The Crisis in Healthcare Cost in the United States–An Actuary's Perspective

The Crisis In Healthcare Cost In The United States–An Actuary's Perspective
by Dan Bailey

When it comes to the question of a crisis in the healthcare industry, the answer could be yes, or it could be no.

Is there really a crisis in healthcare cost here in the United States? Or is it more a crisis in health insurance cost? Is the problem genuinely of crisis proportion, or might it be more accurately described as a problem with healthcare access or health insurance availability? That is the subject to be explored in this article. Healthcare cost and the social issues surrounding it are a complex subject of almost intractable immensity. It is also a delicate subject, and any article about it will not please all the people all the time, to paraphrase a favorite president. After all, healthcare is the largest economic sector, commanding 16 percent of the GDP, not to mention an employer of over 11 million. Ultimately, everyone is a stakeholder in this system, especially when we are sick and most in need of it. No wonder that the range of opinions spans so broad a spectrum of subjectivity and critical bias.

So who is to blame–the culprit de jour? Some say that everyone is; others insist that certain institutions, groups and individuals are responsible to a greater degree. How we got to where we are today is a long, circuitous story, and many say that where we are, with respect to our system for the finance and delivery of healthcare, is not in a bad place, while others denounce it as a fraying patchwork of financial security systems.

Is There Really a Crisis In Healthcare Cost?
"Yes, absolutely," will be the response if you ask some, such as an uninsured person working for a small business that does not provide any health coverage. Add a chronically ill family member and a large undiscounted hospital bill from an inpatient stay, and we have a family crisis at a minimum. Multiply this by the number of people similarly affected, and we, in part of the nation's opinion, have a full–blown "crisis."

Ask the same question, however, of someone with a generous Fortune 100 employer–based benefit, and the answer will be "not for me." Such an employer plan may pay as much as 80 percent to 90 percent of the total first dollar cost of that person's annual family medical expense. Not that all Fortune 100 companies have such "rich" benefits, but typically the largest and perennially most successful companies do offer more substantial health benefits to employees and their dependents. That same individual might go on to extol a life–saving operation, paid almost in entirety by commercial insurance, that has added 10 years to his life expectancy, or added to her quality of life–an operation that was unavailable 25 years earlier. Anecdotally, while living outside the United States, I learned of individuals from other nations who obtained, at personal expense, such a life–prolonging procedure here in the United States, where the survival rate for the operation was much greater. My own bias is to include such facts in an analysis of the costly healthcare in the United States.

The allegation of crisis comes from those who pay for healthcare–employers, employees, individuals and taxpayers. To use hyperbole, we are a nation that wants it all, wants it perfect, now, for free. I recently watched a telecast of a speech in which a politician used the metaphor of a wrecking ball to describe current healthcare cost in the United States. At the other extreme, I have heard the infinite–demand metaphor of the search for the fountain of youth. Each view seems to stretch the truth past its breaking point, but I will endeavor to refrain from turning this article into a pure opinion piece and encourage readers to form their own fact–based actuarial opinion on this subject. To be more broadly perceived as valid participants in these national discussions, actuaries need to demonstrate that we can add value objectively. In similar discussions during the early 1990s, actuaries were often marginalized and suspected of being representative of the special interests of health insurers and managed care organizations. That was unfortunate because our profession can offer insights that no other profession has. No matter how one views the current situation in healthcare cost in the United States, alongside its neighbor, managed care, it has a reputation that is not much more positive these days than nuclear energy had after the mishap at Three Mile Island.

What Exactly Is Healthcare Cost?
The Oxford English Dictionary defines cost as "that which must be given or surrendered to acquire something." What unit(s) should we use in measuring healthcare cost? The Centers for Medicare and Medicaid Services (CMS) tracks our aggregate annual national total spending, in whole dollars–this is the National Health Expenditure (NHE). It is also tracked on a per person per calendar year basis and as a percent of GDP. Since the U.S. population has been growing, it makes more sense to use the per person metric–take the aggregate national spending for a specified calendar year (NHE) and divide by the number of people in the United States. The NHE includes all sources of spending and funding. Although there are other measures, NHE is as good a measure as any for the purpose of this article. This type of cost is sometimes referred to as a form of "first dollar" cost because, in health insurance terms, it is not only the insurance company liability that is incurred after an initial deductible is met. CMS publishes NHE data and updates it annually.

