Why medical costs are rising

Wealthier nations all spend more on health. However, the U.S. spends well above what would be expected, compared with its peers. McKinsey Global Institute used data from 13 industrialized nations to develop a measure it called Estimated Spending According to Wealth (ESAW). By McKinsey’s calculations, $477 billion of the $1.7 trillion the U.S. spent on health care in 2003 was in excess of what it should have spent based on its wealth. Analysts said the condition of Americans’ health did not explain the higher costs. Hospital and physician care accounted for 85 percent of the excess spending.

McKinsey said a huge driver of costs is the fact that providers are expanding capacity, in part because they can produce their own demand. This echoes ample research showing that health-care use rises when facilities expand or open, independent of population health. McKinsey also cited technological innovation that invariably delivers more expensive care, and the fact that patients are insensitive to high prices because their out-of-pocket costs are, in general, so low.

In a classic Health Affairs journal study called “It’s The Prices, Stupid: Why The United States Is So Different From Other Countries,” the researchers argued that Americans spend more on health care even though they use fewer health services than other developed nations. The difference, they said, was that the U.S. health-care providers charged higher prices.

For example, the U.S. consumes 10 percent fewer drugs per capita than other industrialized nations. However, the U.S. spends 70 percent more for drugs. The U.S. also has comparatively lower disease prevalence because it has a younger population and lower smoking rates. It also has the lowest hospital usage compared with 10 peer nations and ranks eighth out of 10 in the number of physician visits.

The reason for higher U.S. prices is that buyers lack negotiating power – or choose not to exercise it. Other nations consolidate their bargaining power either in their governments or as cooperatives. They negotiate one standard – and invariably lower – price for health services and pharmaceutical drugs. In the U.S., there is no government purchaser willing to bargain on behalf of constituents. The continuing consolidation of hospitals and physicians leaves health plans in weaker negotiating positions.

The government shies away from using its buying power. Mike Leavitt, Health and Human Services secretary under President George W. Bush, said he opposed negotiating Medicare drug prices because “it really isn’t about government negotiating drug prices. It’s a surrogate for a much larger issue, which is really government-run health care.”

During the health-reform debate, the Obama administration dropped the “public option” insurance plan, even though it would have been one of several available options on the health insurance exchanges. It also decided not to seek to negotiate lower drug prices for Medicare.

Other nations do not have a choice on whether to drive a hard bargain with health-care providers. If they spent the same portion of GDP as the United States did, the required tax burden likely would cripple their economies. The United States is not at that point, but is well on its way.

The International Federation of Health Plans surveyed 12 industrialized nations on the costs of 14 common procedures. Each nation but the U.S. reported one price. The U.S. reported a range of prices because of its fragmented negotiating landscape. The price differences were significant. The cost of delivering a baby was $2,667 in Canada, $2,147 in Germany and an average of $8,435 in the U.S. A comparable length of hospital stay cost $1,679 in Spain, $7,707 in Canada and ranged from $14,427 to $45,902 in the U.S..

Even though U.S. physicians deliver less care than doctors in other industrialized nations do, their average income is about three times greater. The ratio of physician income to that of the average U.S. employee is 5.5, compared with 1.5 in Great Britain and Sweden.

Health reform attempts to reduce the amount of care consumed, rather than attempt to control prices. It will encourage doctors and hospitals to form accountable care organizations (ACOs) and pays them a fixed sum to discourage unnecessary care. The law also funds comparative-effectiveness research in an effort to reduce less effective treatments. However, many health-policy analysts consider these  measures too weak to counteract the proliferation of expensive procedures and emerging, costly technologies.

The fragmented health-care sector is also larded with excessive administrative costs. The McKinsey Global Institute estimated that administration accounted for 21 percent of ESAW. Most of that is because of the incredibly complex U.S. private insurance system. The U.S. spends about six times more on insurance administration than other industrialized nations.

Consumers weigh in

Few health consumers blame technology and market power for rising health-care costs. Instead, they point to favored demons, real and imagined. In a HealthDay/Harris Interactive poll, 6 out of 10 blamed insurance companies and pharmaceutical firms. About half blame hospitals.

