BBI Contributing Editor

IRVINE, California — The U.S. economy is moving out of recession based on a variety of measures, with most economists providing increasingly optimistic forecasts for growth over the next one to two years. That trend, which is expected to drive renewed growth in a wide range of industries throughout the U.S., is also likely to help support continued expansion of the health care products and services markets. A number of positive trends are now in place, including a decline in initial claims for unemployment insurance benefits and in the number of persons drawing unemployment benefits, low rates of inflation, and increased rates of growth in health care spending.

As discussed by Jim Glassman, director of U.S. economic issues research at JP Morgan Chase & Co. (New York), at the recent Health Care Forecast Conference sponsored by the University of California Irvine (UCI; Irvine, California), new applications for unemployment insurance benefits have been declining since late September and are now close to the level at which layoffs match rehiring. Although the seasonally adjusted unemployment rate increased to 5.6% in January 2002, vs. an average of 4.8% in 2001, unemployment remains acceptably low. Inflation rates also remain low, at 1% to 2%, so government can move to stimulate the economic recovery without fear of sparking price increases. The combination of low interest rates and low inflation sets the stage for a long-term expansion of the economy, albeit one that will probably be moderate rather than explosive. The main question mark regarding the economy at present is the potential impact of a major military action by the U.S. against Iraq, which some experts believe is inevitable in the coming months.

The market for health care products and services was largely unaffected by the brief recession, and in fact health care spending has grown much more rapidly than economic output throughout the downturn. As shown in Table 1, U.S. health care spending is now at approximately 13% of gross domestic product (GDP), and grew at a 6.4% annual rate during the 1990s. According to projections from the Center for Medicare & Medicaid Services (CMS; Washington), spending on health care will grow at a 7.4% compound annual rate over the next eight years, with expenditures reaching 15.9% of GDP by 2010. Health insurance premiums in the private sector increased at double-digit rates in 2000 and 2001, and even higher increases may be in store this year. Key factors in the U.S. health care market include the decline of managed care, increases in employee payments for health care, rapid growth in the number of uninsured individuals, escalating prices for prescription drugs, and hospital capacity limits and labor shortages that are fueling inflation of health care costs.

According to other presenters at the UCI conference, new government initiatives will also be a factor in increased health care spending, including the possible implementation of a prescription drug benefit for Medicare beneficiaries as well as provider givebacks. In addition, most economists view new medical technology as a driver of inflation in health care costs, and the pace of innovation in the medical industry, including the pharmaceutical sector, remains strong.

Long-term technological trends that are expected to impact the health care sector include new developments in biotechnology and genomics, advances in health care information technology including telemedicine, web-based health care and continued advances in diagnostic imaging modalities. For suppliers of such technologies and other health care products, the economic picture is encouraging because of the increased ability of hospitals and other care providers to demand higher payments from third-party payers. Sectors that are likely to benefit the most from forecast trends in the health care market, according to presenters at the conference, include cardiology, orthopedics, neurology, and pharmaceutical products.

Continued growth in spending

The trend in health care insurance premiums is a striking indicator of the recent upturn in health care spending, although at least in part the premium increases are contributing to improved profitability for insurers. For example, Wellpoint Health Networks (Thousand Oaks, California), the parent of Blue Cross/Blue Shield, reported net income of $414.7 million for 2001, an increase of 21% over 2000, on revenues of $12.4 billion, up 35% vs. the prior year. Premium revenue also increased 35% to $11.6 billion. Cigna (Philadelphia, Pennsylvania) reported operating income of $1.1 billion for 2001, up 6%, on revenues of $19.1 billion. As shown in Table 2, trends in health care insurance premium increases have been almost the exact reverse of trends in the U.S. economy, dropping to historically low levels throughout most of the 1990s when economic growth was strong, and trending upwards in 2000 and 2001 as the recession set in. General price inflation and increases in worker earnings were not factors contributing to premium increases, as both have remained low (at 4% per year or less) since 1988.

