BBI Contributing Editor

IRVINE, California The U.S. market for healthcare products and services, which totaled about $1.7 trillion in 2003 and comprised 15.3% of gross domestic product, has consistently grown more rapidly than the overall economy, with significantly higher growth over the past two years, increasing 9.3% in 2002 and at a projected rate of 7.8% in 2003, according to analysts at the Office of the Actuary at the Centers for Medicare & Medicaid Services (CMS; Baltimore, Maryland). Over the next decade, spending growth is expected to continue to outpace growth in gross domestic product, with spending projected to reach 18.4% of GDP by 2013.

As discussed by leading economists and experts in healthcare policy at the University of California, Irvine (UCI) Graduate School of Management's annual Health Care Forecast Conference here last month, future trends in the healthcare market will be dependent on multiple drivers, including demographic and technological factors, as well as the impact of government programs that account for almost half of all healthcare spending in the U.S. The CMS projections do not take into account the impact of the new Medicare Prescription Drug, Improvement and Modernization Act, which is expected to result in more rapid growth in Medicare program spending, although, at least based on CMS estimates, not resulting in a major change in overall costs.

Speakers at the UCI conference differed in their projections of economic trends, although the differences were related to the timing of the economic expansion rather than fundamental differences on the course of the economy. The market assessments were not limited to the U.S., with some data presented that demonstrate strong growth is also occurring in foreign markets, particularly in Asia, that is expected to play a role in the development of the international healthcare market. Growth in U.S. healthcare spending is, however, projected to be slower than in recent years, due in part to efforts by employers to promote more prudent utilization of healthcare services by insured employees, and a resultant slowing of the rate of price increases and growth in utilization. Significant issues remain to be addressed within the healthcare system, including development of an effective means to deal with the growing number of uninsured individuals in the U.S., as well as implementation of long-range strategies to bring healthcare cost increases into line with overall economic growth, since the current pace of growth in healthcare spending is unsustainable over the long term. In addition, not all sectors of the healthcare market are expected to benefit equally from the expansion in spending, with growth in spending for hospital services in particular expected to slow.

Global economy outperforms forecasts

As discussed by Jim Glassman, managing director and senior economist at JP Morgan Chase (New York), the U.S. economy is now in the midst of the 33rd expansion in recorded economic history, with GDP growth estimated at 4.8% in 2003, vs. 3.5% growth projected at the beginning of last year. He is projecting growth of about 5% in 2004. In addition, regions such as Asia are reporting growth equivalent to that in the U.S., with Japan's economy expanding by 4% in 2003. Combined with slower growth in Europe, the overall average growth for the global economy was in the 2% to 3% range throughout 2003. Glassman said he believes a combination of monetary stimulus, productivity and profit improvements, pent-up business spending and a synchronized global rebound will act to drive continued strong growth in the U.S. economy. While job growth is lagging at present, with total non-farm payrolls still down slightly vs. 2001, the driver of that trend is strong growth in productivity, which has outpaced growth of the economy. The lag in job growth also allows the Federal Reserve to keep interest rates low, which should help to prolong the economic growth cycle.

Certain factors that often are cited as potential threats to the economic expansion, including the large and growing U.S. trade deficit and the federal budget deficit, which is projected at $477 billion for 2004, may not be as negative as many believe, according to Glassman. The trade deficit is the result of stabilizing, not threatening, economic forces, and is mainly attributable to the fact that the U.S. economy is growing more rapidly than the economies of most other countries, while the budget deficit, although at a high level in absolute terms, is near the average for the U.S. historically as a percentage of GDP. As shown in Table 1, the federal deficit for 2003 was 3.5% of GDP, which is very near the average level of 2% to 6% from 1974 to 1994, with only brief periods of budget surpluses during the past three decades. Glassman predicts a continued expansion of the U.S. economy, a trend that is expected to sustain growth in healthcare spending at a level of more than 7% per year, as shown in Table 2 below.