Health economists say insurance and drug-company profits account for about 2 percent of total health-care spending. A 2009 analysis of hospital finances found that the median profit margin for U.S. hospitals was zero.

More than 1 in 3 poll respondents blamed obese and overweight people. The least-cited reason: Their own excessive use of health services.

In health care, cost does not equal quality

Cost and quality are not the same in health care. Many health-care providers charge high prices because they can. However, there are physicians and organizations that deliver high-quality care at 20 percent below the average price. If everyone could do the same, the percentage of GDP devoted to health care would decline from 17 to 13 percent – an annual savings of about $640 billion.

Most Americans have two perspectives on health-care quality and costs: the nation’s and their own. About 80 percent say they are dissatisfied with the cost of health-care nationally, and more than half are dissatisfied with overall quality. However, nearly 9 out of 10 are satisfied with their own insurance coverage and the quality of care they receive. More than half are satisfied with their own health-care costs.

Those who are dissatisfied with national costs point to several culprits. About half blame what they believe are excessive profits for drug and insurance companies. About a third blames fraud and waste, physician and hospital profits and medical-malpractice lawsuits for rising costs. About 30 percent say unnecessary treatments and Americans’ unhealthy lifestyles are boosting costs. Only 28 percent agree with health-policy experts who say expensive technology is the main culprit. One in 8 says higher costs are yielding better care.

The U.S ranks poorly in international comparisons of health systems.  A 2000 World Health Organization report ranked the U.S. 37th in the world. The report measured the extent to which investments in public health and medical care improved health, reduced disparities and protected citizens from medical impoverishment.

The Commonwealth Fund ranked seven industrialized nations in 2010 on quality, efficiency, access to care, equity and the ability to live long, healthy and productive lives. The U.S. was last.

In these rankings, the glaring conclusion is that the U.S. does not create value in proportion to what it spends. While there are certainly inefficiencies in other U.S. economic sectors – such as education, transportation and energy – health care stands as an egregious outlier. However, health-care providers are paid for quantity, not quality, of care. We get what we pay for.

Health care squeezes family budgets

As state and federal lawmakers grapple with skyrocketing health-care costs, households across America are doing the same.

Expecting health reform to provide relief is wishful thinking.

In less than a decade, the annual health-care costs for a typical family have more than doubled, to $19,400. That is the price of a 2011 Hyundai Sonata. The average family bears about 40 percent of that cost, with employers paying the rest. However, a more realistic view is that employees pay for all of it because most wage-and-benefit increases go toward health-insurance costs.

Most people have only a vague notion of how valuable health insurance can be. The median household income for a four-person U.S. family in 2009 was about $70,300. However, the Congressional Budget Office (CBO) estimates the true figure to be $94,900. A footnote on page 65 of a CBO budget forecast said this: “All income is assumed to be from compensation, which includes employment-based health insurance and the employer’s share of payroll taxes.”

That additional value does not mean much to those living paycheck to paycheck. Each family has a different financial pressure point. The media often focus on catastrophic costs inflicted on people with no insurance. The broader story of health-care costs is about financial strain spread across a wide swath of American households. The pain affects much of the middle class and some of the upper middle class as well, including those with employer-sponsored insurance.

Americans actually pay a far lower share of health expenses than they used to. The main purpose of health insurance originally was to cover catastrophic episodes. Before the introduction of Medicare and Medicaid in 1965, patients paid more than half the cost of care out of pocket. That shrank to 15 percent in 2008. Meanwhile, private health plans’ share of the bill rose from 21 to 35 percent and government’s portion doubled, to 50 percent. The perception that medical bills are the responsibility of someone other than the patient has been a prime contributor to health-care demand over the past four decades.

A Deloitte study estimates that consumers pay an additional 15 percent out of pocket on personal health not captured by government statistics. These costs include unpaid caregiving, over-the-counter medications, and complementary and alternative medical care not covered by insurance.

The inability to pay medical bills and buy prescription drugs is the most persistent household finance problem, according to a recent Consumer Reports poll. About 40 percent of Americans had trouble paying medical bills in 2010, up from 34 percent in 2005. More than one-quarter of insured households reported problems with medical debt.

