When contemplating the threats facing our health care system, inflation is usually not the first thing that comes to mind. Yet, its broadly felt effects, ranging from standard of living to volatility in the stock market, can include rising costs for medical care. Given recent increases in inflation, it’s worth understanding how it works and what relationship it has to health care.
What is inflation?
Inflation refers to a decline in the purchasing power of a given currency over time; the immediate impact is a rise in the cost of goods and services. It’s monitored and influenced by the Federal Reserve, which was introduced in 1913 after a series of bank runs caused prominent financial institutions to fail in the 1907 bank crisis. This led to the desire for more central control of the monetary system in hopes of alleviating future financial crises. Despite preemptive measures in some cases, the Fed has presided over 15 recessions/depressions since its genesis.
The organization controls inflation by setting the cost of borrowing for banks, thereby influencing the interest rate at which households and businesses can borrow money, and by extension, their willingness to spend it. The Fed can also “create money” through monetary policies such as quantitative easing to meet a perceived need — stimulus checks being printed during the pandemic is a recent example. This is typically done when government expenses surpass government income (taxes), leading to a national deficit. To meet the deficit, the government creates more money by way of the Fed.
New money can provide economic relief but also carries the risk of promoting inflation by increasing the population’s purchasing power for a limited supply of goods and services. Since the Fed’s inception, the inflation rate has averaged 3.12% with varied fluctuations year to year.
The COVID-19 pandemic has led to sharp increases in inflation. Potential causes include increasing consumer demand, supply chain constraints associated with labor shortages, the challenges of operating under new pandemic safety regulations, and the influx of millions of dollars into the economy from relief packages and stimulus checks. Overall, the cost of goods has increased by 5.3% in the past year — the most since July 2008.
When industries face greater operative costs because of increased prices for goods and services, they often raise prices to balance their books. The business of health care is no different.
How can inflation impact the U.S. health care system?
To better understand how inflation can affect health care, it’s worth diving into how our health care system is structured.
The United States has the most expensive health care system in the world, leading in health care spending per capita. Spending has increased consistently year over year, and is expected to rise over 5% annually for 2019–28. Research shows that “[the cost of] medical goods and services is [also] projected to accelerate, averaging 2.4% per year.”
There are multiple reasons for the continual increase in costs. As is the case with other industries, medical entities must get paid for the services they provide, typically referred to as reimbursement. Governmental programs such as Medicare and Medicaid account for the largest percentage of health care spending in the United States — approximately 37%. Private health insurers account for an additional 34%. Together, these entities reimburse health care providers based on the number of patients seen and cared for.
Essentially, this is a fee-for-service system — when more services are provided, more fees are paid. This reimbursement structure incentivizes a high volume of care and frequent testing. The business of health care is structured not only to provide care, but also to see as many patients as possible, perform as many procedures as possible, and discharge quickly to maximize patient turnover.
Medicare spending has been increasing only 1%–2% annually, not keeping up with the pace of inflation. From 2019–20, however, there was a staggering increase in spending, ostensibly due to health care costs associated with COVID-19. Expanding programs such as Medicare and Medicaid increases access to care for those who were previously uninsured. Yet, the downside is that pharmaceutical companies, hospitals and other big players may increase prices because of increased demand for services.
More people are using health care services given recent policy expansions, but Medicare is not reimbursing all services at full cost (in part because costs are inflating). Medicare physician payments have actually declined by 22% from 2001 to 2020. Since about half of hospital revenue comes from the public sector, if this sector is reimbursing at less than 100%, health care providers meet their costs by demanding more from the private sector, which includes commercial insurance companies.
Hospitals and providers are well positioned to demand higher prices, on average charging insurance companies 122% what Medicare pays for the same service. “[This] leaves businesses and privately insured patients to foot higher bills,” comments Robert Pearl, M.D. It’s still a matter of debate whether higher private insurance payments are necessary to compensate for lower public sector reimbursement.
What are the implications of increased health care costs?
Higher costs entail higher insurance premiums (lowering the affordability of private insurance) while increasing out-of-pocket costs for the uninsured. Insurance companies may also seek to limit expenditures by curtailing the procedures they reimburse. If private insurers pick up less of the bill, this could mean decreased revenue for hospitals.
Excessive inflation is bad for all industries, especially for the health care system and the patients it seeks to care for. One way to combat expensive care is to restructure the way our health care system works. Specifically, we have to hedge against inflation in medicine. This may mean revisiting our fee-for-service structure and replacing it with something better. However, deciding on what’s better is not easy, and is a lengthy conversation on its own.
See more here: What is Inflation? (video)
Suggested Book: Mistreated: Why We Think We're Getting Good Health Care — and Why We're Usually Wrong by Robert Pearl, M.D.
Related Article: “What Broke American Health Care And How To Fix It” (forbes.com)
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