The recent increases are primarily attributable to the exodus of members from health maintenance organization (HMO) plans and into preferred provider organizations (PPOs) and point of service (POS) plans offering more benefits at a higher premium. Based on data from the Kaiser Family Foundation and the Health Research and Educational Trust (Washington), nationwide HMO enrollment fell to 23% in 2001 from a peak of 31% in 1996. HMO enrollment in California dropped below 50% for the first time in at least eight years, to 48% in 2001 from 55% in 2000. As discussed at the UCI gathering by Jon Gabel, PhD, of the Health Research and Educational Trust, the trend may signal the end of the era of managed care. The decline in enrollment in HMO plans effectively results in a loss of the ability of the health care system in the U.S. to ration services. The trend is the result of a consumer backlash against the limitations imposed by managed care, coupled with the fact that employees in employer-sponsored health plans are largely shielded from the true cost of care and view managed care plans as simply limiting their access to necessary services. Furthermore, premium increases do not represent the full extent of increases in health care spending, since many employers are now requiring employees enrolled in HMOs and POS plans to pay more out of pocket for health care. The trends show that consumers are not only rebelling against restrictions on the availability of services, but are also agreeing to pay more for health care.

Recent increases in health care costs have been highest for hospital inpatient care and prescription drugs. Over the period from 1994 through 2000, according to data presented by Gabel, the annual percentage change in per capita prescription drug costs rose from about 5% to between 15% and 20%. According to another presenter, David Helwig of Wellpoint Health Networks, about 40% of the increase is due to an increased number of prescriptions, while 36% is due to the use of higher-cost drugs. Hospital inpatient costs actually declined each year from 1994 to 1998, but registered a slight percentage increase in 1999 and 2000. Since, in aggregate, hospital inpatient costs represent a large proportion of total health care costs, small percentage increases result in large growth in dollar volume costs. Increases in hospital outpatient and physician costs, on the other hand, remained relatively stable over the 1994-2000 period, at about 8% and between 1% and 5% respectively. Increases in prescription drug costs are, of course, an issue of wide concern among consumers and politicians. New rules are already being considered for the Medicare program that will limit spending for drugs prescribed under Part B services. That is in response to projections that show per capita spending for prescription drugs for Medicare patients increasing from $2,238 to $4,818 between 2003 and 2011.

Increases in the cost of hospital inpatient care are attributed in part to hospital capacity limits and labor shortages. Hospital admissions have been rising at double the historic rate, according to Sheryl Skolnick, PhD, of Fulcrum Global Partners (New York), a presenter at the UCI gathering. "Same store" hospital admissions are up 6% or more vs. historic increases of 1% to 3%. Hospital length of stay also is increasing, from a level of 4 to 5 days on average in the past to 5.2 to 5.3 days at present. Many intensive care units are filled to capacity, in spite of the high cost of care in that setting. Nursing shortages and shortages of other health care professionals such as laboratory technologists are likely to drive up labor costs. Faced with such strong demand, hospitals have succeeded in justifying increases in reimbursement levels in contract negotiations with insurers, and higher occupancy rates coupled with a more acutely ill patient population have driven up total expenditures for hospital inpatients even in the absence of rate increases. One approach to reducing inpatient costs is to treat patients in alternative care settings whenever possible, expanding use of ambulatory surgery centers, home health care services, and other lower-cost alternatives to hospital inpatient care. However, the sub-acute care industry has essentially disappeared, and spending for home health care has dropped 50% since the implementation of the Balanced Budget Act. Additional cuts in home care spending by the federal government have been stipulated in budget legislation, but have not yet been implemented due to lobbying efforts by the home health care industry. Those cuts are still, however, pending. As a result, there is a limit to the degree to which hospital inpatient care costs can be reduced by switching to alternative care options. Since many physicians and plan administrators believe that a considerable proportion of the care delivered in the hospital inpatient setting could be moved to lower-cost alternative care sites with no loss in quality or adverse effect on outcome, the stage seems to be set for growth in alternate site care. However, the past history of fraud and abuse in the home care industry continues to dampen efforts to revive that sector, and data showing that half of all home care visits are for non-Medicare services does not stimulate policy makers to emphasize home health care as a solution to rising hospital costs. Attracting investment to expand capacity in other alternative care settings, with the exception of ambulatory surgery centers, is likely to prove difficult, based on past investor experience in that segment.