As a result of continued growth in healthcare spending in the U.S., healthcare expenditures are projected to almost double from $1.7 trillion in 2003 to $3.36 trillion by 2013, rising from 15.3% to 18.4% of GDP. Segments of the healthcare market expected to exhibit above-average growth, with corresponding 2003-2013 compound annual growth rates shown in parenthesis, include personal health expenditures (11.9%), retail outlet sales of medical products (9.9%), and prescription drug expenditures (10.9%). Increased spending for drugs will be driven in part by implementation of prescription drug coverage for Medicare recipients, resulting in increased utilization of drugs by Medicare patients as well as switching to higher-priced drugs that are not covered by Medicare at present but will have coverage once the legislation becomes fully effective in 2006. Medicare and other government healthcare programs continue to play a key role in the overall healthcare market. As shown in Table 3, spending by all government payers combined comprises about 45% of total national health expenditures, followed closely by expenditures by private payers. In-patient hospital care remains the largest single category of health expenditures at about one-third of the total, while prescription drug spending is rapidly becoming a more important component of overall healthcare costs.

Growth in spending by the private insurance sector has been fueled in recent years by double-digit increases in healthcare insurance premiums. Based on the results of a survey of 1,856 public and private employers conducted by the Health Research and Education Trust (HRET; Washington), and discussed by Jon Gabel at the UCI conference, private health insurance premiums increased 13.9% in 2003 in the U.S., following increases of 12.9% in 2002 and 10.9% in 2001. Increases in insurance premiums have outpaced both overall inflation and growth in workers' earnings since 1999, with the gap in 2003, when earnings increased 3.1% and inflation was at 2.2%, reaching the highest level since 1990. Premiums have risen for all types of insurance plans, including HMOs, PPOs, POS plans and conventional plans. Gabel predicts that premiums will increase at about the same rate in 2004 as last year. The trend is largely the result of the insurance underwriting cycle, which is now in the profit phase for insurers. He expects premium increases to decline at some point post-1994 as new companies enter the insurance market and competition drives down prices. In particular, premiums are now increasing faster than underlying claims expenses, due largely to a trend for companies to shift more of the burden for healthcare costs to employees, and a resulting drop in utilization, combined with more price-sensitive selection of providers. That trend provides an opportunity for increased competition among insurers and should eventually provide some relief for employers from the recent trend of double-digit growth in health insurance costs.

As shown in Table 4 below, results from the HRET survey indicate that PPOs are now the dominant type of health insurance plan in the U.S., accounting for 54% of all employer-provided insurance. HMOs rank second, although they represent an option that has declined in popularity due to consumer backlash against utilization constraints, while POS plans continue to decline in importance. The average annual insurance premium for family coverage in the U.S. is now $9,068, of which workers pay an average of $2,412. In addition, employers have begun to require employees to share an even larger share of hospital costs in an attempt to contain growth in the largest category of claims expense. Higher deductibles are another tool increasingly used by companies to provide a disincentive to over-utilize healthcare services. A new development that will further increase the emphasis on consumer-driven healthcare is the implementation of Health Savings Accounts (HSAs), which are a more flexible version of Archer Medical Savings Accounts (MSAs). MSAs have been in existence for seven years but have attracted little interest because funds in the account earn no interest and cannot be rolled over to subsequent years. HSAs, which were included as a component of the MMA legislation, eliminate those and other restrictions, and are expected to become increasingly popular with consumers as they become more widely available and awareness of their benefits grows. About 400,000 consumers now participate in MSAs of some form. Definity Health (St. Louis Park) is the leader with about 175,000 participants, and most major insurers including Aetna (Hartford, Connecticut), Cigna (Bloomfield, Connecticut) and Wellpoint (Thousand Oaks, California) also offer such plans. As insurers begin to offer newer and more attractive HSAs, enrollment is expected to expand rapidly, resulting in a slowing of the rate of growth in healthcare expenses for employers.

