Cutting health care costs means reducing utilization

by Mark Coyne

The core of the health care debate revolves around the perceived spiraling cost of health care in America. There are many quotes in the media, and from politicians, that health care costs are increasing by more than 10 percent a year, and consistently increasing by more than wage growth – which is unsustainable in the long term. The basic point being made is correct, the overall cost of health care is increasing by an unsustainable rate versus wages, but the reason for that growth is less well understood. The reason is important as it goes to the root problem in the American health care system and therefore has a huge impact on what the solution should be.

The frequently quoted cost of health care is the amount of premium that an average insured individual or family pays each year. What is important to remember about premiums is that:

1. They are based not only on unit cost, but also utilization, i.e. the amount of units consumed, and therefore their trend includes both aspects.

2. They only show part of the health care cost story since all health care consumers pay additional out of pocket costs.

3. They can be easily reduced by shifting cost away from the premium to out of pocket expenses such as deductibles, co-pays and coinsurance, effectively lowering the premium but not impacting the overall health care cost trend.

A better measure of actual medical care cost trend is to use the same approach used to measure growth in unit costs for any other good or service, i.e. inflation or the consumer price index (CPI). As luck would have it, the government (the Bureau of Labor Statistics) actually monitors this number for the health care industry and issues a Medical Care CPI number that includes all healthcare costs such as physician salaries, hospital costs, medical equipment costs and drug costs.

What is interesting about analyzing this number is that it has stayed remarkably constant over the past 10 years with a variation between 2.8 percent and 4.7 percent from 1997 to 2007. This is certainly nothing like the 10+ percent we hear in from politicians, and is actually only a little more than overall CPI. Bottom line, actual unit medical care costs are not out of control, the procedure you got last year is not that much more expensive this year and your physician is not earning significantly more than they did last year.

So where is the disconnect? Well, as mentioned before, premiums – which are typically quoted as representing health care costs – include not only the unit price, but also the utilization of units. It doesn’t take a genius to draw the conclusion that if underlying unit costs are relatively consistent and below the growth trend of premiums, then what must be changing is the amount of units that are being consumed each year. It is not that the medical procedure you had last year is costing more, it’s that you are receiving more of them than you did last year, that is why your premium keeps going up!

Of course, I don’t mean this literally, you may not think that you are receiving any more care than you did before, but when aggregated to the level of an insurance pool and averaged out across every member of the pool, as a group more care is being delivered than in the prior year.

Why is this important? Because it shows that solutions that focus only on reducing the underlying unit cost while ignoring the utilization will ultimately fail to have any long-term impact. For example, government or insurer attempts to simply reduce costs by reducing payments for a service will not change the basic upwards trend, it will simply delay it, distort the trend temporarily and ultimately result in payments for services that are below cost (some would argue that Medicare is already at this point).

This is perhaps the most important place to start when understanding the problems in health care. Unfortunately, the solutions shift from the typically popular ones of insurance company bashing, medicare payment reductions, increasing coverage, improving benefits, etc. to a stark understanding that we need to address the processes of rationing health care, improving population health, and increasing the financial responsibility of individuals in their health care so they do not perceive it as ‘free’ once a premium check is paid.

These are politically difficult issues to address, so don’t expect the politicians to tell you about them any time soon, but unless you see direct attempts in the health care reform to address these issues you can be sure that your premiums will continue to up.

Mark Coyne is President of Zepherella.

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