Factors Accelerating—and Slowing—Spending in U.S. Healthcare

Michael Chernew, PhD, Professor, Department of Health Care Policy, Harvard Medical School; Director, Healthcare Markets and Regulation Lab, Harvard Medical School

Calls to lower healthcare costs come from many groups, political and otherwise, in this country. However, what we’re spending is not the key point: The main concern is the gap between spending on healthcare and income growth. In the 1970s, the gap was 2.6 percent. In the 2010s, the gap was 1.8 percent. That gap must get closer to zero. 

Another serious concern is the expanding gap between the haves and the have-nots. Between 1980 and 2020, the income gap grew by 39 percent. No wonder almost half of American adults report difficulty affording healthcare. 

Most agree we need to rein in costs. The questions are: How much can we spend? What will we get if we spend the money? And if we pay less, what do we lose? The data indicate some avenues we should pursue to slow the spending in healthcare. Those roads aren’t necessarily pothole free, but they are passable.

First, let’s address how we got here.

Factors Accelerating Healthcare Spending

The factors accelerating healthcare spending are many. For one, Americans have chronic diseases. Nearly half of adults are obese, many in the prime of their lives; everyone in this audience knows this disease’s sequelae. Also, ours is an aging population that is moving on to Medicare. As for prescription drugs, they are expensive to develop and expensive to buy. In 2020, consumer spending on prescription drugs grew by 3.7 percent. In 2021, that growth was 7.8 percent, up to $378 billion.

Consolidation

Consolidation is another contributing factor. In the private sector, hospitals are merging with hospitals, while hospitals and insurers are buying physician groups. Insurers are merging with each other over time. As organizations consolidate, they can charge more, and they do. Consolidation may bring the potential to improve quality (although evidence that it does is scant), yet systematically, it raises prices.

We have largely financed healthcare in this country by borrowing money, not raising taxes. Consequently, the public debt has increased by 120 percent in the past decade. That is not sustainable. This country can borrow only so much. As healthcare costs go up, their impact is felt elsewhere, like on household income. Last year, the average private industry employee paid 22 percent of their medical premium, according to the Bureau of Labor and Statistics.

Borrowing vs. Taxation vs. Political Pressures

Decisions need to be made. To what extent do we raise taxes or borrow even more? Or do we try to control spending? Each of these possible solutions has drawbacks, considering that spending on U.S. healthcare happens through different sectors, namely Medicare, funded through the federal government; commercial insurance, funded by way of healthcare payments to private insurers; and Medicaid, funded by a state and federal blend. As institutions, each sector has different reasons for its existence, so therefore a financial solution for one will not be the financial solution for another. 

The political challenges facing each of these sectors are significant: They all have some form of government engagement. The pressure is often manifested by calls for state-level regulation. The states are responding in ways that are suitable for them, because the legislative policy debate is not only about health but also about taxes and other policy priorities.

The states are paying more for their Medicaid programs, partly due to increased enrollment thanks to the Affordable Care Act (ACA). They also experienced expansion during the pandemic. Between 2008 and 2017, total U.S. spending on Medicaid increased by 68 percent.

A few states, like Arkansas and Idaho, have already cut people from Medicaid benefit rolls. Many people who lose their Medicaid coverage have difficulty finding coverage on the healthcare exchanges, creating other problems. An estimated 7.8 million people, at minimum, could lose their Medicaid coverage during the so-called unwinding period. 

As for Medicare, spending is expected to double within the next 10 years, in part due to more beneficiary enrollment. However, Medicare fees are expected to fall relative to overall inflation. So, Medicare does not have a price problem, per se. The financing problem is providers may need more support at a time when Medicare faces fiscal challenges. The pressure on Medicare will be to increase prices for hospital and physician services. Even now, providers want prices higher than what current law specifies that they will get.

The challenge for Medicare is the volume and intensity growth, including the development and introduction of new drugs. For instance, new drugs for cancer, diabetes, and cardiovascular disease may significantly raise spending.

The pressure that's coming from employers is the demand to lower employee premiums. We can't afford these premiums, businesses are saying, because they are dampening wage growth and businesses. 

Means of Slowing Healthcare Spending

Let’s focus now on ways to slow this spending. They include:

1. Redesigning the Medicare Advantage (MA) programs. 
2. Increasing the number of accountable care organizations (ACOs), particularly those based on independent physician groups.
3. Slowing the rate of consolidation in the healthcare system and addressing high prices. 

Growing Medicare Advantage (MA) Programs

Right now, 51 percent of Medicare recipients are enrolled in MA plans, up from 37 percent in 2018. In some markets, up to 80 percent of enrollees have MA. MA plans can deliver care more efficiently than traditional Medicare. They bid 85 percent of fee for service. They could probably provide Part A and Part B services about 10 percent cheaper through prior authorizations and other initiatives. They have fewer hospital days, more efficient use of prescription drugs, less low-value care. On average, MA appears in a flattering light in terms of mortality (lower) and satisfaction (fairly high).

Yet MA plans code more completely (maybe more aggressively) than fee for service, so they are often paid more than their beneficiaries would spend in fee for service. The MA payment system further inflated payments to plans. Thus, despite delivering care more efficiently than traditional Medicare, greater MA enrollment raises Medicare spending. Moreover, MA plans have other drawbacks. For example, most MA plans require prior authorizations, unlike Medicare, and a government study showed that 13 percent of prior authorization requests were inappropriately denied under Medicare coverage rules. Moreover, aggressive coding can drive overpayment to MA plans. 

Increasing the Number of Doctor-Owned Accountable Care Organizations (ACOs)

An ACO is a contractual payment model between payers and providers who take responsibility for the total cost of a patient’s care. If providers can hold spending below a target, they save, and if they don’t, in some models, they have to pay that funding back. More than 1,000 ACOs have been created since their inception due to the ACA. They reduce low-value care, and they provide better experiences. 

The Medicare Payment Advisory Commission (MedPAC) thinks we need to build a portfolio or a system of alternative payment models that work together. 

Slowing the Rate of Consolidation in the Healthcare System and Addressing High Prices

Consolidation in the healthcare sector has been significant and continues. Slowing this consolidation and addressing high prices in the commercial sector will be important to slow spending. We need to level the playing field between sites of care, which may help slow consolidation, enforce antitrust rules, and regulate markets (and prices) when prices are egregious. 

There's no guarantee that cost-reining is going to be done in a coordinated way. Like the healthcare system itself, the healthcare policy landscape is very fragmented and has many competing stakeholders. Publishing hospital price transparency data will not solve our problem, and converting to a single-payer system has significant limitations. In our more incremental approach, there will be ongoing successes and a lot of failures, while some attempts will zig, others zag. But if we can better design the MA programs, expand alternative payment models, particularly ACOs for independent practices, reduce consolidation, and control prices, probably through some regulation, healthcare cost growth should slow.