Employers are clearly interested in strategies that will address the growing cost of healthcare. As discussed by Arnold Milstein MD, of Mercer Human Resource Consulting (San Francisco, California) at the UCI conference, participants in the American Business Roundtable cited healthcare costs as their No. 1 issue by a large margin in 2003. The gap between growth in GDP and health insurance costs is not sustainable over the long term, requiring some new measures to rein in costs, even though the combined impact of global competition (to slow U.S. GDP growth) and introduction of new higher-cost medical technologies (a major factor driving up healthcare costs) will counteract such efforts, according to Milstein. Two approaches he advocated that could help to contain rising costs are performance enhancement and quality improvement in healthcare. Some large employers are now collaborating with organizations such as the American Association for Retired Persons (AARP; Washington) to develop tools to allow comparison of performance of healthcare providers. The tools are scheduled to be available by 2007. Milstein said he also believes that savings of as much as 50% may be achievable by improving the quality of healthcare alone, with additional savings possible via performance enhancement. Examples of some specific approaches that have been developed in the area of performance enhancement include automated telephone systems such as one implemented by Humana (Louisville, Kentucky) that suggest lower-cost drug alternatives, and financial incentives to providers that encourage the use of disease management to reduce hospitalizations for patients with heart failure.

One important change in the way insurers pay for healthcare that could result in a significant reduction in cost is a switch from the current focus on unit pricing for healthcare services to a focus on longitudinal cost efficiency. Today, preferred providers are typically those that offer the lowest unit price for a set of services. However, that approach fails to stimulate use of options such as disease management, which may necessitate use of a treatment option with higher unit pricing in order to achieve a lower rate of subsequent re-intervention or re-hospitalization, and result in a lower total annual cost per patient. Existing payment systems often penalize providers who adopt a longitudinal cost efficiency strategy, when, for example, a provider offers preventive health screening but is unable to reap the long-term benefits as members leave the plan. Milstein said he believes that longitudinal cost efficiency and quality are compatible in healthcare, and that a combination of provider incentives to encourage re-engineering of hospital processes, along with improved technologies for allowing consumers to make more informed choices about preferred providers, can help drive net gains in both cost and quality.

Expansion of government programs

Trends in the government's Medicare and Medicaid programs obviously have a major impact on the overall course of the healthcare market in the U.S. A key challenge facing the Medicare program over the coming two decades is the growth in enrollees that will occur starting in 2010 as the baby boom generation begins to reach 65. That trend will result in the ratio of workers per Medicare beneficiary dropping from four at present to 2.4 in the future. In addition, the newly legislated prescription drug coverage program will only add to the burden of funding Medicare. Analysts at the Congressional Budget Office expect the rate of growth in Medicare expenditures to increase from 6.8% annually to about 9% as a result of the new bill. The new Medicare modernization act represents somewhat of a retreat from the goals of Medicare reform that were proposed two to three years ago, according to Robert Moffitt, PhD, director of domestic policy studies at the Heritage Foundation (Washington). Those proposed goals included tying Medicare subsidies to actual trends in insurance premiums, development of a market-based payment system, introduction of coordinated care (disease management) into Medicare, resolving the issues surrounding delays in introducing new technologies into the system, reducing the micromanagement of the program by the government, and increasing flexibility of the program for beneficiaries.

Another goal was to eliminate the major costs imposed on providers such as physicians and hospitals for regulatory compliance. According to Moffitt, most of those goals will not be achieved under the new modernization bill. Instead, the introduction of the new prescription drug program probably will result in an acceleration of the dropout of employer-based retiree coverage. Within a few years, the federal government will be purchasing over half of the prescription drugs used in the U.S., with one likely long-term outcome being government-imposed price controls on pharmaceuticals. The new Medicare program will significantly enlarge the role of government in the U.S. healthcare system, without addressing the shortcomings of the existing government programs, Moffitt said.

The new bill, which includes 400 provisions and encompasses 700 pages, represents the largest expansion of Medicare since 1965. Only 100 of the bill's provisions are now in effect, with the remainder scheduled to become effective by 2006. As discussed by Elizabeth Fowler, PhD, chief health counsel for the U.S. Senate Finance Committee, it adds $400 billion in outpatient benefits and implements coverage for diabetes and cardiovascular disease screening. In addition, it includes provisions to stimulate the use of electronic prescriptions and promotes some expansion of market competition in healthcare by implementation of the Health Savings Account, as well as by replacement of the dysfunctional Medicare Plus Choice program with Medicare Advantage, a program designed to entice managed care to enter Medicare, hopefully resulting in slower growth in program expenditures. The new bill will certainly benefit Medicare recipients, since it will reduce their drug costs by half. In addition, Fowler views moving seniors into coordinated care programs as a positive development. However, certain aspects of the bill, such as moving the rural Medicare population into health plans administered by private insurers, are expected to be more costly than under the existing system. It is also almost certain that the provisions of the bill will change as it is implemented, since many legislators did not even have an opportunity to read the complete bill before voting.

