Thought-Leaders newsletter

Perspectives on a selected key topic January / February 2022

ow significant do you anticipate health care provider pricing inflation, and or health plan premium inflation might be over the course of this year, and what issues and implications might arise as a result?"

Glenn Melnick, PhD
Senior Fellow, USC Schaeffer Center
Blue Cross of California Chair in Health Care Finance, USC Price School of Public Policy
Professor, USC Price School of Public Policy

I expect health care provider prices to increase in the coming years for several reasons.

First, the long-term trend of health care provider consolidation has not only continued but has likely accelerated due to financial pressures created by the COVID pandemic. Increased consolidation will result in less provider price competition in many markets, resulting in higher prices when contracts come up for renewal in coming years.

Another factor that has been exposed and exacerbated by the COVID pandemic is the tightening labor supply in the health care sector. The aging population along with increases in the population with health insurance coverage are combining to generate increased demand for medical care over the long run. At the same time, the supply of trained new health care professionals is not forecast to increase appreciably in the short run. This supply constraint along with earlier than expected retirement of front-line workers due to COVID burn-out has resulted in labor shortages in many health care organizations and rising labor costs, as organizations compete for needed staff. This is a new cost push factor that could also drive provider prices higher in the coming years.

Alan Trimakas
Principal, BDC Advisors

“Foresight is not about predicting the future. It’s about minimizing surprises.”
- Karl Schroeder

At the December 2020 meeting of the Federal Open Market Committee (FOMC), the median consumer price inflation estimate for 2021 was 1.8%. As we all know, inflation ended up ringing in at 7.0% for the year, the largest 12-month gain since June 1982. If we were able to accurately predict this uptick, many of us may have pursued different purchasing decisions (accelerating buying of a car, home, cryptocurrency, etc.), but obviously the developments of the past year were impossible to foresee.

Estimating and planning for potential health care pricing inflation is a wholly different beast, however. This is because in many ways, provider pricing inflation is a lagging indicator. The cost to deliver health care went up significantly in 2021 (precipitously in many cases), while most commercial payment rates remained on previously negotiated trajectories (i.e., normal inflationary environment). Though the federal government enacted legislation to soften the financial blow, many of these programs are expiring, and will result in an ever-widening gap between expenses and revenues for providers.

The CMS Market Basket (an industry-standard measure of cost inflation) has shown that annual cost increases at inpatient hospitals have averaged 2.7% nationally over the past 10 years. COVID-19 has shifted this curve upward by changing the underlying cost structure of providers, accelerating long-term inflationary pressures as well producing an exogenous, one-time permanent increase to the cost base. Key inflationary drivers include:

• Contract labor – Health care labor is now a national market (particularly for nursing), leading to critical clinical labor shortages and exploding hourly contract rates at health systems across the country

• Employed labor – Employed caregivers and administrators have increased compensation expectations as a result of consumer price inflation as well as a constrained labor market; provider organizations are attempting to meet these expectations through wage hikes

• Equipment and medical supplies – Supply chain logjams impacted the availability of medical goods, leading to estimated annual increases of over 8% in supply costs and 12% in drug costs per adjusted discharge, according to Kaufman Hall

• Demographic / payer mix trends – As the population ages, providers’ case mix continues to shift towards payer segments that struggle to cover costs (i.e., governmental payers becoming larger and larger share of the revenue pie). This places further strain on the traditional cross-subsidization model, requiring even higher increases from commercial payers

Taken together, these factors drove an estimated 6% to 10% increase in total health care delivery expenditures over the past year. Providers are now under enormous pressure to reopen negotiations with commercial payers as soon as possible to match reimbursement levels to this elevated cost structure.
However, it is unlikely that providers will be able to shift the entirety of these increases to payers, both because of payer resistance to significant payment increases and negotiation timing issues (many commercial payer contracts are only negotiated every 3+ years).

Despite the aforementioned pitfalls related to predictions, we believe the outlined data supports the estimate that on average, health care provider prices will rise 5% to 6% in 2022.

Implications

Such outsized price increases will have ripple effects across the health care industry and the U.S. economy at large. Some key potential implications arising from these price increases include:

1. Payers and providers will be heavily incentivized to transition care and payment models towards value-based structures, which reward effectively managing the total cost of care for populations

2. Relatedly, health systems will devote appropriate resources to developing and improving their population health and care management infrastructures

3. High-performance networks, where payers and providers collaborate to offer streamlined network products, will take hold and proliferate. As provider margins diminish, they will be incentivized to accept reduced rates in exchange for greater potential volumes

4. Negotiations between providers and payers will become more contentious. As such, more negotiations will stall and 2022 may experience record numbers of providers exiting health plan networks

5. Providers will increasingly seek to engage key local stakeholders (i.e., employers, brokers, etc.) to help them understand the challenges that providers are facing and the reasons for health care premium increases. As difficult negotiations unfold, it will be particularly important to explain that appropriate increases in health insurance contract rates help to preserve the long-term health of the local community.

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