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TRENDSHealth Spending Rebound Continues In 2002
U.S. health care spending climbed to $1.6 trillion in 2002, or $5,440 per person. Health spending rose 8.5 percent in 2001 and 9.3 percent in 2002, contributing to a spike of 1.6 percentage points in the health share of gross domestic product (GDP) since 2000. Hospital spending accounted for nearly a third of the aggregate increase. During the past three decades, per enrollee spending for a common benefit package has grown at a slightly slower average annual rate for Medicare than for private health insurance, with more pronounced growth differences recently reflecting legislated Medicare reimbursement changes and consumers’ calls for more loosely managed care.
Growth in health spending rose from 8.5 percent in 2001 to 9.3 percent in 2002, advancing much faster than the rest of the U.S. economy for the second consecutive year. It rose at more than twice the rate of growth of gross domestic product (GDP, 3.6 percent), causing health spending’s share of GDP to rise from 13.3 percent in 2000 (where it had remained largely unchanged since 1993) to 14.1 percent in 2001 and 14.9 percent by 2002. Aggregate health spending climbed to $1.6 trillion, or $5,440 per person (Exhibit 1  ). After overall health expenditures are adjusted for economywide inflation, constant-dollar growth rose 7.1 percent per capita in 2002, compared with 4.9 percent average annual growth over the past four decades (Exhibit 2).
Private sources accounted for more than half of the $132.3 billion growth in health spending in 2002, as private health insurance payments rose $54.0 billion and direct payments from consumers rose $12.0 billion. Private health insurance alone contributed the largest share of the increase in 2002, 41 percent, while out-of-pocket spending contributed 9 percent, and other private funding accounted for 4 percent.1 In the public sector, growth in the Medicaid program accounted for 20 percent of the overall increase as more people became eligible for enrollment. Other public funding accounted for 26 percent of overall health spending growth.
From the health care provider perspective, spending growth also reflected a return to higher growth in hospital care. Hospitals’ contribution to aggregate spending has rebounded, as hospital spending growth rose from an average annual rate of 3.7 percent between 1993 and 2000, to 7.5 percent in 2001, and 9.5 percent in 2002. This service comprised 28 percent of the aggregate spending increase in 2001 and 32 percent in 2002 (Exhibit 3
Continued acceleration of health spending—without a similar increase in economic growth—threatens the affordability and generosity of sponsored health care benefits. Sustained weakness in the job market resulting in the loss of coverage also could shift some of the growing health care burden to the jointly funded federal-state Medicaid programs.
In 2002 the share of spending paid through state and federal Medicaid programs (16 percent) nearly matched that of Medicare (17 percent). Medicaid’s share has increased slowly over time, by an average 0.5 percentage points per year since 1989, as programs expanded to cover larger portions of the uninsured population. Medicare’s share declined from a 19 percent peak in 1997 to 17 percent in 2002.
Medicare.
Much of the variation in the public spending trend in recent years can be attributed to changes in Medicare, a federal program that accounted for $267 billion in payments to health care providers and for administrative costs in 2002 (Exhibit 4
Against a backdrop of a large cohort of baby boomers reaching Medicare eligibility over the next decade and projected depletion of the Hospital Insurance Trust Fund by 2026, the debate continues on how to structure the Medicare program (including coverage of prescription drugs) and the potential role of the private sector.3 This debate often turns to comparisons of Medicare and private-sector spending trends, sometimes using data from the National Health Accounts (NHA). On a per enrollee basis, Medicare spending has grown at an average annual rate that was two percentage points slower than growth in private health insurance spending during the past three decades (Exhibit 5 ). This is attributable in part to Medicare’s lack of coverage for out-patient prescription drugs. However, when one compares spending only for benefits provided by both Medicare and private health insurance (hospital, physician, clinical, and other professional services, plus durable medical products) from 1969 through 2002, Medicare’s per enrollee spending has grown at a slightly slower average annual rate than private health insurance, with more pronounced differences in growth occurring after 1985. Between 1970 and 1985 average annual per enrollee growth rates for these benefits were similar. Since 1985, when Medicare implemented the first prospective payment system (PPS) for inpatient hospital services, per enrollee costs for these common services in Medicare have actually grown more slowly than in private insurance. Although this is cited as evidence of Medicare’s ability to contain cost growth, it is difficult to unravel the effects of growing first-dollar coverage and expanded benefits in private health insurance during the 1990s when Medicare’s coverage remained relatively unchanged.4 In the most recent period (1999–2002) Medicare per enrollee spending grew 6.2 percent for these benefits, compared to with per enrollee growth in private health insurance of 8.7 percent. During this period Medicare spending responded to a series of policy changes aimed at better managing public funds, while private health insurers responded to consumers’ demands for more costly, less tightly managed plans. In the Federal Employees Health Benefits Program (FEHBP), often cited as a market-driven model for Medicare reform, per enrollee growth for a common benefit package has been estimated to be similar to that for all private health insurance during 1985–2002.
