Health Care Inflation: It's Baaack!

Costs are shooting up--and by 1998, increases could hit double digits

Stephen N. Karp doesn't like what he sees in his crystal ball. The benefits vice-president for Miami-based Ryder System Inc. anticipates a 5% rise in health costs for 1997--a big jump after three years of below-inflation increases. But it's 1998 that has Karp really worried. He's hearing that health-care costs may climb by 10% or 12% as insurers hike administrative fees and hospitals and doctors forget about cost containment and press for rate hikes. "It's pent-up cost pressure," Karp says. Insurers, he figures, "will take a deep breath and pass on some of their increased costs to customers."

Corporate America's health-cost holiday is coming to an end. For three years, employer costs rose slowly, or even fell (chart). But for 1997, health-care spending is rising more quickly than other prices--and in 1998, costs could shoot up at a double-digit pace. "The last few years have been great for employers, but now the pendulum's swinging back," says John C. Erb of benefit consultants Foster Higgins Inc. He predicts 10% hikes next year.

PLENTY TO PRUNE? Some analysts say that's too pessimistic. America's health-care providers still have plenty of costly facilities and inefficient practices to prune. With 40% of hospital beds empty every night, "we have enough excess capacity to keep a lid on costs through the turn of the century," says John F. Sheils, vice-president of health forecaster Lewin Group. But even optimists say costs will grow faster than inflation through 2000--and then accelerate.

That's bad news for the economy, for companies--and for workers. If the rising cost of health care, which accounts for 15% of the economy, triggers a jump in overall inflation that could have widespread repercussions next year and beyond.

Some consumers are already getting socked. Even with slow health-care inflation, companies have cut coverage and shifted costs to employees. The share of full-time workers with health insurance fell from 76% in 1992 to 73% in 1994, according to Princeton University economists Alan B. Krueger and Helen Levy. As costs rise, more workers are likely to face limits on medical care as employers struggle to cope.

Costs are headed up because the overhaul of the health-care system that began in the early 1990s is running out of steam. Shocked by double-digit medical inflation, major corporations launched a wholesale switch to "managed care." Millions of workers were transferred from costly fee-for-service setups, in which they went to the doctors they chose and were reimbursed by the insurer, to managed-care networks. Enrollment in such plans--health-maintenance organizations, preferred-provider organizations, and point-of-service plans--shot from 48% of covered workers in 1992 to 77% in 1996.

Since managed-care plans cost less--$3,305 per employee in 1996, vs. $3,739 for traditional insurance--every employer who made the switch saw immediate savings. Now that phenomenon is winding down. "Managed care has penetrated about as far as it can," says Paul Fronstin, health-care economist for the Employee Benefit Research Institute in Washington. The bulk of employees--50%, in Foster Higgins' latest survey--have settled into PPO or POS plans. And, fearing employee backlash, few companies are willing to cut costs further by forcing workers into HMOs, the most restrictive networks. So employers must count on competition among managed-care firms to hold prices down.

But managed-care operators aren't keen to bear the brunt of competition. In the rush to win business, insurers sacrificed margins. That became obvious last summer, when higher-than-expected drug and outpatient claims cut into HMO earnings. Minneapolis-based HMO giant United HealthCare Corp. saw profits fall 16% in 1996's second quarter, and its stock got hammered, along with those of other HMOs.

Now, insurers want their profits back. United hiked rates 5% on average for 1997, and pressed some small accounts to cough up 12% increases. It's also trying to boost efficiency, targeting better management of high-cost diseases such as congestive heart failure. But cost control is not enough, says CEO William W. McGuire: "To align the price of service with the cost of service, we've got to increase our prices."

NARROWER MARGINS. Washington is piling on costs, too. In a crowd-pleasing election-year gesture, President Clinton pushed through a measure mandating two-day maternity stays, ending "drive-by" deliveries. Now he has a budget plan that could put cost pressure on providers. Clinton expects to wring one-third of his $100 billion in Medicare savings from HMOs. Plans serving the elderly would see their reimbursement cut from 95% of local medical rates to 90%. That will still cover costs for the mostly healthy seniors who sign up for HMOs--but leaves insurers with narrower margins and less leeway to offer discounts to other customers. Meanwhile, lawmakers are responding to a consumer backlash against HMOs with laws that could hike costs.

Insurers are also taking heat from providers. Consolidation is helping hospitals and doctors win back some of the pricing clout they gave up to join managed care. The biggest consolidator is Nashville-based Columbia/HCA Corp., which has absorbed more than 300 hospitals, 135 surgery centers, 550 home-health providers, and a growing number of physician practices. "As its market share grows, Columbia's less inclined to give discounts to HMOs," says Salomon Brothers health-care analyst Mark Banta.

Size can work for health-care buyers, too, of course. Health plans that try to put through rate increases "are going to lose their competitive position," warns Helen Darling, who oversees health-care benefits for Xerox Corp. Large employers, she says, "don't have to take those increases." Big employers can also avoid the insurers. Xerox and Minneapolis' Business Health Care Action Group, a coalition of 25 Twin Cities firms, are experimenting with ways to eliminate the HMO middleman--buying medical services directly from hospital and doctor networks.

But such innovations will only delay the runup in health-care spending. Medical researchers predict a burst of costly new techniques--just in time for baby boomers hitting their golden years. "We'll have a fully implantable artificial heart by 2000--$100,000, installed--and just about everybody over 50 could benefit from a new heart," says Burton A. Weisbrod, professor of economics at Northwestern University. Based on an analysis of a half-dozen emerging technologies, William B. Schwartz, professor of medicine at the University of Southern California, concludes that health spending will grow at double-digit rates well into the 21st century.

Better treatments, of course, mean longer and better lives. But for employers, they ensure that the struggle to check health spending will be long-lived and vigorous, too. Corporate America may look back on the mid-'90s as a golden age of medical restraint.

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