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Health Care Costs: Market Forces and Reform

Health Care Costs: Market Forces and Reform

After much anticipation regarding health care reform, 1994 ended without passage of any national legislation. The debate will probably resurface in the new Congress, since the issues and concerns surrounding the U.S. health care system still exist. However, it is unlikely that the discussion will be framed with the same sense of urgency as in 1994. Furthermore, results of last November's elections suggest a considerably reduced probability that health care reform will entail a total overhaul of the system. Nevertheless, some action can be expected at the national and state levels on issues such as pre-existing conditions and the accessibility of health insurance. Although some form of universal coverage may continue to be viewed as a goal, the time span for its achievement will likely be lengthened.

Despite the absence of major health legislation at the national level, the delivery and financing of U.S. health care have undergone, and will continue to undergo, modifications. Similar to the pattern of recent years, much of the change will continue to be initiated at the state level. While quality of care remains a major element of the debate, cost has been the major driving force behind many of the changes.

The desire to control sharply rising costs appears to have steered the U.S. health care system in the direction of managed care. Recent trends suggest that enrollment in health maintenance organizations (HMOs) for 1994 is close to 50 million, with market penetration approaching 20% [1]. Although surveys differ as to the estimated level of enrollment, they are consistent in pointing to significant growth in recent years. Existing and prospective competition have precipitated a consolidation within the various industries that encompass the health care system. Barring any dramatic shift in course, these market forces are expected to intensify during the remainder of the 1990s.

National Health Expenditures

Many of the cost issues and other concerns over health care in this country led to a focus on the level and growth of national health expenditures. The latest estimates from the Health Care Financing Administration (HCFA) put 1993 health care expenditures at $884.2 billion, representing an increase of 7.8% over spending in 1992 [2]. This was the slowest growth rate recorded by national health expenditures since 1986. As shown in the Figure 1, total health care spending is projected to exceed $1 trillion in 1995. The annual growth rate for the 1990 to 1995 period is expected to average 8%, compared to 9.9% for the previous 5 years.

According to Health Care Financing Administration data, spending on personal health care totaled $782.5 billion in 1993, an increase of 7.2% over the prior year. Table 1 shows a breakdown by type of expenditure and source of payment. Hospital care and physicians' services combined accounted for more than three-fifths of personal health expenditures. In the past, the relatively low out-of-pocket share for these categories has been singled out as a main cause for the sharp increase in expenditures. Although this share remains low for both categories, especially hospital care, each showed relatively slow growth in 1993. Among the various categories, home health care continues to display the fastest growth, by far, while "other professional services" continues to record above-average growth.

Although the growth rate for health care spending has slowed in recent years, it remains above that of the overall economy. National health expenditures were equivalent to 13.9% of Gross Domestic Product (GDP) in 1993. Current estimates for 1995 put the ratio of national health expenditures to GDP at 14.3%. Just 5 years prior, spending on health care represented 12.6% of the goods and services produced in the United States, with the ratio 10 years ago at 10.8% [3].

The rising share of resources being channeled into US health care, as evidenced by this ratio, remains one of the focal points of the ongoing debate in the United States. The extent of the health care claim on resources is even more apparent when viewed in a context of marginal analysis, ie, looking at incremental changes [4]. The $70 billion increase in national health expenditures projected for 1995 represents 18% of the expected dollar increase in Gross Domestic Product. Thus, despite a discernible slowing in spending on health care, still almost one-fifth of new economic resources in 1995 will be devoted to this category of spending.

International Comparisons

International comparisons have also played a central role in the questions regarding resource utilization and health care in the United States. The latest data from the Organization for Economic Cooperation and Development (OECD) [3] show US health care spending at a significantly above-average percentage of gross domestic product. In addition to the current relatively high share of gross domestic product, the data show that during the 1985 to 1992 period, the United States exhibited a larger increase in the share compared to other major industrial countries. Interestingly, Canada, whose single-payer system has been touted as a possible model for the United States, came in second in terms of both relative share and growth since 1985.

