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Cause for Concern

Health-care costs are rising—and the experts aren't sure why

Last week's news about Obamacare enrollment was great. But health care policy wonks have something else on their mind now: the cost of health care. It’s starting to rise more quickly than before. That could be a problem.

For the last four years or so, national health care expenditures—that is, all the money that Americans spend on medical services and supplies—has been growing at historically low rates. It’s gone up every year, as it almost always does, but only by 3 or 4 percent. That’s just a little bit more than inflation. Typically health care spending has risen more quickly. Sometimes, in the 1980s and again in the early 2000s, it's risen much more quickly. Keep in mind that when national health care spending rises much more quickly than the economy is growing, you feel the impact—as relatively higher insurance premiums, higher out-of-pocket costs, and higher taxes to support government insurance programs. You may not have noticed it, but the recent slowdown has been good for your finances.

Rising health care costs via Altarum

Now the respite may be ending. You can see it in the latest monthly reports from the Altarum Institute, an Ann Arbor-based think-tank that monitors national health care spending. These reports, based on government data, are the equivalent of an early warning system for medical costs. They are one of the first places a spending spike would show up. According to Altarum, expenditures started to rise more quickly in the middle of 2013. Since then, the rate has gone up even more. Reports of rising costs have already gotten the attention of savvy health care observers in the media, like Philip Klein and Sarah Kliff. The question now is how long the trend will continue, how quickly spending will accelerate, what should be done about it—and, of course, what it means for Obamacare.

First economists have to figure out whether the recent reports are accurate. They may not be. The key evidence of accelerating health costs comes from monthly government statistics, particularly those produced by the Bureau of Economic Analysis. There’s a reasonable chance, three or four months from now, BEA will announce that costs haven’t been rising so quickly—in much the same way government sometimes revises unemployment statistics, upon learning there were more jobs than the initial data suggested. If that happens, analysts like those at Altarum will have to redraw that graph above and the outlook might look more encouraging.

But most experts I know are betting against that. For some time, they have expected health care costs to rise, because the primary factor in the slowdown was the economy. When unemployment is high and wages aren’t rising, you are less likely to consume more health care for the same reason that you are less likely to consume other goods—it costs money you might not have. You can’t avoid treatment for a heart attack, obviously. But the pills you take for a chronic condition? Getting somebody to look at a nagging, but tolerable pain? You might push that off until you had a little more cushion to pay for the co-pays and deductibles. That’s what people did during the recession. And now that the recession is over, they’re almost certainly starting to spend more again, partly to take care of those problems that they allowed to linger.

In fact, exactly one year ago Monday, an op-ed in the Washington Post predicted that health care spending would start rising about now. The op-ed was from Drew Altman and Larry Levitt of the Kaiser Foundation, based on work they and their colleagues had done with the analysts at Altarum. Historically, they noted, health care spending followed economic growth, albeit with a time lag. So pretty soon after the economy picked up again, people would start spending more money on health care—until it was rising at about 7 percent rather than 4 percent. Sure enough, according to the latest Altarum analysis, annual growth in health care spending as of February was 6.7 percent. That would be the highest rate since late 2007, just before the recession started.

But the recession wasn't the only reason health care spending stopped rising so quickly, which means there's reason to think the long-term trajectory on medical spending really has come down—at least a little. The whole health care industry is in the midst of some pretty significant transformations right now. One of them is a change in the design of health plans, which are transferring more and more out-of-pocket costs onto individuals. That change has tended to slow down health care spending for the same reason that the recession did: It makes people more cost-conscious, because every bill is another direct hit on their wallets. Conservatives and economists tend to think this is a good thing, because it gives people “more skin in the game.” Liberals and public health experts tend to think this is a bad thing, because it gives people incentive not to get medical care they might need. Either way, it’s been happening.

Another change is one taking place in the places where people get medical care, particularly hospitals. It’s a vast re-engineering project, one that attempts simultaneously to make systems run more smoothly and to pay closer attention to the issues that make people sick (or, at least, prevent them from getting better). One sign of this progress is a dramatic drop in hospital “readmissions” across the country—that is, patients going back to the hospital shortly after discharge, for the same reason they were admitted previously. (See the graph below.) This is no accident. It’s a product of “transitional care” programs that hospitals like Mount Sinai in New York started a few years ago. Basically, the hospitals identify which patients are at high risk for readmission, educate them while they are still in hospital, and then provide follow-up outpatient care once the patients have left.

Readmissions via Cutler

How real are these changes? And how widespread? Nobody is sure. But one encouraging sign is the trajectory of spending within the Medicare program. Seniors’ consumption of health care doesn’t track the economy so closely, since their fixed incomes vary less and Medicare (with supplemental policies) provides such comprehensive insurance. Sure enough, Medicare’s cost trajectory fell a few years ago—and it has stayed low even as the economy has recovered. As Peter Orszag, the economist and former Obama Administration official, noted recently at Bloomberg View, “Even though copayments and deductibles in Medicare are usually small, Medicare beneficiaries, too, seem to be having fewer elective procedures and unnecessary doctor visits. This year, for example, Medicare has seen a reduction in the number of costly hip, knee and other major joint replacements, which are sometimes more a choice than a necessity.”