Even more disturbing is widespread self-rationing. Nearly 6 out of 10 adults said they delayed care because of cost. About 40 percent of those in fair or poor health did not fill at least one prescription in the past year. People with chronic conditions who fail to take medication are flirting with disastrous consequences.

Americans generally cite lack of access as the greatest obstacle to health care, followed by costs. Lack of access can mean several things. In some instances, people cannot see a physician or specialist promptly. Nearly 60 percent say they cannot find care after physician office hours, 40 percent cannot get service by phone and 30 percent cannot get a timely office appointment.

Increasingly, though, lack of health-care access means not being able to afford it.

According to an ongoing household survey, the incidence of delaying needed care rose sharply between 2003 and 2007. Insured people are among those facing cost pressures. They are paying more out-of-pocket for care, finding fewer doctors who accept their insurance and facing more limits on what insurance will cover. During those four years, the percentage of those with unmet medical needs increased more among the insured than the uninsured.

It is difficult to pinpoint when health-care costs become burdensome. The Center for Studying Health System Change found that financial pressures increase significantly after out-of-pocket spending exceeds 2.5 percent of family income. Unlike a mortgage, groceries and utilities, medical costs are less predictable and often unexpected. High medical expenses generally are urgent and associated with serious conditions. Significant injury or disease may also result in loss of income. Even two-thirds of Americans earning more than $75,000 a year worry about getting or paying for future care.

Women experience greater cost and access problems. More than half of women have trouble getting care, and more than 60 percent under age 65 have difficulty paying medical bills. Women use the health-care system more than men do. They often must make choices between getting care or paying credit-card bills, the mortgage or for basic necessities.

Why the U.S. spends more on health

Wealthier nations all spend more on health. However, the U.S. spends well above what would be expected, compared with its peers. McKinsey Global Institute used data from 13 industrialized nations to develop a measure it called Estimated Spending According to Wealth (ESAW). By McKinsey’s calculations, $477 billion of the $1.7 trillion the U.S. spent on health care in 2003 was in excess of what it should have spent based on its wealth. Analysts said the condition of Americans’ health did not explain the higher costs. Hospital and physician care accounted for 85 percent of the excess spending.

McKinsey said a huge driver of costs is the fact that providers are expanding capacity, in part because they can produce their own demand. This echoes ample research showing that health-care use rises when facilities expand or open, independent of population health. McKinsey also cited technological innovation that invariably delivers more expensive care, and the fact that patients are insensitive to high prices because their out-of-pocket costs are, in general, so low.

In a classic Health Affairs journal study called “It’s The Prices, Stupid: Why The United States Is So Different From Other Countries,” the researchers argued that Americans spend more on health care even though they use fewer health services than other developed nations. The difference, they said, was that the U.S. health-care providers charged higher prices.

For example, the U.S. consumes 10 percent fewer drugs per capita than other industrialized nations. However, the U.S. spends 70 percent more for drugs. The U.S. also has comparatively lower disease prevalence because it has a younger population and lower smoking rates. It also has the lowest hospital usage compared with 10 peer nations and ranks eighth out of 10 in the number of physician visits.

The reason for higher U.S. prices is that buyers lack negotiating power – or choose not to exercise it. Other nations consolidate their bargaining power either in their governments or as cooperatives. They negotiate one standard – and invariably lower – price for health services and pharmaceutical drugs. In the U.S., there is no government purchaser willing to bargain on behalf of constituents. The continuing consolidation of hospitals and physicians leaves health plans in weaker negotiating positions.

The government shies away from using its buying power. Mike Leavitt, Health and Human Services secretary under President George W. Bush, said he opposed negotiating Medicare drug prices because “it really isn’t about government negotiating drug prices. It’s a surrogate for a much larger issue, which is really government-run health care.”

During the health-reform debate, the Obama administration dropped the “public option” insurance plan, even though it would have been one of several available options on the health insurance exchanges. It also decided not to seek to negotiate lower drug prices for Medicare.