Medicaid. Medicaid spending rose 11.7 percent to $250 billion in 2002, compared with 10.2 percent growth in 2001, reflecting growing demands on government programs as the labor market remained weak. The growth during these two years far exceeded recent growth rates, which averaged 6.7 percent during 1995–1999. Slower growth during these years was attributed to a strong economy and consequently slower growth in the number of adults enrolling in Medicaid, and other factors such as increased use of managed care plans. Between 2000 and 2002 the weak labor market along with program expansions helped drive a 5.6 million increase in the number of children and adults eligible for Medicaid.5 State Children’s Health Insurance Program (SCHIP) campaigns contributed to these enrollment gains as outreach programs identified Medicaid-eligible people. Although the growth in adults and children accounted for approximately 85 percent of the growth in the number of eligible people, they accounted for only 36 percent of the increase in Medicaid spending. A small increase in aged and disabled recipients, along with their much higher per recipient spending compared with other enrollees, accounted for most of the increase in Medicaid spending.6 Rapidly increasing Medicaid spending combined with states’ slow revenue growth has led forty-five states to institute measures aimed at controlling spending growth.7 These include provider rate freezes or reductions, cuts in discretionary benefits, and specific policies to contain the growth of prescription drug spending. Some states have made plans for higher Medicaid drug copayments or are imposing them for the first time.8 In recent years states have looked for fiscal relief. Among the mechanisms used were upper payment limit (UPL) arrangements and disproportionate-share hospital (DSH) payments, which shifted some spending from state to federal governments. Those UPL and DSH funds returned by hospitals and nursing homes to state budgets for other uses are not counted in this paper.9 New legislation will help lessen the burden of high Medicaid spending growth on states. The Jobs and Growth Tax Relief Act of 2003 raises the federal matching rate for states that maintain their eligibility criteria and thus lowers the percentage of Medicaid costs that states must pay. States that tighten eligibility standards and thus cut their Medicaid spending would then receive a smaller percentage of federal aid than those that do not, perhaps leading some states to safeguard Medicaid eligibility.10 Private insurance. Private health insurance covers approximately 70 percent of the noninstitutional population, but because it tends to cover a younger and less costly population, it accounts for a much smaller share of overall health care spending (35 percent).11 Spending for benefits rose 9.6 percent in 2002, with 37 percent of the growth spent on hospital care, 32 percent on physician services, and 26 percent for prescription drugs. Aggregate private health insurance premiums rose 10.9 percent in 2002, compared to 10.3 percent in 2001, to reach $549.6 billion. Premiums per covered worker rose even more rapidly than aggregate premiums, because premiums calculated in this paper combine changes in the number enrolled—which fell during 2002—with changes in per worker rates. A few key factors have contributed to the rising trend in insurance premium costs, the most notable being the high rate of growth in claims and the rising net cost of insurance (the difference between private health insurance premiums earned and benefits incurred includes administrative costs and profits earned). Net cost totaled $70.2 billion in 2002, or 13 percent of private health insurance premiums, up from 12 percent in 2001. In the aggregate, enrollment in employer-based coverage declined for the second year in a row. In both 2001 and 2002 enrollment in employer plans declined by about 1 percent, a consequence of lower employment, a shift in employment to smaller firms that offer insurance less frequently, and higher employee-paid costs, which might have reduced take-up rates.12 Losses in job-based coverage might not be over, as employment declines continued into 2003. Although employers’ spending for health benefits as a share of compensation held steady during the mid-1990s, it has crept upward since 1999. Data for 2003 reveal a health benefit share of compensation comparable to the 1993–1994 period, when rapidly rising health costs prompted employers to evaluate alternatives to conventional coverage more intensely.13 To counter the rising burden, some employers have shifted expenses to employees through higher premiums, copayments, or coinsurance; some have reduced benefits or dropped coverage altogether.14 Consumers are increasingly facing higher copayments and deductibles. In particular, workers are facing increased drug copays and more frequently are given incentives to select less costly drugs under tiered cost-sharing arrangements. More than half of covered workers were enrolled in three-tier plans by 2002, compared with 29 percent in 2000.15 In 2001 and 2002 more than half of the rise in aggregate out-of-pocket spending was related to increased drug spending, whose share of out-of-pocket spending was higher than that of most other health care services. Employers’ efforts to shift increases in health care costs to consumers have slowed the relatively steady drop in the out-of-pocket share of spending.16 While this share declined from 21 percent in 1988 to 15 percent in 1994, it has fallen more slowly since then. In 2002 it was 13.7 percent, as aggregate out-of-pocket spending ($212.5 billion) grew 6.0 percent, its fastest pace since 1998. This faster pace of growth could reflect a rising uninsured population as well as rising copays and deductibles paid by the privately insured.17
Growth in spending accelerated for most services. Retail prescription drug sales continued to grow at the fastest pace. Increases in the spending rate for the largest spending category—hospitals—caused its share of the spending increase in 2002 to exceed its share of total health spending for the first time since 1991 (Exhibit 6 ).
