BBI Contributing Editor

IRVINE, California Inefficiencies, inequities, escalating costs and issues of access within the U.S. healthcare system have continued to challenge both the public and private sectors for well over a decade. Healthcare costs entered a new upward spiral in the late 1990s, which continued to intensify through 2002, defying a slowdown in the economy that makes rising benefit costs an increasingly serious problem for both the private and public sectors. Federal budget surpluses that helped defuse the debate over the rising cost of entitlement programs such as Medicare and Medicaid have quickly disappeared, restoring a new sense of urgency to efforts to find solutions to the widely recognized problems plaguing the health care system. The government, however, has so far had minimal success in devising, let alone implementing, any meaningful measures to fix the healthcare system.

Industry has responded to soaring health benefit costs by shifting more of the cost burden to employees, and by limiting long-term coverage provided to retirees. Smaller companies have eliminated health benefits entirely, driving the number of uninsured Americans to record levels. The growing problems facing the healthcare system, as well as approaches that are being developed in an attempt to address those problems, were the topic of the annual Health Care Forecast Conference, sponsored here by the University of California, Irvine (UCI) in the latter part of February.

Advances in medical technology are one factor that may help resolve some of the problems. While advanced technology is often blamed as one of the root causes of escalating costs, some new technologies can make a positive financial impact and improve patient outcomes at the same time. Biotechnology is one of the fields that may produce such advances, according to presenters at the conference. Politicians also are actively developing new programs aimed at improving the healthcare system, although major questions remain about the ability of Washington to agree upon and implement substantive change. Without change, however, existing problems in healthcare will only get worse, so pressures for positive action by government are likely to intensify. Data presented at the conference on disease incidence trends, for example, indicates that some providers already are beginning to see significant increases in disease prevalence. As the baby boomer generation begins to reach age 65 toward the end of the decade, those trends are expected to accelerate.

Healthcare cost spiral defies economic trends

There is no debate about the fact that healthcare costs are increasing out of proportion to increases in the overall price level, a trend that has persisted for a decade but that has worsened considerably over the past two to three years. Over the past 10 years, healthcare inflation has been double the general inflation rate, and total healthcare spending in the U.S. has reached $1.5 trillion or 14% of gross domestic product. Spending is forecast to reach 20% of GDP by 2010 if present trends continue. As discussed by Evan Moore of New Capital Advisors (El Segundo, California) at the UCI conference, new technology and pharmaceuticals are perceived as the driving forces in increased cost. The constraints imposed by managed care in the early to mid-1990s that helped restrain healthcare cost increases to levels close to the rate of economic growth have also essentially disappeared, particularly for hospital-based services, which comprise the largest component of national health expenditures (31% of the total in 2001). Increases in expenditures for prescription drugs began to outpace growth in spending for hospital care and physician services in 1995, and in 1999 were almost four-fold higher. In 2001, prescription drugs accounted for 10% of national health expenditures, and over the 2004-2013 period, the Congressional Budget Office expects prescription drug spending to grow at an 11.5% compound annual rate.

The growth in healthcare spending has certainly not been matched by economic growth in the U.S. While the economy is recovering from recession, the recovery has been somewhat anemic, with growth dipping in the last quarter of 2002. Economists now are projecting growth of about 3.5% for 2003. Those trends are a major cause for concern among employers, particularly those with a large number of retirees having generous benefits. The average cost increase in health insurance premiums rose from between 2% and 4% in the mid-1990s to 12% in 2000 and 14% in 2002, and a 16% increase is expected in 2003, according to a survey conducted by Towers Perin and presented by Tom Lerche of AON Consulting (Newburyport, Massachusetts). Federal and state governments also are coming under pressure as the combination of a slow economy and reduced tax revenues in the face of rising expenditures results in mounting deficits. As shown in Table 1, federal spending for Medicare is expected to almost double from 2004 to 2013, while Medicaid spending more than doubles.