Other nations do not have a choice on whether to drive a hard bargain with health-care providers. If they spent the same portion of GDP as the United States did, the required tax burden likely would cripple their economies. The United States is not at that point, but is well on its way.

The International Federation of Health Plans surveyed 12 industrialized nations on the costs of 14 common procedures. Each nation but the U.S. reported one price. The U.S. reported a range of prices because of its fragmented negotiating landscape. The price differences were significant. The cost of delivering a baby was $2,667 in Canada, $2,147 in Germany and an average of $8,435 in the U.S. A comparable length of hospital stay cost $1,679 in Spain, $7,707 in Canada and ranged from $14,427 to $45,902 in the U.S..

Even though U.S. physicians deliver less care than doctors in other industrialized nations do, their average income is about three times greater. The ratio of physician income to that of the average U.S. employee is 5.5, compared with 1.5 in Great Britain and Sweden.

Health reform attempts to reduce the amount of care consumed, rather than attempt to control prices. It will encourage doctors and hospitals to form accountable care organizations (ACOs) and pays them a fixed sum to discourage unnecessary care. The law also funds comparative-effectiveness research in an effort to reduce less effective treatments. However, many health-policy analysts consider these  measures too weak to counteract the proliferation of expensive procedures and emerging, costly technologies.

The fragmented health-care sector is also larded with excessive administrative costs. The McKinsey Global Institute estimated that administration accounted for 21 percent of ESAW. Most of that is because of the incredibly complex U.S. private insurance system. The U.S. spends about six times more on insurance administration than other industrialized nations.

Consumers weigh in

Few health consumers blame technology and market power for rising health-care costs. Instead, they point to favored demons, real and imagined. In a HealthDay/Harris Interactive poll, 6 out of 10 blamed insurance companies and pharmaceutical firms. About half blame hospitals.

Health economists say insurance and drug-company profits account for about 2 percent of total health-care spending. A 2009 analysis of hospital finances found that the median profit margin for U.S. hospitals was zero.

More than 1 in 3 poll respondents blamed obese and overweight people. The least-cited reason: Their own excessive use of health services.

Only a few spend the most

Efforts to cut health-care costs are complicated by the fact that medical dollars are spent on a relatively tiny sliver of the patient population. High-deductible plans will not make much of a dent in that group.

The healthiest 50 percent of Americans spend only about 3 percent of health-care dollars. On the other hand, more than $1 out of $5 health-care dollars are spent on the sickest 1 percent. The top 5 percent accounted for about half of total spending in 2009.

Technology and the market power of monopoly health-care organizations drive the lion’s share of medical inflation. Unless we want a highly regulated health-care system, those two factors are out of our control. The only other way to control health-care spending is to use less of it. We need the healthiest 50 percent to stay healthy.

When faked surgeries work as well as the real ones

The current issue of Health Affairs has an excellent case study of the aftermath of two rigorous 2009 studies in the New England Journal of Medicine that showed that vertebroplasty – an invasive back procedure that injects bone cement into the spine to treat fractures – offered no more pain relief than “surgeries” that were faked.

Two years later, Medicare and insurance companies continue to pay for the procedures. Science is ignored, and patients apparently are being ill served. This does not bode well for health reform’s efforts to increase comparative effectiveness research to determine the best way to treat medical conditions. There is a political constituency arrayed behind every procedure – the physician, the facility where it is performed and the medical device maker who produces medical supplies. A meek effort to stop paying for vertebroplasty by a Medicare carrier in the western U.S. was squashed by medical-lobbying forces.

In 2002, 180 patients with osteoarthritis were randomly assigned to undergo either arthroscopic knee surgery or fake surgery, although neither group was aware of the parameters. The results indicated that knee surgery provided no more pain relief or added mobility than the fake surgery. Predictably, the results were attacked by those who do knee surgeries. A second set of researchers did a similar study in 2008. The results were the same. Regardless, more than 500,000 patients spent $3 billion on arthroscopic surgery for arthritic knees in 2009.

An estimated 30 percent of medical spending is considered to be of no benefit. If the U.S. payers do not react to solid evidence such as this, we have no hope of dealing with medical costs that are overtaking government and household budgets.