If you can remember the days of sub-$1-per-gallon gasoline, there's also a good chance you can remember a time when health care seemed relatively affordable. Although it's been pointed out on numerous occasions that health cost inflation is currently at a five-decade low of just 4%, it certainly doesn't feel like it, with costs rising at a faster pace than inflation, wages, and U.S. GDP growth for the past 50 years.
Since 1960, the percentage of spending devoted to health care relative to GDP has more than tripled from just over 5% to approximately 18%, while health-care spending per person, when adjusted for inflation, is up nearly eightfold.
These out-of-control health expenditures are what led to the formation and passing of the Patient Protection and Affordable Care Act, known better as Obamacare, which was signed into law in 2010 and is set to become effective and enforceable, at least on an individual-mandate basis, beginning on Jan. 1.
The basic premise of Obamacare is that it will require insurers on an open and transparent exchange to compete for new members who can therefore make an educated decision about their own health insurance. In addition, insurers are no longer allowed to deny coverage to people with pre-existing conditions and must spend at least 80% of premiums collected on medical care. In return for this added level of transparency and competition, individuals are legally required to have health insurance come Jan. 1 or face a penalty of the greater of $95 or 1% of their annual income when they file their 2014 taxes.
The thought process here is that increased competition and transparency, coupled with getting healthier young adults who are currently not insured, into the fold will help lower health-care costs over the long term. While a novel idea on paper, I'm not certain it will work. In fact, I have a strong suspicion that health-care inflation in this country may never dip below the historical inflation average over the past 100 years of 3.6%, and I have five reasons for believing this way.
1. We're living longer
The good news is that with better medication and increased health awareness, people are living longer now than they were decades ago. The bad news is that this also means that we're more dependent on health-care prescriptions and preventative visits to the doctor to keep us going longer than ever before. When you compound to that the fact that baby boomers are just now beginning to hit their retirement age, you have a recipe for higher medical costs. Something else to think about here is that the elderly represent about 13% of the total population in the U.S., but they account for 48% of all health-care spending!
2. There are simply too few doctors
I believe that one of the most overlooked potential flaws of Obamacare is the surge of preventative doctor visits that will come about as previously uninsured lower-income Americans suddenly get insurance. Now, don't get me wrong; having more people get insurance isn't the flaw. The problem is that the rate of doctor growth in this country has been appallingly slow for decades, and, as a simple case of supply and demand, doctors will always have the upper hand on the patient when it comes to pricing.
There are only a finite number of doctors, a relatively opaque number of choices for consumers once they're locked into an insurance plan, and few alternatives given that millions of Americans will soon be insured and flooding doctors' offices for preventative visits and other health concerns. With that being said, I wouldn't be surprised if doctor visit costs rocketed higher over the coming years.
3. Hospital costs are climbing
I could very easily separate out the rising costs of medical equipment from the high operating costs of hospitals, but I figured since hospitals are the eventual buyer of most medical devices, why not lump them all under one category?
There are a lot of factors causing hospital costs to soar, from the cost of labor for its staff to the medical equipment that it buys to treat patients. Intuitive Surgical (NASDAQ:ISRG), for example, offers hospitals a potentially safer way to perform minimally invasive soft-tissue surgeries with its da Vinci surgical system. Unfortunately for the hospital and the patient, Intuitive's system costs upwards of $1.5 million to purchase, and you can bet that the hospital is eventually passing along the costs to purchase this surgical machine, as well as Intuitive's innovative costs, to patients.
Another negative factor here is doubtful accounts, or uncollectable revenue accounts from treated patients that were subsequently uninsured or underinsured and unable to pay. In 2012, HCA Holdings (NYSE:HCA), the nation's largest hospital operator, was forced to write off about $3.77 billion in services rendered as uncollectable because of uninsured and underinsured patients. Obamacare should help reduce some of the uninsured revenue collection problems HCA has been having, but it doesn't do anything to stem the rising cost of medical device technology, which is only likely to exacerbate non-payment in certain instances.
4. Drug development costs are soaring
In addition to the rising costs of medical devices costs and hospital care, the price of prescription drugs is soaring.
According to a study by the Health Cost Institute, brand-name prescription medicine saw price increases of (and I hope you're sitting down) 25.4% just last year! Of course, branded prescriptions written also fell nearly 21%, as the utilization of generics is taking hold with a sizable patent cliff hitting numerous big pharmaceutical companies, so this jump isn't as painful as it sounds.
However, this demonstrates exactly why Obamacare will have little effect on branded drug pricing, since drug companies ultimately dictate how much their research is worth when they set pricing of a drug. The simple fact that branded drugs are patented over such a limited time frame means drug companies need to pump up their pricing, within reason, to deliver the maximum profit possible. Alexion Pharmaceuticals' (NASDAQ:ALXN) rare-blood-disorder drug Soliris, for example, carries with it a $409,000 annual price tag. Although no generic competition or alternative medicines exist, the simple fact that Soliris treats a very rare disease means a beefed-up price point for Alexion to make up for the clinical research that went into the development of the drug.
5. Insurers remain in control of pricing
Finally, even though Obamacare is requiring insurers to compete on a transparent health exchange in each state, and it's capping insurers' medical loss ratio at 80%, insurers are still very much in control of how much they can charge consumers for health insurance.
The thing you have to understand about the insurance industry is that insurers are money-making machines. Sure, an adverse event strikes now and then that causes them to earn a bit less than they'd like, but they simply use that event as justification to boost premiums.
In addition, just because prices are transparent on state and federally run health exchanges, that doesn't mean there's enough competition or access to health care in some states to have any meaningful impact on lowering health-care costs. In remote or low-population states, and in states where just a handful of insurers are competing, costs are significantly higher than the national average.
Ultimately, insurers will always price themselves at a level where they'll make a consistent profit, even with Obamacare's new restrictions.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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