Total spending in both categories combined will surpass Social Security spending by 2009. The projections do not include added costs due to the proposed Medicare prescription drug benefit. Due in part to rising spending on entitlement programs, the federal budget deficit is expected to reach $200 billion in 2003, dropping to $145 billion in 2004. By 2007, the Congressional Budget Office is projecting a return to budget surpluses, but some of the assumptions underlying that forecast (e.g., a drop in Medicare physician fee payments in 2003) have already been invalidated. As discussed by John Gabel, PhD, of Health Education and Research Trust (Washington) at the UCI conference, the rise in costs may be partly due to the austerity measures implemented within the Medicare and Medicaid programs in the 1990s, which reduced hospital capacity to levels that are insufficient to meet today's rising demand. The consequent shortage of resources, while not uniform across the U.S., has placed hospitals in a strong bargaining position to make up for the lack of price increases they endured in the 1990s.

Employers are facing similar increases in cost but have been quick to implement changes in their benefit structure to help mitigate the impact on profits. Most importantly, employees are being asked to pay a larger share of the cost of healthcare, or to choose a reduced level of covered services. According to data cited by Gabel, co-payments for prescription drugs in employer-sponsored health plans increased almost two-fold (from $16 to $26) between 2000 and 2002, based on a survey of 2,014 public and private employers. The average monthly worker contribution for family coverage more than tripled between 1988 and 2003 (from $52 to $174), and deductibles also have increased significantly. Some 40% of all firms in the survey have increased the retiree share of health insurance premiums, and 9% eliminated retiree health benefits altogether for new employees who have not yet retired. Besides reducing the financial burden on companies, such cost-shifting in principle gives employees an added incentive to become more discriminating consumers of healthcare, although it is debatable whether the consumer has adequate information or incentives to make appropriate changes in providers or in the type of services provided.

One additional impact of the rising cost of employer-sponsored health insurance has been a decline in the percentage of firms offering health benefits. The drop, while relatively modest so far, has been most evident among small firms (three to 199 workers). The result is an increase in the number of uninsured individuals in the U.S., which now is between 39 million and 43 million at a given point in time. Between 80% and 90% of the uninsured are in working families, and most are not offered insurance by their employer. Data presented at the UCI conference by Kate Kirchgraber of the Senate Finance Committee (Washington) indicates that every percentage point drop in the level of employer-sponsored insurance coverage results in the addition of 1.4 million people to the ranks of the uninsured.

The increase in the uninsured population is becoming a more serious issue as government-provided support programs such as Medicaid, which pay for a significant portion of the care provided to uninsured individuals, are cut back as a result of ballooning budget deficits at the state level. The states recorded a collective budget shortfall of $35 billion to $40 billion in 2002, and the deficit is forecast to reach between $60 billion and $85 billion by 2004, according to Kirchgraber. Forty-five states already have implemented or planned cuts in Medicaid outlays in 2003, either by tightening eligibility requirements or by reducing benefits. Medicaid covers 47 million individuals in the U.S. or about 16% of the population (more than Medicare), and covers gaps in individual or employer-provided coverage as well as populations that private insurance does not cover.

Because of the shrinking safety net provided by Medicaid, the uninsured face an increasingly challenging environment when they are forced to seek medical care. Furthermore, uninsured individuals typically are charged higher rates by providers for medical services than are insured individuals or Medicare patients, because of discounted rates negotiated by private insurance companies and the Medicare system. Proposals by the federal government to deal with Medicaid funding shortfalls including switching to block grants from the federal government (vs. the matching payment scheme in place now), tax credits for insurance costs incurred by individuals, tax deductions for long term care insurance, and a permanent extension of medical savings account legislation. However, Kirchgraber's analysis shows that those proposals would address only a limited proportion of the uninsured, and would have a minimal impact.

As discussed by Walter Zellman, former president and CEO of the California Association of Health Plans (Marina del Rey, California), part of the issue with the uninsured relates to attempting to lump all uninsured individuals into a single group, when in reality there are several different categories of the uninsured. For example, only 16% of the uninsured population remains uninsured for more than 24 months, and only 10% of those in the 55 to 64 age group are uninsured. In California, the uninsured population totaled 6.3 million in 2001, but only 3.5 million had been uninsured for the past 12 months, and only 4.3 million are uninsured on any given date. And 1.3 million of the state's 4.3 million uninsured on a given date are eligible for state aid programs, with those figures including undocumented aliens. Those data show that a significant number of the uninsured (over 25%) may not utilize government or other types of assistance programs even if they are made more widely available. In addition, a practical solution to the problem of the uninsured may involve devising different types of programs for the different categories of the uninsured population.