Exactly what expenses count as healthcare cost? NHE is quite broad and includes dental care and other forms of medical spending, such as hearing aids and eyeglasses, which might not be covered under a health insurance policy. NHE also includes personal medical expenditures, such as over–the–counter drugs and remedies. While this is not exactly the perfect metric for health insurers, unless some items are removed, it is appropriate for health policy analysts. On the CMS Web site, the government defines the medical costs included in NHE, and they distinguish between various categories of cost; public and private. This is more inclusive than the claims cost that underlies health insurance. If we look at the per member per year (pmpy) claims cost of private health insurance, over–the–counter items (Tylenol and cough syrup) are not included in the insurer's liability, nor is member cost–sharing–copays, deductibles, coinsurance, balance bills and the cost of non–covered services, which may include claims denied for lack of proper authorization. CMS, however, does estimate first dollar cost. For Medicare, CMS similarly tracks how much the average Medicare beneficiary spends out of pocket for medical costs that are not provided by Medicare, such as deductibles, coinsurance, copays, balance bills and other costs. For many reasons, the cost of covered services varies considerably from plan to plan, and the cost that the privately or publicly insured individual pays in premium and various types of cost–sharing should be considered, as should the cost of non–covered services.

One of the measures that health actuaries use is benefit adequacy; this is the ratio of paid claims to alloweds. This ratio ignores non–covered benefits, but for a reasonably comprehensive health plan, it is a quick test of how much of the plan's cost of covered benefits is paid by the insurer and how much by the member in the form of cost–sharing. This ratio has one shortcoming if used to compare a very rich plan (with little member cost–sharing) with a lean one; the allowed cost of the rich plan reflects a higher level of utilization–the lower cost–sharing on the richer plan generally induces utilization and leads to greater allowed cost. Although the Rand study is dated, it revealed a universal truth about health cost and induced utilization that still applies today–the more one must pay out of his or her own pocket for healthcare, the lower his or her utilization will be. Naturally this inverse relationship has limits–the man hobbling into the ER with an arrow in his thigh does not care how much his copay is–but the point is that, for the privately insured, the richness of the plan of benefits has a great deal to do with the level of health cost.

In recent years, employers have been less inclined to bear 100 percent of the annual cost increase of commercial cover. Consequently, a greater share of the cost increase has been placed on the employee. It has taken the form of increased cost sharing as well as increased member premiums. This is especially true for small employers and less so for the largest ones. For small employers, the employee may be paying the majority of the increase, whereas for the largest employers, it seems to be the other way around. Health actuaries speak of "benefit buy–downs," meaning that, upon renewal, many employers opt for plans with higher copays and greater cost sharing. Benefit buy–downs reduce an employer's premium cost increase by means of reducing benefit adequacy; this may occur concurrently with the employee paying a larger share of the premium as well. In fact, over the past several years, some employees' cost of care has been trending at a higher rate than their small group employers, which have adopted more of a defined contribution approach to healthcare benefits. Actuaries who work in employee benefits refer to this as cost shifting, since it is not a form of saving in total cost–it is just a switch from ER to EE funding. For the sake of this article, we will look at the first dollar cost of care, which includes funding from all sources. First dollar or not, all health actuaries agree, however, that the average annual per person cost of healthcare is increasing at a rate much greater than underlying inflation.

One last comment regarding the definition of cost as involving something that must be given up: Who should pay? Who does pay? If healthcare is a right, an entitlement, does that mean that other people should pay? Who has how much skin in the game? The nature of insurance is that only those with a covered loss are spenders. Except for individual coverage, the funders (payers) and the spenders are not the same party in health cover. There is some redistribution of income in today's system. Will the system of tomorrow redistribute income differently, and if so, how will this affect healthcare cost? In Germany, employer and employee alike each pay a payroll tax of about 7 percent to cover their universal health coverage; this is similar in concept to the payroll tax we use to finance Part A of Medicare.Also, about 8 percent of German people, those making above approximately $55k annually, can buy their health coverage privately, outside the public system. But Germany is a different country in many ways. For the moment, we leave the question open as to who does pay in the United States, but should we return to it, the question of who does pay will inevitably lead to the question of who should, and this raises the related issues of uncompensated care and social adequacy versus individual equity.