A concern for health care policy makers is the continued rapid increase in the number of uninsured individuals in the U.S. According to Dean Rosen, Republican staff director of the Senate Labor Committee, the proportion of the U.S. population without health care insurance may increase from 20% at present, or about 55 million people, to 24%, about 73 million, by 2010. That compares to a level of 45 million in early 2000. The main driver of the increase is the imbalance between wage increases and increases in the cost of health care insurance. According to one formula that has been developed in California, between 20,000 and 40,000 people lose health insurance each year in that state (which accounts for 12% of the U.S. population) for every percent difference between insurance premium increases and wage/salary increases. A related issue is the increasing number of patients who are becoming caught in payment disputes between insurers, particularly HMOs, and providers, as well as patients whose insurers have filed for bankruptcy. Many states are moving, sometimes in a highly visible manner as in a recent dispute between the state of Texas and PacificCare in California, to protect patients and providers in such situations, but such actions inevitably will force premiums even higher, worsening the problem with the uninsured.

The long-term outlook for the health care industry, according to many of the presenters at the UCI conference, is a transition from managed care to an era of consumer incentives to control health care costs. As discussed at the UCI conference by Paul Ginsberg, PhD, president of the Center for Studying Health System Change (Washington), significant cultural changes in medicine could result. Health care is now moving from the 1990s-based approach of integrated delivery systems and evidence-based medicine to one that includes direct access to specialists, reduced authorization requirements, broad provider networks, and appeals processes for patients who believe they have been denied care unfairly. The change was to some extent inevitable, according to Ginsberg, because certain elements of the managed care approach, such as steep discounts by providers and gatekeepers charged with rationing of care, were not sustainable or not acceptable to patients. One insurer, United Healthcare, a unit of UnitedHealth Group (Minnetonka, Minnesota), led the move to reduced managed care authorization requirements in 1999 with its Care Coordination program, and demonstrated cost savings with that approach, along with the implementation of disease management programs. However, reduced authorization requirements have not worked as well for other insurers, according to Ginsberg. Disease management programs, which are positioned as a positive approach to health care vs. crisis-based medicine, have had some successes, but overall have had a limited impact.

The current trend toward reduced constraints on the availability of care, sharply higher premiums and increased co-pays by patients succeeded initially in large part because of the booming economy, a herd effect among employers to use improved health benefits as an incentive to hire and retain employees, and the relatively low cost levels that were engendered by managed care. With the economic slowdown, the trend to shift costs to the patient is likely to accelerate, and reductions in benefits are also likely. One new approach already introduced by some major insurers (e.g., Wellpoint and Aetna) as well as some smaller ones is defined contribution plans, which provide employees with a high-deductible insurance plan plus a fixed amount from the employer in a medical savings account that is used at the discretion of the employee to purchase health care, in theory at the best price. However, comparison shopping for health care by consumers is difficult if not impossible because of the limited availability of cost data, and there is also an issue with changes in the risk pool structure that could result in lower revenues for insurers without a corresponding lowering of costs. Another alternative, that of shifting costs to employees by requiring higher co-payments or reducing benefits, has the disadvantage of loss of the tax benefits of medical savings accounts, plus the obvious reluctance of employees who are high consumers of health care services to participate. While a health care system that provides a solution to the myriad issues facing the industry today remains elusive, there are some initiatives that can clearly help. Skolnick, for instance, noted that technology can provide some answers. For example, processing costs for health care claims and reimbursement can be reduced through the effective use of information technology, and automation and streamlining of processes is another valuable tool. For health care providers as well as medical product manufacturers, improving the cost-effectiveness of care has been an ongoing priority, but in the future it is likely that the market will become even less tolerant of a failure to succeed in controlling costs.

