States in a box: Nothing to do but reduce their payments and benefits

Accelerating health care spending. A steep and lengthy drop in revenues. These twin evils are at the heart of the states’ ongoing fiscal crisis, says the National Governors Association (NGA).

Commenting on the latest Fiscal Survey of the States, released at the end of June by NGA and the National Association of State Budget Officers, NGA executive director Raymond Scheppach noted that health care represents about 30% of state budgets, and Medicaid accounts for about 20%. While Medicaid growth was high in the early 1990s, the rate of growth fell to just 3.3% by 1996. But it then increased dramatically to an average of 9% in 2000 and jumped again to 13.1% in 2002.

"Unfortunately," Mr. Scheppach says, "this explosion took place at the same time that revenues were collapsing. States have limited ability to control the cost of Medicaid or other health care costs such as the cost of drugs or increased copayments. Double-digit cost increases are a national problem affecting all health care purchasers — the private sector, the federal government, and nonprofit organizations. All states can do is reduce provider payments, restrict eligibility, or reduce benefits."

As a percentage of state budgets, Medicaid ranges from a low of 8.7% to a high of 30%. NGA says the far western and northeastern states are facing the worst budget problems, with both the deepest drop in revenues and a high percentage of their budgets devoted to Medicaid spending.

The fiscal survey report indicates that Medicaid cost increases stem primarily from increased costs for pharmaceuticals and enrollment increases. As their costs have increased, state Medicaid expenditures have exceeded the amounts originally budgeted for the program. Some 25 states experienced Medicaid shortfalls in fiscal year 2002, and 28 states are expecting shortfalls in the coming fiscal year, according to the report. State shortfalls as a percentage of the total Medicaid program in FY 2002 ranged from less than 1% to 23% of program costs, with an average of 5.5%. The combined amount of the shortfalls in FY 2002 and 2003 totals more than $6 billion.

The reality of what states are facing in health care costs is seen in a report on a study by the Center for Studying Health System Change (HSC), which found that although the rate of growth in health care spending eased slightly in 2002 compared with 2001 (a 9.6% increase rather than 10%), it still is extremely high by historical standards and represents a much steeper increase than that seen in the overall economy, which went up 2.7% in 2002 as measured by per capita growth in gross domestic product.

The study was published on the Internet as a special Health Affairs article, and quotes HSC president Paul Ginsburg, a co-author of the study, as saying that "the good news is that health care spending growth slowed for the first time in five years, but the bad news is that health care spending continues to increase rapidly. Unless underlying health care cost trends slow significantly, health insurance premiums will continue to rise rapidly, and the number of uninsured Americans will increase."

Despite the slight decrease in 2002 spending growth, employer-based health insurance premiums rose again in 2003 by an average of 15%, the largest jump in at least 10 years. There are indications that the premium increases would have been even higher, perhaps 18%, if not for increased consumer cost-sharing through higher deductibles, copayments, and coinsurance.

More than half the overall spending increase was attributed to rapid growth in hospital spending per privately insured person for the second straight year. Of special concern to analysts: Hospital cost increases are driven increasingly by inflation, not by increased use of services.

Spending on inpatient hospital care increased 6.8% in 2002, accounting for 14% of total spending growth. Spending on outpatient hospital care grew 14.6% in 2002, surpassing prescription drugs as the fastest-growing spending component and accounting for 37% of overall spending growth.

After going up 8% in 2001, the increase in hospital utilization slowed to 5.7% in 2002, likely as a result of increased patient cost-sharing and completion of the transition to a looser form of managed care.

Hospital prices increased 5.1% in 2002, the largest one-year jump since at least 1994. As a result of higher prices and the slowing trend of increased utilization, price inflation accounted for almost half the increase in hospital spending in 2002, compared with about a third of the increase in hospital spending in 2001.

For the third year in a row, according to the HSC study, prescription drug spending increased at a slower pace, growing 13.2% in 2002 and accounting for 22% of overall spending growth. Factors affecting the slowdown in prescription drug prices include increased use of three-tier copayment structures, a reduction in new drugs coming to market, and a greater availability of generic drugs.

HSC says spending on physician services increased 6.5% in 2002, which was 27% of the total spending increase. Both higher prices and increased use of physician services played a role, but growing utilization was the more important factor.

Mr. Ginsburg says that even with the mixed results, it is an important development in spending trends that 2002 was the first year in five years that a one-year increase in spending did not exceed the preceding year’s increase.

Consumers can expect a second round of sizable increases to cost-sharing requirements in 2003, according to Mr. Ginsburg’s report. He says employers’ ability to pass along sizable increases in cost-sharing to their employees is likely a reflection of the continuing softness of the U.S. economy and rising unemployment that has led to a loosening of labor markets.