What Is a Crisis?
While on the subject of defining essential terms, the dictionary definitions are a) an unstable condition leading to abrupt change or a turning point, b) an incident or situation involving major threat or c) the point in the course of a patient's disease in which he or she either dies or gets well. In retrospect, the Cuban missile crisis met the definition. What about the healthcare cost crisis?

For many people, the term healthcare cost is synonymous with the cost of health insurance. About 45 percent of the cost of healthcare in the United States in 2004 was paid by the government and 55 percent was privately funded. Most OECD nations publicly fund a much larger percentage, and they consequently have higher tax rates. In 1960, only 25 percent of the cost was publicly funded in the United States. In addition to Medicare and Medicaid, which were established in 1965, another large portion of government funding is on behalf of government employees of municipalities, states, the federal government and the military. Nations with universal healthcare generally have earmarked taxes, such as a payroll tax, to fund all or part of it. Other forms of taxation, such as general taxation, help to fund healthcare in all countries, including the United States. Here in the United States, however, our tax system works very differently in one major respect. Our employer–based system permits an employer to record the cost of health insurance premiums (or self funded health claims) as a normal business expense. In a for–profit world with 35 percent tax, that becomes 65 cents of employer (ER) cost on the dollar of employee (EE) benefit; furthermore, it is not a taxable benefit to the EE and his or her covered dependents. This simple fact about the taxability of commercial group coverage is fundamental to understanding how and why ER–based health insurance has evolved into what it is today. Methods exist that allow an employee to pay some medicalcost on a before–tax basis, but most out–of–pocket cost is paid with after–tax dollars in the United States.

During the last 15 years that I have worked as a health actuary, the word "crisis" has shuttled back and forth between the front and back burner of public consciousness. It does not affect everyone the same way at any given time. One thing is sure, however: it does not matter how we look at it, healthcare cost has been increasing faster than our means and thus consuming an increasing portion of our growing GDP. While this is true for other nations as well, it has generally affected the United States to a greater degree than it has other large OECD nations. As Howard Bolnick has explained in some of his articles, while the United States continues on more of an expansionary trajectory, most other countries have more social and political mechanisms that compress cost increases and thus long–term healthcare spending.

How Much Does Healthcare Cost in the United States?
To provide some global perspective, first consider the entire two–dimensional "pie" of healthcare cost in the United States, and then slice it into the various public and private sources of funding. In 2002, the rounded numbers were easy–the United States spent about $1.5 trillion on healthcare–that was the total spending represented by the area of the pie. Also in 2002, our GDP was about $10 trillion; thus we spent 15 percent of GDP on HC. In 2004, in rounded numbers, NHE was about $1.9 trillion, $6,280 per person, and 16 percent of GDP. By some accounts, this is projected to reach about 20 percent in 2015. Despite all this spending, a number of related issues contribute to the perception of a healthcare cost crisis in the United States, especially the uninsured problem:

  1. According to the most recent census report of August 2006, 46.6 million Americans currently have no health coverage, despite the fact that the United States spends more in whole dollars and as a percent of GDP than other nations. Ironically, many of the uninsured are working. In addition, another 10 million may lack coverage transitionally at some point during the year. Some describe this as a form of de facto rationing, and they remind us that the only other OECD nation without universal coverage is South Africa. Others assert that, in a free market economy, there will always be some who, given the choice, choose to spend their money on other things and choose not to have health insurance. That number is probably much less than 46 million; and economic circumstance is likely the determining factor for many of the poor, working uninsured.
  2. Medicare spending alone has grown to 3.2 percent of GDP since the inception of Part D in 2005, and is projected by the Office of the Actuary to rise to over 12 percent by 2075 unless some compression of cost occurs. Over the first 40 years, total Medicare spending increased roughly 100–fold, from about $3+ billion in 1966 to $330 billion in 2004. In the 2006 Trustee's Report, it was reported that Medicare must increase the Part A (HI) premium tax by 121 percent or substantially reduce Medicare benefits to maintain solvency.
  3. Medicaid spending is also rising and has increased approximately 10 percent annually over the past 10 years as the number of covered individuals has grown to over 50 million. This includes the roughly 6 million elderly poor in nursing homes who are covered by both Medicare and Medicaid. Over half of the total U.S. Medicaid cost is paid by the federal government, with the remainder paid by the state depending on its relative wealth. States are finding it increasingly difficult to fund their portion of Medicaid. In 2002, 41 percent of births in the United States were financed by Medicaid; eight states and the District of Columbia had rates of 50 percent or more. Also in 2002, the United States paid $288 billion in Medicaid.
  4. Healthcare spending as a percent of GDP is higher in the United States than in any other OECD country, and the U.S. GDP per person is higher than almost all other nations. The vital statistics of the U.S. health system itself, however, such as life expectancy and infant mortality, are in lower standing than most OECD countries. This fact is often cited as proof of the waste and inefficiency in the U.S. system.

