The basic premise of all insurance is to mitigate risk. Take a future unknown cost or liability and turn it into a budget able, known, upfront and predictable expense. For example, rather than face an expensive unpredictable medical event in the future that could lead to financial stress or ruin, elect for medical insurance whereby the risk of that potential event is transferred to a third party in exchange for monthly premiums. The coverage becomes viable when enough people enroll in the plan and those who don’t submit a claim can help cover the cost of those that do, thereby pooling the risk. Naturally, the premiums paid for this coverage are in large part comprised of its cost. As the cost of the loss event increases, all else being the same, the premium would also increase. The next issue is how much the premiums will be, and if those who are looking for coverage can afford to pay the premiums.
This arrangement works as long as wages are growing at the same pace as the cost of insurance, and the members purchasing power is preserved. However, if wage increases don’t keep up with premiums and member cost sharing, then the insurance becomes unattractive and members will either drop for forego coverage. As it turns out, wages aren’t keeping up with the cost of insurance and consumers are feeling it. According to the LA Times1, “As long as out-of-pocket costs for deductibles, drugs, surprise bills and more continue to outpace wage growth, people will be frustrated by their medical bills and see health costs as huge pocketbook and political issues”. This leads to an interesting question: could healthcare costs increase to the point that not only is the event the insurance is meant to protect against unaffordable, but the premium for said insurance is also unaffordable?
A lot has been said about the rising cost of healthcare in the United States. Many laws and new forms of reimbursement have been undertaken in an attempt to curtail those costs. Healthcare is a special consumer good unlike many others for several reasons. The demand for it is inelastic, it is not sensitive to the cost, and only increases as a person gets older. The need for healthcare also greatly increases as a person gets older. Societal culture and norms prescribe having medical insurance as a way of life and that everyone should have coverage.
One of the distinguishing characteristics of healthcare is consumers are largely insulated from its cost. This insulation comes from multiple avenues. First, a large majority of people who interact with the true costs of the healthcare system do so with a third-party payer, whether it’s an insurance company, government agency, or employer and not directly. Using a third-party payer can produce discounts on services but cost transparency is often lost to the consumer, they never see the actual costs of the services they consume. This insulation can introduce moral hazard on both the consumer and provider side. Given that a third party will pay for the coverage, the insured could consume more, and the provider could charge more or order more services. Additionally, government programs can cause a shift in healthcare costs. A provider will shift the costs to the consumer market if they aren’t reimbursed enough through government programs. On the premium side, if coverage is through an employer, it’s possible the employer could pay a portion if not all the premium on behalf of the member. This has a double whammy effect on the consumer. The employer would face ever increasing healthcare premiums, some of which will be passed through to the employee, and some would be offset by paying lower wages.
An analysis of all drivers of wages is beyond the scope of this article but looking at its relation to healthcare costs illustrates a couple of important points. Table 1 below compares the annual median income2 to the CPI-All Urban3 Consumer Medical Care index. Both have been normalized to $1,000 for year 1984 for comparisons.
Table 1: Medical Cost vs. Median Income
Healthcare cost growth outpaces wages growth
Not only has healthcare cost growth (blue columns) consistently outpaced wage growth (green columns), but there are times were the difference (orange line) accelerates. Many things can contribute to rising healthcare cost; increasing units costs, increased utilization, a different mix of services, etc.
Healthcare costs are recession proof, wages are sensitive to recessions
As previously mentioned, the demand for healthcare is inelastic, especially for those with a medical condition. The cost of care, or the ability to pay for it, doesn’t change the need or demand for it much. A diabetic will still seek to check their blood sugar levels and take insulin to manage their condition regardless of cost or ability to pay. The healthcare industry tends to be recession proof due to its necessity. Wages, however, are not recession proof. There are three recessions in the time period covered in the table above and they coincide with the orange difference line having a sustained positive slope. The early 1990s particularly took a toll on consumers. The small recession was accompanied by backlash from HMO products that were very popular at the time. Consumers and some lawmakers were unhappy with restricted access and managed care, so they responded by limiting some care management practices and sought more choice. These two events caused healthcare costs to increase faster than usual and suppressed wages to a greater degree.
Once the HMO backlash of the early 1990s ended and cost increases were slowed, unemployment and wages improved, and wage growth briefly outpaced healthcare leading to the turn of the century. The 2000s saw an especially troublesome pattern. The “.com” recession of the early 2000s started the cycle of suppressed wages and before they could recover the housing crisis exacerbated the problem to the point where wages further declined.
A different view of the data in Table 2 below illustrates the difference in the growth rates of Medical Costs and Median Income. Except for the managed care backlash of the 1990s, the blue Medical Cost line increases at a somewhat constant rate and is unaffected by economics conditions where wages are affected.
Table 2: Cumulate Change in Medical Cost and Median Income
Table-2 shows medical cost always increases where wages do not. This further illustrates the previous point that, among other things, medical cost increases are recession proof. Secondly, not only are medical cost increases less susceptible to economic conditions, the rate of increase is usually greater than the rate of increase for wages, or at least more sustainable. Across time, even if wage increases can keep up with medical cost increases, it is only for a short amount of time before they inevitably slow down. Lastly, the slopes and large divergence of these lines suggest that medical cost will only continue to outpace wage increases. This will continue to put pressure on employers’ budgets for healthcare expenses, as well as members wages to cover their premium.
The recession proof nature of healthcare adds strain to an already expensive cost. In times when incomes or revenues are suppressed elsewhere, healthcare costs continue to rise. Premiums also continue to rise since the underlying cost of insurance makes up the largest portion of premiums. If these trends continue indefinitely, absent premium subsidies or cost reductions, healthcare could get expensive enough to where even the premiums for coverage are unaffordable.
About the Author
Sean Lorentz, ASA, MAAA is a Consulting Actuary at Axene Health Partners, LLC and is based in AHP’s Temecula, CA office.