While the new bill does include provisions that are intended to promote participation of managed care providers in Medicare, with the goal of lowering costs through competition, the success of that aspect of the legislation is in doubt, according to some experts at the UCI conference. As noted by Rep. Bridgette Taylor, a member of the Committee on Commerce in the U.S. House of Representatives, drafters of the legislation found it necessary to offer large subsidies (of up to 125%) to entice managed care companies to participate in the program, casting doubt on the premise that cost savings will be realized.

Another government-administered healthcare program in need of major reform is the Medicaid program. Expenditures in that program are now close to the level for Medicare. The program has been one of the main contributors to ballooning budget deficits at the state level because of the requirement for states to match federal spending for the program. As discussed by Thomas McCaffrey, chief deputy director of the California Department of Health Services (Sacramento, California), more than half of the increase in spending that has created the state's existing budget crisis is due to healthcare, with total spending up 43% while revenues increased only 25%. One tactic used in California to attempt to reduce the burden of the Medicaid program is a 5% across-the-board cut in spending, with an additional 10% cut now proposed. In addition, proposals call for capping enrollment in certain programs such as healthcare for AIDS patients, insurance programs for the genetically disabled and the California Healthy Families program.

Restructuring of the Medicaid program at the state level is problematic because of Federal regulations that require equal benefits for all program participants and that limit the ability to alter the benefit structure of the program. Many states have obtained waivers from the federal government that provide more flexibility in structuring Medicaid and that allow more cost sharing by beneficiaries, as an approach to fixing their programs. However, as demonstrated by events in California, obtaining federal clearance for Medicaid restructuring does not eliminate all barriers, since challenges in the courts are now threatening even the 5% proposed cutback in Medicaid spending. Other tactics to help close the budget being considered by the states also may encounter hurdles, such as a plan in California to enroll beneficiaries in two overlapping programs that qualify for federal matching funds, and receive two federal dollars for each dollar contributed by the state. Such measures indicate the desperate financial situation that exists in many states, most notably California, with respect to funding of their Medicaid programs.

Healthcare spending in the private sector, in contrast, already is exhibiting slower growth as a result of the implementation of consumer-driven health plans, which place a greater financial burden on plan members and make them more aware of the true cost of healthcare. So-called benefit buydowns, which increase plan deductibles and reduce coverage, have been a major factor driving a slowdown in patient volume. Such measures have helped to contain the increase in claims expenses for insurers, although at the same time creating challenges for providers as elective care is deferred and patients shop for better value for their healthcare dollar.

Providers to focus on improved efficiency

Major providers of healthcare services also are being challenged to contain spiraling costs, particularly as spending on hospital services has resumed a sharp upward trend after a number of years of declining costs throughout most of the 1990s. According to Lewis Sandy, MD, executive vice president of clinical strategies and policy for United Healthcare (Edina, Minnesota), providers face a number of barriers to controlling cost, including the difficulty of achieving rapid improvements in productivity in the service sector, wide variations in medical practice among physicians, and induced demand, i.e., the ability of physicians and other providers to independently stimulate additional utilization of healthcare services. Variations in medical practice patterns are a particularly vexing issue, with five- to 10-fold differences observed in admission rates for a given disease between practitioners across the U.S.

To improve the efficiency of healthcare delivery, Sandy cited a number of provider needs, including new information technologies to provide improved therapeutic decision support; use of information from outcomes assessment studies to impact practice, as exemplified by recent successes in reducing the utilization of arthroscopy; standardized administrative processes within hospital networks; personalized intervention plans; and technologies to support utilization of consumer-driven health plans. He said he believes that changes in the provider system need to be very detailed and focused in order to be successful. In keeping with that theme, specialization of providers is one objective at present, with a goal of creating centers of excellence within a hospital network that focus on expanding procedure volume within certain specialties. That approach not only improves efficiency, but also improves quality because of the well-documented relationship between procedure volume and patient outcome. Some of the most significant overall returns are being realized in disease management programs, where the use of coordinated care helps to ensure complete execution of effective care paths. In consumer-driven health, United has implemented an Internet site and call center to provide plan members with access to tools to help evaluate various treatment options and select the most cost-effective approach.