As seen in Table 2, although GDP is growing rapidly, NHE is increasing faster, and NHE as a percent of GDP is thus increasing. Over the past 15 years, healthcare cost has not grown as rapidly as it did during the prior 15 years. One of the findings of international health cost studies is that a primary driver of how much a country spends on healthcare is simply its ability to pay. This helps explain the fourth point above. Are there other forces at play that help explain this phenomenon? Apart from sustainability, how well do we understand the perceived utility of each additional dollar that people spend on healthcare in a nation as wealthy as the United States? A third world nation gets a much larger delta for its additional dollar–it may vanquish a disease, like smallpox or polio, already absent from the developed world. A literature search still fails to uncover proof that the high level of healthcare spending is a drag on the U.S. economy. Microeconomically, there is some support from CEOs of U.S. companies who assert that their healthcare costs impede their ability to compete internationally. Macroeconomically, there is far less support coming from economists; some health policy analysts even argue the opposite. Is a dollar spent on medical care of less benefit to the economy than a dollar spent on food, shelter or consumer goods, or a dollar spent at the casino? Many are convinced that increasing health cost is unsustainable. As counterpoint to those that claim the sky is already falling, recall the argument made in a 1798 essay by Thomas Malthus, who was convinced that the exponentially increasing human population would soon outgrow its food sources and be consumed by famine. How much higher than 16 percent of GDP can health spending rise? And even if 16 percent is as high as it ever goes, how steeply can GDP itself increase?

Table 1 | Table 2 | Table 3

There are several online sources from which to obtain national health cost information and multi–year national health cost data. One excellent source of data is the CMS Web site: Look for "NationalHealthExpendData." Find the file titled "NHE04.csv"–it is a compendium of health cost data going back to 1960. From 1960 to 2004, the average per capita cost in the United States increased about 8.9 percent per annum; that is, it increased 42.6 times in 44 years. This is considerably higher than inflation over the same period–CPI–U was about 4.3 percent; inflation alone explains growth of 6.3 times over 44 years. If we divide the per capita health cost growth of 42.6 times by inflation's 6.3, we obtain real growth of 6.7 times over 44 years. In addition to medical technology, one of the drivers of the per capita increase is the aging of the population. The total NHE increased 10 percent annually, which is 68 times in 44 years; this is greater than the NHE per capita increase due to the rise in population. Finally, the GDP has been increasing at a rate of 7.3 percent over the past 44 years and has increased 22.3 times. The differential slippage between the 10 percent growth of overall NHE and the 7.3 percent growth of GDP explains the increase in NHE as a percent of GDP. In reviewing this data, I calculated an annualized rolling 10–year trend and a rolling five–year trend. The highest 10–year annualized increases occurred during the 1970s and peaked in the early 1980s. The highest five–year annualized increases also occurred during the 1970s and peaked in 1981. Since 1990, we have been looking at single digit increases in the annualized rolling 10–year trend. For the rolling five–year trend, the same is true since 1986. In the NHE file from CMS, the slices of the annual pie are listed one–dimensionally in columns, and are provided with successive granularity.