Uncertain role of government

Government, both at the federal and state level, is expected to continue to play an important role in the U.S. health care system as a greater proportion of the population qualifies for Medicare coverage. As recently as two years ago the federal Medicare/Medicaid program was projected to reach insolvency within a decade, but that crisis was postponed thanks to a strong economy and budget surpluses. Nevertheless, the Medicare Trust Fund continues to be in jeopardy. Forecasters now predict that outflows will exceed income sometime between 2021 and 2025, and that the fund will be exhausted between 2029 and 2038. No longer facing a near-term crisis, the focus of politicians has shifted from Medicare reform to Medicare modernization. A key initiative is outpatient prescription drug coverage for Medicare patients. However, there are other issues with Medicare coverage that need to be addressed, such as the lack of payment for most routine preventive care or long term care, lack of catastrophic protection, and the seemingly irrational cost-sharing structure of the program. In addition, Medicare pays on average only about 50% of total health care costs for participants in the program (80% of all covered services). Another undesirable feature of the program, according to Murray Ross, PhD, executive director of the Medicare Payment Advisory Commission (Washington), is the inconsistent level of payment by region. Spending varies by region in the U.S. much more than would be expected based on variations in cost of living and demographic factors, indicating inefficiencies in the program.

Options for dealing with the problems facing the Medicare program, according to Ross, include raising taxes and/or premiums; reducing the scope and/or depth of benefits; and increasing program efficiency. Since the first two options are universally unpopular, most modernization proposals have focused on the third. Proposals to improve efficiency focus on cost sharing rationalization, including elimination of payment inequities experienced by rural providers; regulatory relief for providers; and fee-for-service modernization. Bundling of payment for services, selective contracting to allow use of the most cost-effective providers, and the use of cost-sharing to promote improved spending decisions by participants are other proposed mechanisms. In addition, there are proposals under consideration that will benefit providers, the most important of which is a series of provider givebacks totaling $46 billion by 2003, including $16 billion for physicians, $15 billion for nursing facilities, $7 billion for home health care, $5 billion for Medicare Plus Choice plans, and $3 billion for hospitals. The total amount is comparable to the $53 billion in givebacks that resulted from the Balanced Budget Refinement Act of 1999 ($17 billion) plus the Benefits Improvement and Protection Act of 2000 ($36 billion). The physician giveback is to be implemented via a 2.5% rate update, while the home health giveback includes repeal of the 15% cut mandated by the Balanced Budget Act. The Medicare Plus Choice program, which has been effectively been written off by the industry, will be restructured so that providers receive fee-for-service, rather than HMO, rates.

As shown in Table 3, combined Medicare and Medicaid spending increased 30% between 1996 and 2001, and spending is projected to almost double between 2001 and 2010, growing at a 6.8% annual rate. Medicaid spending will grow considerably faster than Medicare spending. However, spending as a percentage of total national health expenditures will increase only slightly, and will remain under the level in 1996. The actual level of spending that can be accommodated will depend to a large degree on the overall budget picture at the federal and state levels. Although budget forecasts have been notoriously unreliable over the past few years, and would likely be completely invalidated in the event of a major war, current projections, as described by Liz Fowler of the Senate Finance Committee, indicate rising surpluses starting in 2004. A $21 billion deficit is projected for this year, dropping to $14 billion in 2003. But by 2012, projections call for a surplus of $641 billion. The projected surpluses rise dramatically in 2011 and 2012 as a result of the expiration of certain federal tax reductions. The projected surpluses could be reduced significantly if a Medicare prescription drug benefit is enacted. Estimates of the cost of such a benefit range from $190 billion in the president's 2003 budget to $1.15 trillion, depending on assumptions. Options for financing such a benefit include use of the expected Social Security surplus (a tactic supported by many seniors), a delay in proposed tax cuts, drug cost containment programs, and identification of offsetting cuts in other parts of the budget. However, if the high-side cost estimate is correct, it may be that a drug benefit cannot be afforded at all.

