Boca Benefits Consulting Group Inc.

In his November 7, 2008 New York Times Economix blog post titled “The Health Care Challenge: Sailing Into a Perfect Storm” Princeton economist Ewe E. Reinhardt tells it the way it is: health care costs accelerate faster than incomes. What he does not say is that it is not a new trend. Having been an employee benefits practitioner of one sort or another for 28 years, I have been an empirical observer of the phenomenon since the very early 1980’s. Along the way there have been some structural shifts in the system such as the middle to late 1980’s when managed care began to wring out the embedded excess utilization and the acceleration of health care costs temporarily abated. However, once the new utilization floor was established, we were right back off to the races. One of the biggest failures of the managed care concept is that it has only really nibbled around the edges of cost acceleration since about 1990.

What caught my eye in Dr. Reinhardt’s piece was the difference in conclusions that he reaches versus what another esteemed economist at Harvard presented to the March 2004 “Skills for the New World of Health Care” group that met for a week in the JFK School of Government. That economist had concluded that the total compensation line for employees had a zero slope — in other words it was completely flat and not an increasing cost to employers once adjusted for inflation and pricing. He further concluded that medical premium had been a tax efficient way of just shifting the mix of compensation along that flat line away from an earnings base that required the payment of payroll taxes.  Being a little cowed by the credentials of the presenter, I only mildly pushed back the concept of opportunity costs and reduced competitive positioning in a world market that comes from the inefficient accruing of non-essential expenses in a product.  I also asked him about the lack of re-investment in critical infrastructure that might otherwise be made with those same inefficiently used medical dollars. Banter was not the proper etiquette of that forum and the subjects were dropped almost as fast as I raised them.

There actually could be some degree of correctness in both economist’s positions. There was a period of time where employers did shift the mix of compensation along a relatively flat line. However, it was never really flat. Health care trend (i.e., for simplicity here just assume it to be health care “inflation”) has compounded faster than the overall CPI, and the increase in employee wages that closely follows the CPI, for 25+ years. The conclusion: more incremental absolute dollars have been going into health care each year than incremental absolute dollars going into wages. It cannot be reasonably argued that this has been nothing more than a dollar shift along a constant, fixed, total compensation line. The line indeed has had a positive slope all along. At the same time employers found it palatable to absorb much of the real health care cost increases each year and give smaller wage increases. It may have even dampened inflationary pressures over the years by moving compensation dollars into one particular commodity and removing them from the broader general economy. There was some false sense of comfort that the line was flat, especially in certain inflationary years where making comparisons was most difficult. However, in fact, every year was just another small bite out of relative competitive positioning.

Fast forward to the present. Employers all over the country have begun to slam on the medical plan funding brakes. The ability of employers to subsidize medical costs has reached the ultimate tipping point. Dr. Reinhardt’s position regarding the carrying capacity of an average family is dead on and it is only getting worse.

• Medical costs continue to exceed increases in CPI/wages
• Employers are paying an ever diminishing percentage of the total
• Many smaller employers who were profitable prior to the 2008 economic meltdown are now either radically cutting back their share of medical costs or they are reluctantly eliminating medical plans in entirety.
• Cost shifting to market based alternatives like HSA’s has only put more risk on employees and only marginally increased their utilization efficiencies
• The underlying cost acceleration drivers in the system have barely been addressed and annual medical cost increases, although not at all time highs, remain at unjustifiable levels

The flat line was always an illusion. Now medical costs hang around an employer’s neck like an albatross that cannot be removed. It is a completely unsustainable economic model over time, both (1) domestically where we fail to efficiently use limited assets in infrastructure reinvestment and continue the death spiral, and (2) internationally where we have a deteriorating competitive position.

• Employers cannot pay any more.
• The carrying capacity of individuals is max’d out.
• The line still points upward and all the cost pressures of the last 25+ years are still at play.
• The base of the line continues to inch up the Y axis in absolute dollars.
• Finally, in a worldwide economic slowdown with severe pressure on pricing and sales, the base of the line has recently made a quantum leap up the Y access as a percentage of total costs and a percentage of total revenue.

In 2004 while at the Harvard course, I made the argument that ultimately health care was less a social issue than it was a crucial economic one. I further argued that the regulators of health care should not be social scientists but rather more hard-bitten business pragmatists with real skin in the game. My scenario had a quasi-governmental Council of 500 (i.e., you can name your number here) that replaced current federal regulators. It also placed the situs of regulation under Commerce or Treasury for the first time. Just enough to make everyone mad!

Right now it is much too easy for the far political right to pillorize those who even mention the concept of highly subsidized or universal health care. They continue the same market driven solutions mantra that has never worked in the U.S. — yes I mean never worked! Supply and demand relationships fail the classic tests because the purchaser of services is not a rational buyer at point-of-sale. He/she is a worried sick person who will do anything they are told by their physician and buy anything they are told to buy. The Econ 101 “propensity to consume” relationships go right out the window. Health care is a virtually inelastic commodity: we will buy the same amount (i.e., the same excessive amount) no matter how high the price is driven.  As with all inelastic models, the naysayers will always point to some degree of ultimate elasticity once the costs are truly out of pocket for the purchaser.  At what human cost (i.e., rationed minimum health care)? At what social cost (i.e., an institutionalized tiered system)?  I will stipulate to the concept of ultimate elasticity with the below caveat.

That is until the entire system fails! A scenario that now seems perilously close and more in focus than it has ever been in the history of this country. Health care executives and the more right leaning policymakers should keep a close eye on General Motors, another monolith that thought it could never be brought down by slow moving changes in market forces and appears to now have been severely stung by its arrogance!