Do we actually get more for our healthcare dollar in the United States than we would if we spent less? That is, could we spend less with the same result? This is a difficult question to answer using the scientific method, but it is one of the central questions of managed care. In a conversation several years ago involving people from Canada and the United States, a Canadian man explained how he had spent the night before a long–awaited operation sleeping on a gurney in a hallway. "I trust you never heard about that sort of thing in the United States," he said. There may be aspects of cost and quality that are difficult to quantify, such as patient satisfaction, which is relative. And somewhere in the discussion, we should include the subject of malpractice litigation as well as its consequence, defensive medicine. Somewhere else we must consider the affect of the patchwork crazy quilt of state regulation and the widely varying benefit mandates across states. Our system seems to be, if not one of contradictions, at least one of co–existing extremes–excellent quality of care, for those who can afford it, alongside 46.6 million uninsured. This amounts to generous public coverage for the poorest poor (Medicaid) and adequate cover for the elderly and disabled (Medicare), while many of the working poor somehow fall through all the safety nets. When they finally show up in the ER, it is often because treatment of their more advanced condition cannot be postponed further.

An issue brief released by the Academy of Actuaries in December 2005, entitled Health Coverage Issues: The Uninsured and the Insured, covers the under 65, non–Medicare eligible population. Like all Academy Issue Briefs, it is intentionally objective, fact–based, grounded in statistical data and information, and presents an actuarial perspective on its subject. It shows that the number and percent of those with health coverage provided by employment has declined over the past two years. Two salient facts emerge about the uninsured in Table 2 on page 3 of the issue brief. The number of uninsured working poor is increasing, as is the number of low income uninsured ( This increase in the number of uninsured seems to be the crux of our crisis. And the vast majority of the uninsured cite cost as the barrier, not availability. Are there low–cost insurance alternatives available that at least cover catastrophic episodes of care?

One of the allegations against the U.S. system is that the many–payer system itself exacerbates the unconstrained growth in the overall cost of care. In other OECD countries, there are generally far fewer payers (purchasers) of healthcare, and they wield far more purchasing clout than the fragmentary multitude of U.S. payers. The AMA has staunchly opposed planned reductions in Medicare reimbursement recently, and throughout their history, they have opposed not only the centralization of purchasing power, but also any new form of government price control, including fee schedules. Providers in the United States eschew the government price controls that are applied in other OECD nations.

Although many attempt to apply economic principles to healthcare, it refuses to behave purely like a widget. Beyond preventive care, we may be talking about the care of people who are sick and dying prematurely, perhaps a child with cancer that could be cured–this is serious business. Some health economists argue that market forces do not apply to healthcare quite the same way as they do to computers, televisions and microwaves. At this point in time, in addition to relatively little transparency in healthcare cost, those with employer–based or public coverage are spending what often feels like other people's money. As such, it does not matter much whether the MRI costs $600 or $1,800, as long as someone else is paying for it. Meanwhile, the United States is headed toward spending over $2 trillion in 2006, which, in the most arcane and advanced actuarial terms, is enough dollar bills to encircle the equator about 7,500 times, if laid lengthwise end to end, and create a literal money–belt over 1/4 mile wide.

The subject of healthcare cost is so complex and far–reaching, it is difficult to offer even a broad–brush view in an article of this length. There has been no mention of acute versus long–term care. And as the population ages further, more of the frail elderly will come under the funding umbrella of both Medicare for acute care and Medicaid for long–term. In conclusion, in the sense of "enormous threat," there is an ongoing crisis in the finance and delivery of healthcare in the United States. Part free market and part government–controlled–the two do not coexist perfectly. An increasing number of politicians, particularly challengers to incumbents, are embracing a transformational "universal healthcare" solution. It has come about as cost has steadily increased year after year, and the number of uninsured has increased, until the system has reached a point at which sufficiently many are crying "no more."

Regardless of what we think about healthcare cost, friend or foe, many question the sustainability of the current situation and how much more cost can increase. On the actuarial other hand, in the sense of "turning point," there has not been a public crisis in the U.S. system that meets the dictionary definition because we have not yet reached a clearly identifiable point where the transformation began. This does not mean it is acceptable that we have 46.6 million uninsured in the United States. One thing is sure, however–this is a remarkably complex social and economic problem of enormous scale with significant implications for our society and economy, for our financial security and that of our descendants. Our political leaders genuinely struggle with this issue. Finally, this is an opportunity for our profession to gain visibility and credibility by contributing to this discussion on behalf of the common good. Is there really a crisis in healthcare cost here in the United States?

Dan Bailey, MAAA, is a health actuary at Aetna in Hartford, Conn. The views expressed in this article are his and do not reflect those of his employer. He can be reached at