Manufacturers Face Rising Healthcare Costs

Both the costs of insurance premiums and deductibles continue to rise.

Mnet 204299 Finance
Michael CollinsMichael Collins

American manufacturers are facing another big threat to growth and profitability in the future. It is the threat of rising healthcare costs. Both the costs of insurance premiums and deductibles continue to rise. Many people and companies are asking why the per capita cost is so high in the United States compared to all other industrialized countries.

The chart below from the Peterson Foundation shows that healthcare costs in the U.S. are twice as high as most industrialized countries.

Mnet 204272 Healthcare 1

The typical response to this fact is that many Americans and politicians say, "this may be unfortunately true, but the U.S. has the best health care in the world." When you dig into the issue of quality and performance of U.S. healthcare, you will find that this claim is simply not true. In fact, the U.S. has the highest percentage of obese adults, the lowest life expectancy, and the highest infant mortality rate compared to 9 other industrialized countries.

Healthcare costs as a percentage of GDP are 17 percent today and are projected to be 19 percent of GDP by 2025. The average healthcare cost percentage for 32 other countries is 9.5 percent of GDP. To give you some idea of health care costs, 17 percent of total GDP for 2017 was more than $3 trillion.

Healthcare costs are becoming a critical problem for U.S. manufacturing companies and for Employer Sponsored Insurance plans (ESI). According to the Economic Policy Institute, the total annual cost of a family ESI plan rose from $5,791 in 1998 to $18,142 in 2016. As premiums rise faster than inflation, it will become harder and harder to provide healthcare plans.

Economic Policy Institute- Congressional Budget Office (2018)Economic Policy Institute- Congressional Budget Office (2018)

The chart above shows that the income of the average worker has gone from 58 percent to 46.6 percent of total personal income. This means that healthcare costs have gone up faster than wages. So, for workers, increasing healthcare premiums means either less take-home pay or higher deductibles.

The problem is price, not utilization.

There are seven major cost problems that are driving healthcare costs higher than in other industrialized countries.

  1. Physicians – First of all, there are fewer physicians in the U.S. than in other countries. In 2010, there were 2.4 practicing physicians per 1,000 people in the U.S. compared to 3.1 in other countries. Primary care physicians in Australia, Canada, France, Germany, and the United Kingdom make about 70 percent of the average income of U.S. primary care physicians. So, physician costs are simply higher.
  2. Hospital costs – The number of hospitals in the U.S. has declined from 7,500 to 5,534 hospitals in 2017. The average stay in a U.S. hospital is $18,000, while the average stay in other countries is $6,000. It simply costs more to be in a U.S. hospital.
  3. Administrative costs – administrative costs for healthcare in the U.S. average 8 percent of GDP, compared to 3 percent in all other countries.
  4. Diagnostic costs - the U.S. does more MRI and CT scans than any other country. We also do more tonsillectomies, coronary bypasses, knee replacements, angioplasties, appendectomies, and hip replacements than any other country. As long as it is covered by insurance, why not do it?
  5. Procedure costs- here are some typical procedure costs compared to other countries:

                                    Other countries                       U.S.

appendectomies                     $4,642                         $16,930

CT scans                                  $409                            $844

MRI                                         $484                            $1,119

angioplasty                              $9,420                         $31,620

hip replacement                     $13,806                       $29,067

knee replacement                   $14,252                       $28,184

               6. Pharmaceuticals – in the U.S. we spend $1,443 per capita per year on pharmaceuticals. The average for all other countries is $749 per year per capita. The biggest difference is in brand-name drugs. For instance, brand-name drug prices in Canada are 35 to 45 percent lower than in the U.S. This has led to Americans purchasing more than $1 billion in brand-name drugs a year from Canada.

              7. Insurance Companies – Major health insurance plans are in a position to simply mark up their prices to cover all rising costs every year to maintain their profit margin. There is no incentive for them to be involved in cost reduction.

Why is the U.S. different?

According to John Steele Gordon, an editor at The Heritage Foundation, the first healthcare plans were created by hospitals, not insurance companies. These plans were not designed to protect against catastrophic illnesses. They were designed “to generate steady demand for hospital services and to guarantee cash flow.” These early hospital plans became the model for the first Blue Cross plan which was started in Sacramento, CA in 1932.

One of the big problems in the early plans was that “they paid only if the medical services were incurred in the hospital—the most expensive kind of medical care.” Another big problem, was that the plan paid for medical services regardless of the type of health problem. So, there was no incentive for the consumer to shop around, and they became indifferent to the costs and prices.

The Blue Shield model spread across the country. The states tried to regulate the new plans with the same standards as other insurance, but regulation did not happen because the American Hospital Association and the American Medical Association "worked hard to exempt Blue Cross (the original healthcare model) from most insurance regulation, offering in exchange to enroll anyone who applied to operate on a nonprofit basis."

The Internal Revenue Service then exempted healthcare from federal taxes because they were formed as non-profit organizations. Blue Cross and Blue Shield were plans that paid physician fees on the same basis as they paid hospital costs, and these plans came to dominate the market and healthcare insurance, holding about half of all the policies outstanding by 1940.

This meant that hospitals were paid on a cost-plus basis and didn't have to compete for patients on a price basis, which resulted in hospital costs sky rocketing. In this scenario, doctors could charge whatever they wanted and these unregulated health plans did not have market or competitive forces to keep them in check. The die was cast. Hospitals could operate on a cost-plus basis, doctors could charge what they wanted and consumers were indifferent to costs and prices.

After 1940, once the under-regulated system was in place, healthcare costs begin to rise faster than inflation. In 1930, healthcare costs were 3.5 percent of GDP, but today healthcare costs average 17 percent of GDP and are rising. The continuous rise of healthcare costs at faster than inflation is simply not sustainable for most businesses. According to the Center for Medicare and Medicaid Services long term outlook, by 2039 healthcare costs will be 22 percent of total GDP, or $5 trillion.

What is the answer?

One possible answer is a "single-payer system", like most of the European countries that can control prices and cover all citizens. But, in our free market capitalist system, the single-payer approach is considered socialism and will be a tough sell unless there is a big political change driven by workers and businesses.

The second possibility is to reform the economics of the current system. This would require reducing prices of physicians, hospitals, diagnostics, procedures, administrative costs, and drugs. Gordon says, "once prices are known and made public, they can be compared, competition—capitalism’s secret weapon—will immediately drive prices towards the low-end, draining hundreds of billions of dollars in excess charges out of the system. Posting prices will also force hospitals to become more efficient and innovative, in order to stay competitive."

This all sounds good, but does not take into consideration the tremendous lobbying power of the American Hospital Association, the American Medical Association and the Pharmaceutical Industry Associations who want to maximize profits and maintain the status quo. Rather than take a cut in their prices, these associations will go all-out to both protect their prices and maintain the system through intensive lobbying. It is unlikely that exposing prices and allowing competitive forces to reduce medical prices would succeed against massive lobbying by the various medical associations.

Regardless of the preferred solution, the time is fast approaching when manufacturing companies and other businesses will no longer be able to offer an affordable healthcare benefit to their employees. No, we do not have the best healthcare system in the world, and the one we have is staggering towards bankruptcy.

Michael Collins is the author of The Rise of Inequality and the Decline of the Middle Class and can be reached at mpcmgt.com.

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