"While employers raised cost-sharing requirements to control rising premiums," says the study, "they made little change to the proportion of the total premium that employees are required to pay … . The fact that employers targeted cost sharing rather than employees’ share of premium to control costs reflects a clear strategy. Employees can avoid some or all of the increase in cost sharing and reduce their out-of-pocket spending by responding to the incentive and using fewer services."

Mr. Ginsburg says the outlook for the future is as mixed as the 2002 results he reported. A number of forces could lead to further deceleration of the health care cost trend, he says, but some developments might drive the cost trend upward again.

Two forces that could contribute to deceleration are growth in consumer cost-sharing and the sluggish U.S. economy. Forces that could exert an upward pressure include cuts in Medicaid provider payments that could lead providers to seek higher payments from private payers. Also, the federal government could further constrain provider payment rates for Medicare patients, which could lead to additional shifting of costs to private payers.

"Despite the uncertainty about future cost trends," Mr. Ginsburg writes, "conditions do seem ripe for the underwriting cycle to turn soon — and slow the premium trend — if the cost trend does not increase in 2003. The health insurance industry is now experiencing strong profitability in general. This will eventually set off a new round of price competition as plans begin to enter new markets and shift their strategic focus from improving profitability to growing market share … . A turn in the underwriting cycle will not, however, bring about a major slowdown in premium increases; this can only be accomplished by a major slowdown in underlying cost trends. Until this happens, employers and employees will continue to face the many negative consequences of high cost growth, and uninsurance will likely continue to rise."

Meanwhile, Commonwealth Fund president Karen Davis told a U.S. Senate Appropriations Committee subcommittee that bold steps need to be taken on the supply side of the health care equation if costs are to be brought under control.

"The U.S. has relied on a mixed public-private system of insurance, managed care, and market competition to shape the health care system," Ms. Davis said. "Yet the U.S. has the highest health care spending per capita in the world, and during the 1990s health spending in the U.S. rose faster than in other industrialized nations. The key to containing costs — as well as getting higher value for what we spend — may well lie in fundamental changes to the supply side of the market. We need to shift our attention to reducing errors, eliminating waste and duplication in clinical care, modernizing and streamlining administration, promoting transparency and accountability for performance, and aligning financial incentives for physicians, hospitals, and other health care providers to reward high-quality and efficient care."

After reviewing many of the all-too-familiar statistics on health care costs, Ms. Davis pointed out that health care spending in this country is higher than elsewhere because we pay higher prices for the same services, have higher administrative costs, and perform more complex specialized procedures.

Sick adults in the U.S. report higher rates of medical errors, she said, are more likely to go for duplicate tests, and are less likely to have their medical records available when they go for care compared with similar adults in other major English-speaking countries. In addition, ours is the only major industrialized nation not to provide health coverage for all.

Ms. Davis testified that steps that could be taken on the supply side include:

  • public reporting of cost and quality data on physicians, hospitals, nursing homes, other health care providers, and health plans;
  • broad-scale demonstrations of new approaches to health insurance coverage, science-based benefits, use of modern information technology, and high-quality care;
  • investment in health information technology;
  • development and promulgation of clinical guidelines and quality standards;
  • payment for high performance in delivery of health services under Medicare, Medicaid, and private insurance; and
  • investment in research to gain evidence of what works to improve care, eliminate waste and ineffective care, and promote greater efficiency, including use of modern information technology, teamwork, and improved processes of care.

"What we all want from our health care system is not necessarily cheaper care," Ms. Davis declared, "but assurances that resources are being invested wisely to buy higher-quality, more patient-responsive care that achieves better outcomes. We should aspire to a high-performance health system — one that is high-quality, efficient, and accessible to all Americans."

She said that in the past, those seeking to control costs have focused primarily on the demand side of the market. In other industries, she said, the path to lower costs lies in greater production efficiency, and financial rewards accrue to those firms that succeed in producing a high-quality product more efficiently. "But in health care we rarely reward or insist on either greater efficiency or higher quality. In the future, we should shift our attention to reducing errors, eliminating waste and duplication in critical care, modernizing and streamlining administration, promoting transparency and accountability for performance, and aligning financial incentives for physicians, hospitals, and other health care providers to reward high-quality and efficient care."

Ms. Davis told the hearing that if the United States has the world’s most costly health system but still fails to give everyone access to care and falls far short of providing the safe, high-quality care that it is possible to provide, the conclusion that there is room for improvement is inescapable.

[The NGA fiscal survey is available at Contact Mr. Scheppach at (202) 624-5300. The HSC study is available at Contact Mr. Ginsburg at (202) 484-5261 or go to Contact Ms. Davis at (212) 606-3800 or by e-mail at]