Medical Care Inflation

Clearly, one of the most notable developments regarding health care costs has been the dramatic slowing in medical care inflation as measured in the Consumer Price Index (CPI), which measures price changes for a specific "market basket" of consumer goods and services. The difference in importance among various items between the medical care CPI and health insurance plans explains, in large part, why cost experiences have shown gains substantially greater than the medical Consumer Price Index. Other factors include technology advances, higher utilization, and the rise in catastrophic cases.

Although disagreement over some of the technical aspects of the Consumer Price Index persist, the deceleration in the medical care component of the CPI has been too significant to be dismissed. As indicated in Table 2, the increase for 1994 is estimated at just 4.8%-the smallest increase since 1973. This result followed a gain of 5.9% in 1993, and was substantially below our forecast of a year ago [5].

Much of the difference from the projection was reflected in a sharp slowing among hospital and related services. The categories in this grouping, ie, rooms, inpatient services, and outpatient services, are displaying their slowest price increases since the mid-1980s-a period when prospective payment and diagnostic related groups were adopted into Medicare. Physicians' services also contributed to the lower-than-expected rise in the medical care component of the Consumer Price Index for 1994.

While some of the slowing in the medical care CPI can be attributed to a lower level of general inflation, a significant narrowing of the gap between the two suggests the presence of factors specific to medical care. Projections for 1995 show the gap narrowing further, despite a slight increase in medical care inflation.

Regional Perspectives

Although the health care issue is viewed nationally, many of the developments regarding health care are transpiring at the regional level. State health expenditure data prepared by the Health Care Financing Administration reveal significant regional variations [6]. According to the data supplied by the HCFA in 1993, New England has the highest spending relative to the country as a whole, with the Rocky Mountain states at the other end of the scale. The fastest growth for the period was recorded in the southeast, at 10.3% annually, followed by New England and the mid-eastern states. The far west, at 8.2%, exhibited the slowest growth. Not surprisingly, the high-cost, high-growth regions were the same as those with an above-average proportion of the population aged 65 and older. The Plains states were an exception. Although showing the largest proportion of older residents, their spending and growth were about average.

Changing Landscape

The factors that differentiate health care from other parts of the economy have been widely discussed: consumers do not pay directly for a large proportion of expenditures; suppliers are intricately involved in the demand decisions; technology advancements increase demand and, in many instances, do not improve productivity.

Despite these attributes, health care is not immune to market forces and the laws of economics. Although much of the industry remains on a nonprofit basis, cost pressures are significantly influencing behavior. Mergers and acquisitions have become commonplace, as firms jockey for position in the new environment.

Summary and Conclusions

The cry for health care reform has diminished somewhat. Nevertheless, more changes are forthcoming. For the foreseeable future, health care will demand a rising share of resources. Earlier estimates put the proportion of health expenditures to Gross Domestic Product at almost 17% by the year 2000.

Although there is no magic number regarding this proportion, its relative level in the United States strongly suggests that changes need to take place. It would appear that the population prefers that changes be instituted through the private sector, and not through extensive government involvement and regulation.


1. Group Health Association of America: Patterns in HMO Enrollment: 1994. Group Health Association of America, Washington, DC, 1994.

2. Levit KR, Sensenig AL, Cowan CA, et al: National health expenditures, 1993. Health Care Financing Review 16(1):251-298, 1994.

3. Schieber GJ, Poullier JP, Greenwald LM: Health system performance in Organization for Economic Cooperation and Development countries, 1980-1992. Health Affairs 100-112, Fall 1994.

4. Vincenzino JV: Developments in medical care costs: An update. Statistical Bulletin 74(1):29-35, 1993.

5. Vincenzino JV: Developments in health care costs-An update. Statistical Bulletin 75(1):30-35, 1994.

6. Levit KR, Lazenby HC, Cowan CA, et al: Health spending by state: New estimates for policy making. Health Affairs 7-26, Fall 1993.

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