Demand for services continues to expand

Although price increases for healthcare services are clearly one significant factor underlying the problems facing the U.S. healthcare system and healthcare systems in most other industrialized countries, increases in utilization also are a major factor. The aging of the population, and particularly of the baby boomer population, often is cited as one of the primary reasons for the growing demand for healthcare services. However, most of the impact of the aging of the baby boom generation will not occur until the next decade, so that factor does not provide a complete explanation for current increases. Regardless of the reason, there are indications that demand already is accelerating rapidly for some segments of the population. As shown in Table 2, data presented at the UCI conference by Robert Margolis, MD, CEO of HealthCare Partners Medical Group (Torrance, California), demonstrates major increases in prevalence for serious chronic diseases that place a major burden on the healthcare system. The trends experienced by HealthCare Partners, while not necessarily indicative of national trends, represent a major challenge for health insurers, particularly for health maintenance organizations (HMOs). According to Margolis, the trends are due in part to adverse selection, since HMOs tend to be attractive to the chronically ill. Such major increases in disease prevalence represent a major threat to the HMO model, he said, since HMOs depend on a balanced risk pool in order to survive. However, continued growth in disease prevalence, which is practically assured as the population continues to age unless major advances in disease prevention occur, will strain all segments of the healthcare system.

One potential answer to treating the growing number of chronically ill that was popular with investors in the 1990s was the use of biotechnology to develop new drugs and other advanced treatment approaches such as cell-based therapies. While the enthusiasm for biotechnology has been dampened considerably by high-profile failures of certain biotechnology products and companies, the field continues to attract investment, particularly in the area of cancer treatment. In 2002, $11 billion was invested in biotechnology ventures, with most going to established firms. As discussed by Kevin O'Boyle, chief financial officer of NuVasive (San Diego, California), cancer drugs represent the fastest-growing segment of investment by biotech companies, with more than 170 pharmaceutical and biotech companies now conducting late-stage clinical studies on over 400 new anti-cancer drugs.

Examples of some recent successes include Herceptin and Avastin from Genentech (South San Francisco, California), Iressa/Erbitux from Imclone Systems (New York) and Gleevec from Novartis Pharmaceuticals (Basel, Switzerland). However, such new drugs, while effective for certain groups of patients, come with a high price tag ranging from $3,000 to $25,000 per year of treatment, and are unlikely to help resolve the financial problems of the U.S. healthcare system. Long-term, there is the potential for developing new approaches using pharmacogenetics to help design drugs that have improved effectiveness and reduced side effects. Such approaches, while perhaps not reducing costs, may allow more effective treatment of the growing number of cancer patients.

Other biotechnology-based therapies are under development that target chronic diseases that place a major economic burden on the healthcare system. For example, stem cell therapies for congestive heart failure (CHF) are showing promise, and may provide a means to cure a condition that affects nearly 5 million people in the U.S. and resulted in direct and indirect costs of $23.2 billion to the U.S. healthcare system in 2002. Medical device companies also are having a positive impact in reducing healthcare costs for chronic diseases, exemplified by companies such as Alere Medical (Reno, Nevada) that have implemented remote monitoring technologies for CHF management that result in reduced hospital readmissions and lower overall costs.

Another important area where technology may play a role in reducing healthcare costs is medical informatics. As discussed by Ralph Sabin of Pacific Venture Group (Irvine, California) at the UCI conference, 52% of 300 hospital CEOs responding to a recent survey on healthcare information technology (IT) believe that IT for patient safety is a top priority for their institutions. According to figures quoted by Sabin, healthcare IT represents a $20 billion market with 6% annual growth. IT not only promises to improve patient safety, but also has the potential to improve efficiency. One barrier to the development of IT for healthcare applications, however, is that the medical informatics segment has historically been an under-performing one from an investment perspective. Furthermore, the level of venture investment in healthcare IT has dropped along with venture investment in the healthcare field in general. As discussed by Sabin, IPOs are almost non-existent in the healthcare sector at present, mainly because of the lack of exit opportunities for investors. However, he said he believes that well-conceived and well-planned ventures focused on niche opportunities have good potential. Pacific Venture Group has investments in the areas of healthcare services, healthcare IT, medical devices and biotech/pharma. From an investment standpoint, healthcare remains attractive, particularly for investments in large-cap stocks. The healthcare sector outperformed the S&P average in 2002, and medical technology outperformed the market by 31% in 2001 and 22% in 2002, according to Sabin. While venture investment, particularly in the biotech segment, is at a low point at present, there are significant growth opportunities in established companies, which will benefit from growing demand for healthcare products and services.

