than GDP. By a lot. CBO published this chart in 2007, showing the projected rise in Medicare spending:

Source: CBO.

But the assumptions that go into this chart are now being called into question. In January, CBO cut its own budget-deficit forecast by $69 billion over 10 years to reflect slower Medicare spending growth.

With per-enrollee costs now growing far slower than anyone envisioned, it's worth asking how many more of those revisions we'll see. Even small changes to the growth estimates add up remarkably fast. As Lowrey notes: "If the growth in Medicare were to come down to a rate of only 1 percentage point a year faster than the economy's growth, the projected long-term deficit would fall by more than one-third."

Then there's the impact falling health-care growth has on wages. Average wages have stagnated over the last decade, yet compensation costs for employers have risen at a good clip as employer-provided health insurance premiums surged. Wages made up about 73% of total compensation in 2000. Today, it's 69.4%. Ten years ago, insurance made up 6.4% of total compensation. Today, it's nearly 9%. Employees have been denied salary increases in no small part because they were crowded out by rising health insurance costs.

That trend may also come to an end if growth in health-care costs keeps falling. If it does, workers may experience something that's been a dream for a decade now: larger paychecks.

A few years doesn't a trend make, and the health-care surge may resume just as fast as it ended. But the recent decline is a good reminder of two important facts. One, nothing can grow faster than the overall economy forever. And two, almost every long-term budget forecast has ended up disastrously off-base. Is this time any different? Remember: No one ever sees it coming.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Pfizer. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On May 01, 2012, at 7:34 PM, canadacomments wrote:

    Good article as usual Morgan. However, in regards to your first sentence, the 4 most common words in forecasts are : "This time is different" (with acknowledgments to Carmen Reinhart and Kenneth Rogoff).

  • Report this Comment On May 02, 2012, at 9:12 PM, CaptainWidget wrote:

    Much of our current health care spending, much like housing spending pre-recession, was largely discretionary. The discretion was funneled into these areas through government fiat.

    Just like all bubbles, when people start going to collect and realize that the equity isn't there, prices have to fall.

    Logic has to state that a $600 medical bill for a sprained wrist is not sustainable. No one would pay that on the open market. But dumb government programs have no problem with that type of bill. This drives up prices for everyone, even those those that aren't in the dumb government program. Since everyone's still a buyer, prices must increase. Which again...dumb government programs have no problem paying....

    Eventually everyone will decide to cash out. Those with insurance will realize that their premiums alone cost more than a healthy lifestyle and out of pocket medical. When people stop becoming buyers, and everyone starts "selling", the bubble is going to burst, the lack of value in the system will be revealed...and we're going to have a LOT of doctors, nurses, and medical facilities without any customers. YAY falling prices.

    All government financed bubbles must come to an end.

  • Report this Comment On May 02, 2012, at 9:30 PM, actuary99 wrote:

    I am an actuary by trade and work extensively forecasting prescription drug costs. True, the generic dispensing rate is trending toward 80%. However, brand drugs manufacturers are dramatically increasing their prices to make up for it, and to make up for the new fees/taxes/etc. imposed on them as a result of health reform (PPACA). And use of "specialty" drugs (basically, drugs costing more than $1000/script) has and will continue to trend in the double digits for both cost/script and use/person. Specialty drugs are projected to be 40% of total drug costs by 2020*.

    *(page 12, Medco 2012 drug trend report, http://www.drugtrendreport.com/Medco-2011-Drug-Trend-Report-...

    There are no price controls on Rx drugs, and the economics do not follow normal supply/demand principles. Most insured people pay copays for drugs, so they are insulated from these price increases. Makers of drugs with patent protection can (and often do) increase prices arbitrarily without a significant decrease in demand, since consumers too often pay no additional costs when drug prices increase.

    Unlike almost all medical costs, the Center for Medicare and Medicaid Services (CMS) does not regulate drug prices, nor does any other government agency that I'm aware of. This includes the Medicare Part D program. Also note that, unlike every medical plan, it does not appear that Medicare Part D plans will be subject to the 85% minimum loss ratio that is part of PPACA (or "Obamacare" as the Republicans like to say).

    My point is, I don't see drug costs going down anytime soon.