Sheryl Skolnick, PhD, managing director of Fulcrum Global Partners (New York), discussed the Wall Street perspective on healthcare insurers and hospitals. At present, the news is generally positive for insurers, with a major factor being the slower-than-expected rise in claims expenses. However, concerns are beginning to arise because of slowing growth in premiums and stagnant membership levels. The trends in the industry are reminiscent of the 1994-1999 period, when medical loss ratios rose precipitously and earnings declined accordingly, turning into losses in many cases. The industry is now in the second year of rising medical loss ratios, with no change in the trend evident as yet. Hospitals are facing a cash-flow crisis, with cash flow per adjusted admission falling in 2003 for the second straight year, and bad debts rising to record levels. Uninsured admissions for Hospital Corporation of America (HCA; Nashville, Tennessee), for example, rose 11.6% in 4Q03, and the average provision for bad debt expense is now well over 10% of revenue. The trend is partly due to rising co-payments and is not attributable only to the poor but also to middle-income patients who have been forced to assume more of the financial burden of their healthcare. Another negative factor for hospitals is the limits on stop-loss payments now being imposed, which have the potential to slash profits and further reduce cash flows.

The primary factor that may prove to be positive for the hospital industry is the anticipated growth in employment if the economic expansion continues, which could add members to the roles of the insured and help turn around the decline in utilization. However, for now, Skolnick said she has placed "sell" ratings on HCA, Health Management Associates (Naples, Florida) and Tenet Healthcare (Santa Barbara, CA), while putting "buy" ratings on United Healthcare and American Medical Security Group (Green Bay, Wisconsin) on the premise that job growth will help health plans before it helps hospitals.

The problem of the uninsured, which is sure to be an issue in the upcoming presidential campaign, remains largely unresolved, and in fact has worsened due to the escalating cost of health insurance and the slow job market. Some 43.6 million individuals in the U.S. were without healthcare insurance at some time during 2002, and the number has trended upward sharply since 2000. As discussed by Richard Kronick, PhD, of the University of California, San Diego at the UCI conference, small businesses are not the main culprit, as commonly believed. Only 21% of the uninsured work in companies with fewer than 100 employees that don't offer insurance. Sixteen percent of the uninsured work in companies with less than 100 employees that offer insurance. Another important factor is that lower prices for health insurance do not stimulate proportional increases in insurance rates, even when prices are lower by as much as five-fold. There is no argument, however, that the high number of uninsured is a serious issue. Kronick referred to data showing that 18,000 deaths per year in the U.S. are attributable to a lack of healthcare insurance, resulting in the loss of 800,000 healthy life-years and a $65 billion to $130 billion loss in productivity.

Solutions to the problem of the uninsured have so far been inadequate. The recent proposal by President George Bush for tax credits for health insurance expenditures will reduce the total number of uninsured by only about 4 million, according to Kronick. A proposed solution by Sen. John Kerry, the frontrunner for the Democratic nomination to oppose Bush in November, would reduce the number by 27 million, but would cost $900 billion. While politicians cannot completely ignore the issue of the uninsured in an election year, Kronick said he does not believe that a failure to reduce the number of uninsured will cause any elected official to lose his or her job. There thus is not a strong incentive for change, and the most productive approach may instead be to focus on the large number of individuals who currently have insurance but are at risk of losing it because of continued increases in the cost of healthcare. At present, hospitals are effectively the insurers of last resort, providing care for the uninsured as needed and typically receiving no compensation for their services. The deficit is addressed in part by charging more to those with insurance, who then effectively subsidize the uninsured. Given the complex nature of the uninsured issue, and the challenges of arriving at a politically acceptable resolution, it is likely that any progress will be the result of economic factors such as rising employment, and not political initiatives.