Solutions remain elusive

Certainly, given the investment environment, technology-based solutions for the problems within the U.S. healthcare system are likely to be slow to develop and will not be able to deal with issues that relate more to the organization of healthcare delivery, misaligned incentives and lack of access to care. To address those issues, both government and the private sector will need to develop new initiatives, addressing some of the structural defects in healthcare. One program recently proposed by the Bush administration is modernization of Medicare. Not coincidentally, a study conducted by MedMark (Houston, Texas) and distributed at the UCI conference identified modernization and restructuring of the Medicare system as one of the top priorities for new federal spending initiatives in healthcare. As shown in Table 3, the Bush administration has proposed spending $400 billion over the next 10 years on Medicare modernization, including $130 billion allocated over the 2004-2008 period. Stated goals of the program include improving Medicare solvency, rationalization of cost sharing and improving Medicare provider relations. A prescription drug benefit for the Medicare program also is a key focus in Washington, with numerous proposals under consideration, as shown in Table 4. While a prescription drug benefit plan is politically popular, it is likely that any such program will drive costs up, not down, adding to the fiscal issues facing the healthcare system.


While the federal government continues to debate approaches to restructuring the healthcare system, private insurers have taken the initiative to introduce their own potential solutions. One approach that is gaining in popularity is Consumer-Driven Health Plans (CDHPs). The CDHP concept is evolving along many paths, and is best characterized as an evolutionary, rather than a revolutionary, process. One of the newest tactics is the use of employer-funded Health Reimbursement Arrangements (HRAs) that provide employees with a fixed fund that can be used to cover healthcare expenses up to a certain amount. If the employee does not spend the allotted funds, the balance can be rolled over to future years, allowing the employee to build up a reserve. If all of the funds are spent, the plan switches over a conventional structure with a deductible and a catastrophic stop-loss. The goal of the CDHP structure is to provide an incentive for the beneficiary to seek the best value and use healthcare services appropriately, while still limiting the financial consequences of catastrophic illness. Another aspect of many CDHPs is improvement of the ability of plan members to be effective healthcare consumers, through tools such as on-line health information, health education, wellness incentives and health coaching. Disease management programs also are an increasingly important facet of the CDHP concept, particularly for employees with chronic disease.

One new tool now being implemented by a number of insurers, pioneered by PacifiCare Health Systems (Cypress, California), is hospital tiering. Tiering uses quality and cost indicators provided by insurers to allow consumers to make an informed selection of their healthcare service provider. The concept stems from the well-documented variability in the levels of care, patient satisfaction and outcome among hospitals as well as physicians. Tiering is disliked by hospitals and has led to anti-tiering clauses in some proposed contracts between providers and insurers. However, it represents one approach that healthcare insurers can employ to regain some leverage in their negotiations with hospitals.

Consumer-driven health plans using HRAs include Definity Health (St. Louis Park, Minnesota), Luminos (Alexandria, Virginia), Humana Smart Suite (Louisville, Kentucky) and Aetna Health Fund (Hartford, Connecticut). Definity is one of the leaders in consumer-driven health and offers its members a Personal Care Account, 100% coverage for preventative care, nationwide provider access, no referral requirements and health tools and resources such as web-based resources for accessing account information, a medical library linked with leading institutions such as Johns Hopkins (Baltimore, Maryland), health risk assessment tools, provider and facility search capabilities, healthcare pricing data and on-line shopping for consumer medical supplies. A telephonic NurseLine and telephonic pharmacy services also are provided.

So far, data on the effectiveness of consumer-driven health plans in improving healthcare resource utilization and lowering costs is not available, although anecdotal information indicates favorable results, including a reduction in physician visits, emergency room visits and prescription drug claims. A key objective for consumer-driven healthcare will be to focus on the 20% of the patient population generating 80% of the costs. Wellness programs may have a limited impact on costs for patients with serious diseases such as cancer, congestive heart failure and end-stage renal disease. Nevertheless, such programs represent a new direction in healthcare that may evolve to become a truly effective strategy for containing healthcare costs while improving patient satisfaction. Such initiatives will be essential to ensuring the long-term viability of the U.S. healthcare system.