Role of new technologies in health care

Medical technology is expected to play an increasingly important role in the U.S. health care system, both in driving advances in diagnostic and therapeutic modalities as well as in improving the efficiency of health care delivery. Information technologies, including telemedicine, are already beginning to play a significant role in health care. For example, web-based health care information is helping to stimulate the role of consumerism in health care, allowing patients to take a more active role. One emerging company, Imetrikus (Carlsbad, California), has introduced the concept of the Internet port for web-based health care. As opposed to existing Internet portals that are primarily informational and static, Internet ports provide chronic disease patients with an interactive and personalized resource that can be used to interface with their physician via the web. The company introduced MyHealthChannel in February 2000 to allow patients to track their health condition in a secure and anonymous setting, to harvest the best medical information from the web and provide it on their desktop, to communicate with caregivers and to purchase health care products specific for management of their particular disease state. The company's customers include Home Diagnostics (Eatontown, New Jersey), Disetronic Medical (Burgdorf, Switzerland) and LXN, now part of LifeScan (Milpitas, California), all suppliers of diabetes management products. Also included are online health care product suppliers including CVS Pharmacy (Woonsocket, Rhode Island), (Bellevue, Washington) and Diabetes Mall (San Diego, California) and a number of information technology suppliers. One application example is a new online service developed in partnership with Disetronic called InSight, which provides patients who use Disetronic's insulin infusion pumps with a personalized, secure diabetes health record. A related service, Disetronic Professional, is available to physicians who prescribe the Disetronic pump for their patients.

Another supplier of web-based health care services is PhysicianWebLink (Mission Viejo, California). PhysicianWebLink has developed WellLink, a web-based product that improves communication between patients, physicians, staff and IPAs. The product enables patients to view their medical records, including hand-written records, on line and provides access to prescription and referral information as well as lab results. The system also provides connectivity between physicians and their central organization, such as an integrated delivery network. The use of such technologies to improve the efficiency of health care delivery is one approach to controlling health care costs that avoids the need for politically unpopular options, while providing opportunities for medical technology companies.

Telemedicine has been an evolving application for information technology in health care for a number of years. However, it has only recently that applications in mainstream medicine have begun to materialize. As discussed by Robert Bratton, MD, of the Mayo Clinic Florida (Jacksonville, Florida), telemedicine applications are now under development for management of a number of chronic diseases including diabetes, hypertension, asthma, chronic obstructive pulmonary disease and congestive heart failure (CHF). Mayo physicians are evaluating a new telemedicine system manufactured by Motion Media Technology (Bristol, UK) in a retirement community in Florida for chronic disease management. The device allows two-way audio-video communications and also allows interface of various devices such as blood pressure monitors and blood glucose monitors to provide physicians with patient data collected in the patient's home, nursing homes or other alternate sites.

Other companies are focusing on specific applications such as monitoring of weight and blood pressure in CHF patients, and field studies have already shown significant cost advantages. Bratton referred to a study conducted in 1992 by Arthur D. Little (Cambridge, Massachusetts) that concluded that health care cost savings of over $200 million per year could be realized by the use of video conferencing for remote medical consultation, and noted that costs for telemedicine equipment have declined significantly since that study was performed. The cost of the Motion Media system ranges from $5,000 to $15,000, and the system provides interfaces to a blood pressure monitor, body weight scale, pulse oximeter, thermometer, glucometer, peak flow meter, electronic stethoscope and ECG monitor. The cost for the communications line, which can be a telephone line, fiberoptic cable or Internet connection, ranges from $50 to $500 a month. A 2000 report published by Waterford Telemedicine Partners (New York) estimates that the telemedicine industry will grow 40% annually for the next 10 years and that telemedicine will represent at least 15% of all health care expenditures in the U.S. by 2010.