  • Report this Comment On May 02, 2012, at 9:47 PM, actuary99 wrote:

    @CaptainWidget

    "Logic has to state that a $600 medical bill for a sprained wrist is not sustainable. No one would pay that on the open market. But dumb government programs have no problem with that type of bill. This drives up prices for everyone, even those those that aren't in the dumb government program. Since everyone's still a buyer, prices must increase. Which again...dumb government programs have no problem paying...."

    You are dead wrong here, but I'm sure you'll be glad to here me correct you in a way that still puts blame on the government.

    Government programs basically set the price for medical services and devices. Increasingly commercial insurance plans reimburse providers and physicians on a "% of Medicare" basis. The per-service cost the government pays is lower than the per-service cost of any private payor, especially for Medicaid services. Many physicians do not accept Medicaid or Medicare enrollees because of the low level of reimbursement.

    Physicians and providers make up for these artificially low prices by increasing the price charged to commercial patients.

    This editorial, written by a highly regarded actuary, succinctly why government health coverage programs put us on an inevitable track toward a single-payer healthcare system:

    http://publications.milliman.com/publications/health-publish...

    Especially impressive is that this was written BEFORE Obama was elected.

  • Report this Comment On May 02, 2012, at 10:00 PM, Darwood11 wrote:

    Good article. " A few years doesn't a trend make.." is a significant statement.

    My recent personal experience indicated that some costs are rising. For example, an accident for a family member necessitated a trip to an "urgent care" clinic to stop the bleeding.

    After it was all over, the question of a tetanus shot came up. It was necessary to get one. The price at the clinic? $500!

    We declined and went to the nearby drugstore and got the same shot for $63.

  • Report this Comment On May 02, 2012, at 11:46 PM, CaptainWidget wrote:

    <<

    Government programs basically set the price for medical services and devices. Increasingly commercial insurance plans reimburse providers and physicians on a "% of Medicare" basis. The per-service cost the government pays is lower than the per-service cost of any private payor, especially for Medicaid services. Many physicians do not accept Medicaid or Medicare enrollees because of the low level of reimbursement.>>

    The government sets the medicare rate of reimbursement, and then doctors refuse to accept medicare because it's under the medicare rate of reimbursement? Go back and check your logic........

    But you're dead right. The government DOES set the rates. Then because they're the primary payer (over 50% of medical expenses are paid by a government program in the US) that rate becomes the "prevailing rate". In most areas of economics they would call that "price fixing", and it's usually not accompanied by positive sentiment. More and more doctors are refusing medicare and medicade because of the ream of stupid rules and reimbursements that come along with it, and the massive amount of bureacuracy it takes to get paid. This is first hand from a friend of mine who own his own practice and is currently initiating the switch away from medicare. It has nothing to do with "under-payment". Medicare rates are almost always higher than the insurance rates, it's just too much of a hassle to deal with the program.

    I realize you're an insurance actuary and have a vested financial interest in high health care costs...but really...it doesn't cost that much.

    Open google. Search for "no health care clinic". You'll find a whole world of doctors who don't take insurance or medicare/medicade and charge less than an insurance copay for treatment. THIS is the true cost of healthcare when they don't have to deal with the massive bureacuracy of medicare rates/reimbursements/mandates. $40 physicals, $70 flu treatment, $100 blood work. All this exists in the real world of free market health care. Open your eyes and get out there. The prices that you actuaries declare "artifically low" is actually the real price......

  • Report this Comment On May 03, 2012, at 12:14 AM, seattle1115 wrote:

    It's tough to make predictions, especially about the future.

  • Report this Comment On May 03, 2012, at 11:07 AM, mtf00l wrote:

    Isn't this all a moot discussion as health insurance will be mandated by law with severe penalties for not having it?

  • Report this Comment On May 03, 2012, at 6:05 PM, actuary99 wrote:

    @CaptainWidget

    "The government sets the medicare rate of reimbursement, and then doctors refuse to accept medicare because it's under the medicare rate of reimbursement? Go back and check your logic........"

    Go back and check your reading comprehension. Physicians and hospitals receive the less money for the same service if the beneficiary is a Medicare or Medicaid recipient vs some who has commercial insurance. Period.

