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Why Health Care Inflation May Lead to Cheaper Health Care

There’s a possible silver lining in the almost unchecked and seemingly unstoppable rise in the cost of U.S. health care, and it will be apparent once you start paying for more of your day-to-day needs.
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The recent analysis by Pricewaterhouse Cooper's Health Research Institute which predicted a drop in health inflation rates from 7.5 percent this year to 6.5 percent in 2014 was hailed by many as good news. And yet, both figures remain significantly higher than the general inflation rate, which stood at 1.1 percent as of April, and represent a continued rise in health-care prices in real-dollar terms.

Between 2005 and 2012, health-care spending in this country increased by 40 percent. And even though health-care spending already consumes almost 18 percent of GDP, this assessment and many others seem to indicate that that percentage will only continue to grow, diverting ever-more money into the insatiable maw of the health-care system and away from investment in infrastructure, education, and jobs creation.

But could there be a silver lining?

As patients start bearing the genuine cost of their care, they will start behaving like real consumers and become much more attentive to price.

One of the reasons that health-care spending is so high is because of inflated overhead and administrative costs. One assessment done several years ago calculated those costs to be as high as 31 cents for every dollar spent, almost double the percentage in Canada, for example.

Under Obamacare, efforts are being made to rein in these costs. Large-group insurance plans, not including organizations that are self-insured, are required to keep overhead spending at or below 15 percent; for smaller-group insurance plans the figure is at or below 20 percent. Plans that do not meet these benchmarks face penalties in the form of rebates they must pay back to consumers.

In 2012, the total amount returned as rebates approached $1.3 billion. While at first glance that may appear to be a lot of money, it’s not for an industry that consumes $2.5 trillion annually. These rebates work out to 0.05 percent of total health-care spending. Fifteen percent of $2.5 trillion, however, is much more: $375 billion. Now that’s a lot of money.

More and more, health-care expenses once paid by employers are being shifted to consumers in the forms of higher co-payments and deductibles. And as the rate of health inflation continues to outpace that of general inflation, these trends will accelerate, for the simple reason that without this migration the cost of providing health insurance at its current levels of coverage will become too prohibitive for employers to bear.

And this is where the silver lining comes in. The more this cost shifting occurs, the faster the demise of the current model of third-party payor insurance, which covers everything from flu shots to lung transplants. Health insurance will evolve into something that makes a lot more economic sense: actual insurance that protects against financial ruin because of catastrophic illness. Most routine medical care services, however, will be paid for by patients, out of pocket and through health savings accounts that accrue over years and into which employers and employees contribute.

This transformation of who pays for health care, and how it is paid for, will have two very positive effects on health-care spending.

The first will be the elimination of third-party payors’ overhead and administrative margin from the cost of all but the most expensive care. This will immediately eliminate the need for the built-in 15-20 percent mark-up for administrative costs included in current charges and in future ones through Obamacare (and which in practice is often exceeded, as witnessed by the rebate pay-outs).

The second, more significant consequence will be that as patients start bearing the genuine cost of their care, they will start behaving like real consumers and become much more attentive to price. Once health-care services provision is transformed into a true marketplace in which prices are driven both by supply and consumer demand, competition between providers should result in prices falling even further.

The existing model, in which prices are determined through negotiation between service providers and third-party payors, leaving patients who pay out of pocket with the highest bills, would quickly collapse. If your doctor had ordered a chest X-ray, for example, you'd make some phone calls and decide where to get it based upon any number of factors, including price, instead of defaulting to the most expensive facility because that happened to be where your physician works. Likewise, even though you currently pay both for the X-ray and for its interpretation by a radiologist, you might elect to forgo the interpretation if your own physician were able to read the film himself, thus saving yourself the additional expense.

Clearly, this doesn’t necessarily need to be an all-or-nothing proposition. It would be advisable to decide that certain health services would be covered by government funding, whether through the catastrophic insurance policies or bodies such as Medicaid and Medicare for those unable to fund health savings accounts. (Even under Obamacare, the number of uninsured is projected to remain close to 30 million.) Among these services, for example, might be preventive medicine such as prenatal and newborn care; childhood vaccines; and screening for cancer, diabetes, and hypertension in patients deemed to be at higher risk for their development. All of these are cost-effective in that they keep the population healthier and reduce overall health-care expenditures for society. By not shifting their cost directly onto consumers, people will be less inclined to forgo them.

Cost-shifting is not necessarily a bad thing, especially when it results in reduced overhead costs and leads to lower prices because consumers are more discriminating about what they’re willing to pay. And fortunately, this unintended consequence of what now appears to be the unstoppable rise in health inflation may actually lead to significant reductions in health-care spending in the not-too-distant future.