One reason for this progress is the Affordable Care Act. The law’s critics predicted that it would make health care more expensive. And there’s one sense in which that’s certainly true. Because of Obamacare, more people will have insurance and more people who already had insurance will have more comprehensive coverage. All else equal, that means people are going to get more medical care, at least initially. That’s particularly true for people with medical problems that, for years, they deferred treating because they lacked the ability to pay their bills.

But Obamacare also has provisions that push costs in the other direction. There are cuts to what Medicare pays doctors, hospitals, and insurers who provide alternative private coverage. There are financial incentives that reward providers for becoming more efficient: Pretty much everybody agrees that hospitals wouldn’t be working so hard to reduce readmissions if Medicare didn’t penalize them for each patient readmitted. And then there is the “Cadillac tax”—which gradually reduces the financial advantages of very pricey health insurance. The tax doesn’t start for a few years but, already, employers are talking about readjusting their insurance plans to avoid hitting the threshold that would trigger the tax.

So what does that mean for the future? Over the last few weeks I’ve consulted a number of respected experts—including those at Altarum and the Kaiser Foundation, as well as leading economists like Amitabh Chandra and David Cutler. I’ve also consulted reports from the Congressional Budget Office. Their predictions vary, particularly when it comes to the effects of Obamacare. Chandra, for example, thinks the law has done very little to restructure medical care—he calls hopes for its success at cost control “aspirational.” Cutler, by contrast, thinks the law is having an effect already and is likely to have an even bigger one in the future. (The White House, naturally, has adopted the optimistic view as its own.) But pretty much all of these authorities agree on the general shape of things to come. Health care spending will acclerate for a little while, partly because of Obamacare's coverage expansion but mostly because of the economic recovery. Then it will subside. It will, in other words, be like a wave: Spending will go up, crest, and then return to a lower level.

The good news is that, once the wave is done, year-to-year increases in health care spending should be significantly lower than the historical average. Economists like to talk about “excess growth”—that’s the difference between how quickly health care costs are rising and how fast the economy, measured as Gross Domestic Product, is growing. Over the last 50 years, excess growth has been about 2.6 percent. But the average in the last 20 years has been down to 1.6 percent, thanks to structural changes, some of which date back to the 1990s when insurers first started using managed care. There’s every reason to think that, once the economy fully recovers and Obamacare’s expansion is in place, health care spending will be back to rising at something like the level it was before.

Projected cost growth via KFF

The Kaiser-Altarum projection, for example, assumes excess growth will revert right back to 1.6 percent. (See graph above.) But that would still require some combination of signficantly higher taxes, higher deficits, or higher health insurance premiums in the future. Knocking even a tenth of a percentage point off of that would make a difference. Knocking a few tenths of a percentage point would make a big difference. Is that possible? Sure. But it would mean, first and foremost, standing by the Affordable Care Act’s cost cutting provisions. And the evidence on that front so far has been mixed.

Cuts to hospitals are taking place, for example. But the insurance industry recently won a reprieve on cuts for its Medicare plans. This is why conservative economists think Obamacare is likely to drive up government health spending—and, eventually, everybody’s health spending—no matter what the projections say. They are convinced Congress will never let the tough, cost-cutting provisions take effect, since those parts of the law inevitably take money out of the pockets of powerful special interests. This isn't a crazy argument. Medicare’s official actuary has warned, repeatedly, that proposed Medicare cuts may be too harsh for the political system to sustain.

One challenge, then, is showing the mettle it takes to stand by those cuts. But it will take more than that to significantly reduce spending on medical care. The health care industry would have to find new ways to be more efficient—and consumers would have to become more intelligent shoppers—ideally in ways that don’t compromise the quality of care. The Affordable Care Act can be a catalyst for these changes: Among other things, it created a new "Center for Medicare and Medicaid Innovation" for introducing new ways of paying for treatments and supplies. But it’s not so hard to imagine such efforts failing to take hold—and leaving future generations with a huge bill.

One final note: It’s not always the case that spending more on health care is a bad thing. New or more treatments might alleviate suffering, reduce disability, or extend life—all of which have value. Providing insurance to more people, so that they are more secure financially, also has value. The reason to worry about high health care spending is that the extra money America spends doesn’t actually seem to buy America better health care. But, over the long run, the real goal of health care reforms should be a combination of restraining costs and improving quality.

Sometime this spring, Sylvia Burwell will have confirmation hearings to be Secretary of Health and Human Services. Republicans are sure to use those hearings as a chance to highlight everything they think is wrong with Obamacare. That’s fine. The purpose of confirmation hearings, after all, is to establish some democratic accountability. But it would be great if senators from both parties used the moment to ask her about what's happening with health care costs and what, if anything, the government plans to do about it. As Cutler said a year ago, in an interview with the Harvard Gazette. "We have a lot of control over this, through policies in the Affordable Care Act and Medicare and Medicaid. It’s not easy—no change is ever easy—but if we continue to do the right things, like stressing efficiency and helping people choose less expensive alternatives, then we can make sure this trend continues."