Hospitals. Hospital spending ($486.5 billion) rose 9.5 percent in 2002, the fourth year of accelerated growth following a period of managed care expansions during 1993–1998 when hospital spending growth averaged 3.4 percent. Medicare spending rose 8.8 percent in 2002, contributing 29 percent of the increase. The trend in 2002 reflects growing demand for services, rising compensation and other expenses, and hospitals’ increasing ability to negotiate higher prices from private payers.18 Growth in hospital spending can be disaggregated into population, price, and a residual component that primarily includes changes in quantity and intensity of services consumed.19 In both 2001 and 2002, increases in prices played a dominant role in the escalation of hospital spending, although acceleration in the residual also occurred. Of the 7.5 percent and 9.5 percent increases in hospital spending in 2001 and 2002, price factors were responsible for 3.6 percent and 5.0 percent of the growth. Growth in quantity and intensity factors of 3.0 percent and 3.6 percent in 2001 and 2002, more rapid than in earlier years, also contributed to faster spending in the hospital sector, but to a lesser degree. Population growth accounted for the remaining 0.9 percent growth in each year. A large share of hospital-specific price inflation could be tied to payroll and other input costs. In the hospital sector, compensation is estimated to account for 62 percent of operating expenses.20 Growth in compensation costs per hour worked for civilian hospital employees grew rapidly in 2001 and 2002 at 6.4 percent and 6.4 percent, respectively, compared with average annual compensation growth of 2.7 percent during 1994–2000.21 Rising wages associated with the nursing shortage, benefit cost increases, and rising malpractice costs absorbed by hospitals in certain areas have contributed to larger increases in hospital prices over the past few years.22 Additionally, hospitals have regained market power since the mid-1990s, improving their negotiating power and ability to secure rate increases from private insurance plans. Some of the recent growth in hospital spending reflects increases in hospital volume, as measured through admissions and average length-of-stay. Hospital inpatient days declined 23 percent during 1990–2000, mostly through reductions in length-of-stay. Following this decline, inpatient days rose 1 percent in 2001 because of stabilization in days per stay as admissions continued to increase.23 More recent indications of growing demand for hospital services come through hospital employment, which grew 2.5 percent in 2002 compared with an average of 0.6 percent in 1994–2001. Through July 2003, however, growth in employment moderated, perhaps signaling slower growth in utilization.24
Physicians.
