Health Care: The Patient Will Live, But...

>>Employers and consumers will continue to get hammered by rising premiums
>>But health-care costs will rise a bit more slowly, which is good news for insurers

Like death and taxes, annual increases in U.S. health-care costs are inevitable. But 2004 will upend this rule of nature a bit. Yes, medical costs will continue to rise, and at a rate considerably faster than that of overall inflation. But a shift toward cheaper generic and over-the-counter drugs, coupled with lower hospital use, caused health-care inflation to slow in 2003, and the trend will continue this year. Total national spending on health care will increase by about 7% in 2003 and will do the same in 2004, according to the Centers for Medicare & Medicaid Services. Not insignificant, granted, but at least it's less than the roughly 9% gains logged in each of the prior two years. Health-care spending in just about every category is expected to rise at the slowest rate in the past five years.

That's good news for health insurers, since they will be able to push through premium increases that will more than compensate for the higher reimbursements they must shell out for drugs, hospital procedures, doctors fees, and the like. Hospitals, though, will have a tough time of it, just as they did the year before and the year before that. They are still caught between the high cost of serving the nation's 43 million uninsured and pressures from Medicare and other insurers looking to reduce payouts.

Employers who offer health insurance to their workers won't get much relief, either. Towers Perrin, a human resources consultant, predicts that 2004 will mark the fifth consecutive year of double-digit rises in employers' total health-care costs. Judging from a recent survey of large companies, insurance premiums and other health-care costs should increase 12% in 2004. "Companies are paying twice as much in health-care costs today as they did six years ago," says James K. Foreman, a managing director of Towers Perrin.

That's certain to accelerate the trend toward shifting costs to employees. Another company survey by Mercer Human Resource Consulting LLC found that 25% of employers plan to increase worker contributions for health plans in 2004, while 23% will reduce benefits. However, this cost shift will almost certainly force some employees to join the ranks of the uninsured because they can no longer afford coverage, predicts the nonprofit Center for Studying Health System Change in Washington. And that in turn will contribute to overall health-care inflation.

The insurers themselves are insulated from all this pain. When UBS Warburg analyst William McGeever issued a report on the managed-care industry in mid-2003, he titled it Vital Signs as Strong as Ever, and the diagnosis still stands. He expects medical costs for insurers to increase by some 11% in 2004, after 12.5% gains the prior two years. But premiums charged by health maintenance organizations should increase by 13% to 14% this year, after 15% hikes in 2003, more than offsetting higher costs. Also, the Medicare reform bill that went into effect on Jan. 1, 2004, gives private insurers the opportunity to compete with Medicare, opening a new market.

Negotiating Clout

This steady premium acceleration is due to quickly dwindling price competition in the industry. Consolidation has swept over insurers the past few years, capped by the October, 2003, announcement that Anthem Inc. will acquire WellPoint Health Networks Inc. (WLP ) in a $16.4 billion deal that will create the nation's largest health insurer. On the same day the current largest insurer, UnitedHealth Group Inc. (UNH ), said it would acquire Mid Atlantic Medical Services Inc. (MME ) for $3 billion.

The wave of mergers and acquisitions will likely continue, with WellChoice Inc. (WC ) and Cigna Corp. (CI ) widely mentioned as the next potential targets. That gives the few remaining players unprecedented clout in negotiating with customers and hospitals. "This industry is basically an oligopoly, and that means health plans have the ability to pass along cost increases to employers and employers can't do much about it," says McGeever.

Hospitals do not have the same advantages. Although they do gain some relief from a slower acceleration of prescription drug costs, they are also suffering from fewer patients, a result of the recession. When times are lean, patients tend to postpone nonessential surgeries, and beds go empty. Patients' numbers should increase as the economy improves, say analysts, but the hospitals must also contend with the high cost of caring for uninsured patients and the very sick.

In addition, a severe nursing shortage will continue, boosting labor costs. The Center for Studying Health System Change found that the hourly cost of compensating nurses at private hospitals has been growing by more than 8% the past two years -- which is more than 6 percentage points greater than the average increase from 1995 to 2000. A newly passed California mandate requiring higher nurse-to-patient ratios could spur similar legislation in other states, increasing pressures even more.

Grim Picture

So the hospital picture only grows grimmer. Moody's Investors Service's (MCO ) bond ratings for not-for-profit hospitals were running at a 3-to-1 margin of downgrades over upgrades at the end of 2003, and Moody's analyst Bruce Gordon sees nothing in 2004 that will change that trend. "We are seeing a lot of credit volatility," he says. "Medicare payments are down, utilization is down. It really is a tough environment."

For-profit hospitals must also contend with the fallout from the Tenet Healthcare Corp. (THC ) scandal. One of the nation's largest hospital operators, Tenet is under investigation for Medicare overcharges -- a situation that has left some industry experts wondering if it is possible to profit in this business without cutting corners. "The impact of the Tenet investigation and how it plays out clearly is overhanging the hospital space," says Bain & Co. partner Russell A. Hagey. Hagey says Tenet's newly installed management seems to be taking an "ultraconservative approach" as it attempts to restore fiscal order. Now, if only the same could be done for health-care costs.

By Catherine Arnst in New York

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