    The government sets rates for Medicare and Medicaid, and very often commercial payors use Medicare allowed as a baseline comparison when negotiating prices. The % of Medicare allowed is almost always greater than 100% in commercial contracts.

    "But you're dead right. The government DOES set the rates. Then because they're the primary payer (over 50% of medical expenses are paid by a government program in the US) that rate becomes the "prevailing rate". In most areas of economics they would call that "price fixing", and it's usually not accompanied by positive sentiment."

    No, it's called the "Medicare rate", and the commercial market does NOT follow suit because commercial health insurers cannot set their own prices.

    "Open google. Search for "no health care clinic"."

    I did. I got a hit for this article and a bunch of links to stories about 3rd world countries and their lack of health care. Also stories about inner cities with poor access to health care. They likely have poor access because Medicaid does not pay enough for physicians to cover their costs.

    "I realize you're an insurance actuary and have a vested financial interest in high health care costs...but really...it doesn't cost that much."

    Yes, 17.9% of GDP "doesn't cost that much". You remind me of the people who claim "they" have developed an engine that lasts forever but kept it secret because it would put them out of business. My compensation is not contingent on health care costs. I'm sure you're experience as a conspiracy theorist trumps my years of working as a health insurance actuary and the completion of the grueling accreditation process faced by actuaries. Please, impart more wisdom onto the Fool community.

  • Report this Comment On May 03, 2012, at 6:12 PM, actuary99 wrote:

    "Isn't this all a moot discussion as health insurance will be mandated by law with severe penalties for not having it?"

    In most cases the penalty will be much lower than the annual premium you would pay:

    "The penalty will be phased-in according to the following schedule: $95 in 2014, $325 in 2015, and $695,"... see here if you're interested in the rest:

    http://www.kff.org/healthreform/upload/8061.pdf

  • Report this Comment On May 03, 2012, at 7:55 PM, deckdawg wrote:

    @actuary99,

    I read the article you linked to at millman pubs. The conclusion I'm reaching from the article is that all systems which have separated the payer from the service provider (employer provided insurance, Medicare, Medicaid) have been disasters. I remember reading somewhere that the employer provided health care got its start as a workaround to government wage controls back in the day.

  • Report this Comment On May 03, 2012, at 8:30 PM, Stonewashed wrote:

    All I know is our premiums are higher than ever, for less coverage, and many doctors are opting out of most "networks" making it highly likely one will have to make up the difference between in and out of network costs. The reason for this, is that insurance companies are pegging it to medicare and many doctors don't find those fees sustainable for their businesses, except of course, that make claims for payments through fraud and unecessary treatments..

    Furthermore, what is even scarier, is if you don't have health insurance, you would be charged 70 to 300 percent more for the same procedures.

    But, hey, what do I know. I just write the checks.

  • Report this Comment On May 04, 2012, at 1:16 AM, kahunacfa wrote:

    The growth of Medacare/Medacaid has slowed, perhaps unexpectedly, but not really simply because in anticipation of significant changes in many of the still yet to-be-published or written Rules, many Healthcae providers have simply elected NOT to Accept Medicare or Medacade patients.

    I see a combination of physicians for various routing medical care. I see a Primary Care Internest, as well as several speciality medical physicians. My Primary care physician accepts Medicare, three of my former four Specialists announced last Fall that effective 1 January 2012, they will no longer accept Medicare -- They simply Opted-out. Under the Rules, once a Healthcare provider opts-out of Medacare they can not chane their mind or policy. Once out -- they are OUT FOREVER.

    The incompetant United States Congress makes the Rules, not the patient, the Physician or even the President of the United States who, by-the-way is on Public Record stating that HE and only President Obama will chose which Laws to enforce.

    Humm... I thought I saw him take the oath of Office administered by Chief Justice Roberts swearing to uphold the Laws <ALL OF THE LAWS> of the United States. The Presidents unwillingness to do so is an Impeachable offense to the People of the United States.

    Please remember that November 2012 -- I know I certainly will remember his recent public statement that "He would choose which Laws to enforce."

    Kahuna, CFA

    Venture Capital

    General Partner

    2012 - 2019

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