Spending growth for physician services rose by 7.7 percent in 2002, decelerating slightly from 8.6 percent growth in 2001 and reaching $339.5 billion. While Medicare accounted for only 20 percent of payments to physicians ($68.8 billion), it was the primary driver behind decelerating spending in 2002 (Exhibit 7
Drugs. Spending for prescription drugs decelerated slightly for the second year in a row, increasing 15.3 percent in 2002 following growth of 15.9 percent in 2001 and 16.4 percent in 2000. Growth in Medicaid drug spending, excluding SCHIP expansion programs, decelerated nearly four percentage points in 2002. This spending growth was dampened as states made greater use of preferred drug lists in conjunction with prior-authorization policies for selected drugs, increased copayments, or required the use of generic drugs before allowing more expensive therapies.26 Other factors that could have contributed to slowing aggregate growth included fewer new drugs entering the market (only seventeen in 2002, compared with an average of twenty-five per year in the 2000–2001 period and thirty-five in 1999); a shift in prescriptions toward more generic drugs; continued growth of tiered copayment plans; and a slight decline in direct-to-consumer (DTC) advertising.27 These factors were somewhat offset by continued growth in demand.28 While private spending for prescription drugs grew at nearly the same rate in 2002 (15.4 percent) as in 2001 (15.2 percent), out-of-pocket spending rose more rapidly and private health insurance spending less rapidly than in 2001. Out-of-pocket spending for prescription drugs accelerated by 3.5 percentage points to 14.4 percent in 2002, while private health insurance spending slowed by 2.1 percentage points to 16.1 percent. Faster growth in out-of-pocket spending and slower growth in private health insurance likely reflect changes in coverage among Medicare+Choice and employer-sponsored plans as well as the moderating impact that increasing copays have on prescription drug consumption. Home health. Spending for freestanding home health agency services grew by 7.2 percent in 2002, the second consecutive year of expansion, driven mostly by Medicare. Industry growth is beginning to stabilize following a period of changes to Medicare policies. These policies led to a substantial $4.6 billion drop in Medicare spending between 1997 and 1999 that has been partially offset by an increase of $2.9 billion in Medicare spending since then. This rebound in Medicare, the largest single payer for home health services, has been driven by the implementation of the PPS in October 2000. Medicare spending for home health services grew only 0.6 percent in 2000, compared with 17.6 percent in 2001 and 13.3 percent in 2002. Recent rapid growth in Medicare is partly a result of a change in the interpretation of "homebound" that expanded the number of beneficiaries eligible for services. Countering double-digit growth in Medicare spending, slowing Medicaid spending contributed to the seven-percentage-point deceleration in overall public funding for home health in 2002.29 While public spending growth for home health agencies decelerated rapidly in 2002, the downward trend in private spending appears to be subsiding. Private spending grew by 1.0 percent in 2002 in comparison to a decline of 7.4 percent in 2001. To some extent, the industry’s labor crisis has contributed to the loss of private customers in recent years. Private payers might be seeking alternative care through assisted living facilities or private-duty nurses. In 2002 the weakening economy aided home health agencies’ capacity to deliver services as the availability of aides grew, allowing agencies to fill more vacancies. Nursing homes. Spending for services provided by freestanding skilled nursing care facilities continued at a moderate growth rate of 4.1 percent, slightly slower than the 5.7 percent rate in 2001. This correlates with slow growth in nursing facility capacity and a deceleration in the costs of supplies and services used in the provision of care.30 Despite a deceleration of 0.8 percentage points in public spending for nursing homes in 2002, the public share of payments rose to 64 percent of overall payments, with Medicaid paying 49 percent. States also are seeking to shift more patients from nursing homes and other institutions to community-based settings as they comply with the Olmstead interpretation of the Americans with Disabilities Act that encourages the treatment of people with disabilities in less restrictive community settings.31
The continued acceleration in health care spending growth has posed financial challenges for government, businesses, and individuals alike. Compared with economic growth of 3.6 percent, growth in health spending of 9.3 percent pressures employers to cut other spending increases, possibly through reducing jobs, wage gains, or health benefits or through shifting more costs to employees. State and federal governments face the same dilemma of costs rising more rapidly than revenues, leading every state to scrutinize discretionary Medicaid benefits as the number eligible for coverage continues to grow.32 Forty-four percent of spending growth was attributed to economywide and medical-specific inflation as the personal health care deflator rose 3.9 percent in 2002, compared with 8.8 percent growth in personal health care spending. Recent health care price inflation is affected by a shortage of health care workers, which is expected to continue to propel higher-than-average increases in payroll costs. Hospitals’ improved negotiating power has also led to higher rate increases from private insurance plans. Factors fueling growth in health spending are already showing signs of dissipating in 2003. Preliminary data indicate that hospital use has eased and that wage growth in the health sector has decelerated slightly. Furthermore, Medicare givebacks have expired, and states have begun plans to curtail Medicaid spending growth. Finally, as consumers share more of the increases in cost, the value of health services will be more closely weighed against other purchases, underscoring the considerable value of some services and the discretionary nature of others.
Katie Levit is director of the National Health Statistics Group, Office of the Actuary, Centers for Medicare and Medicaid Services, in Baltimore. Cynthia Smith, Cathy Cowan, Art Sensenig, and Aaron Catlin are economists in that office. The authors thank Rick Foster, Mark Freeland, Sharman Stephens, and John Shatto at the Centers for Medicare and Medicaid Services (CMS) and anonymous peer reviewers for their helpful comments. In addition to the authors, the National Health Accounts team includes Anne Martin, Lekha Whittle, Mark Zezza, Ben Washington, Nate Singer, Carolyn Donham, and Anna Long. The opinions expressed here are the authors’ and not necessarily those of the CMS.
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Sources Of Funds
Spending By Service
