Moderate Growth to Start the New Year? Health Care Spending Growth Slows in First Three Quarters of 2016

Recently released data from the Census Bureau provides a reassuring perspective on the trajectory of health care spending, as seen in the latest Monthly Trend Report from the Altarum Institute.

While a bouncy data point from the second quarter had made it seem that health care spending was potentially heading off the rails, in the third quarter of 2016, health care spending grew at a more moderate pace of 5.2 percent. This puts the average for the first three quarters at 5.5 percent, lower than the official annual rate of 5.8 percent reported in early December by the CMS Office of the Actuary for 2015.

Directionally, this trend fits a narrative about how the expansion of health care coverage has affected national health expenditures. Coverage expansion began in 2014 and peaked in mid-2015; by 2016 the pace of expansion had slowed considerably. Growth in health care spending followed with a lag. Spending growth began to increase a few quarters later—in the latter half of 2014—and continued to increase in 2015 (see Chart on pg. 1).

And while spending growth appears to be lower in 2016 so far, rates have not yet returned to pre-expansion levels, suggesting that the impact of coverage expansion, though declining, is still in play. As the New Year begins, there are questions about the persistence of current trends.  Even more importantly, there is the potential for major policy changes that could have great implications for health care spending growth.

Will prescription drug spending growth continue to decline?

Spending on health care services—comprising nearly three quarters of national health expenditures—grew 5.4 percent during Q3 2016.  Drug spending, by contrast, grew 4.3 percent below the overall trend for the second quarter in a row. Preliminary data from the fourth quarter suggests that this declining trend in spending growth for drugs is continuing. While a relatively small share of overall health expenditures (approximately 10 percent), extremely high growth in prescription drug spending in 2014 and 2015 affected overall spending trends (see Figure 7 on pg. 7). These spending increases were driven by increases in both utilization of medications and prices, particularly for Hepatitis C therapies. Reductions in both utilization and prices for these therapies have contributed to the recent slowdown in drug spending growth.

Since price growth for prescription drugs (5.9%) in Q3 2016 exceeded the growth in overall spending, declining growth in utilization is a factor in the overall prescription drug spending trend (see Chart at top of pg. 2). Yet the measurement of drug prices in these data excludes rebates, which are increasingly important, and may thus overestimate the growth in drug prices, and underestimate the change in utilization. Despite this imprecision, growth in drug spending has been moving closer to the overall trend in national health expenditures since 2014 (see Figure 3 on pg. 4). The inherent uncertainty in the pipeline for new therapies as well as the opacity of pricing and the supply chain makes this component of spending extremely hard to predict. Further, drug prices remain a potential target for federal and/or state policy action.

Will health services prices continue their slow growth?

Growth in spending on health care services seems to be powered almost exclusively by increases in utilization, as price growth for this component has been extremely low, hovering close to 1 percent for the past four years (see Figure 5 on pg. 6). This makes sense, since the growth in health care services spending has been fueled by an increase in the number of people with health insurance. And while there has been much public concern about “underinsurance” and the unaffordability of health care for those with insurance, this pertains largely to changes in how health care is financed through benefit design, particularly the growth in high deductible plans. Trends in actual payments to physicians and hospitals for health care services have been quite moderate, as has been shown, for example, in data on trends in “allowed amounts” paid to physicians for office visits.

Many worried that coverage expansion would lead to a “demand shock” that would compromise access for new and existing patients, and bid up wages and other input costs. It appears so far that neither has occurred. Service price increases have been very low, and data from multiple sources suggests that access trends have been favorable. The blistering pace of job growth in health care provides some insight into how capacity has expanded. Employment in the sector grew steadily starting in 2014 and job growth has finally started to decline over the last two quarters, after peaking at 3.3 percent in Q1 2016. Early data from Q4 suggests that this decelerating trend is continuing. Job growth has lagged the utilization increase, and the rate of growth in utilization has exceeded that in jobs, suggesting that the productivity of labor in health care has increased (see Figures 9 and 10 on pg. 8). We have much to learn about the pathways through which this has occurred, likely involving changes in sites of care, new uses of technology, altered staffing arrangements, and the growth of new occupations.

What lies ahead?

The growth in health care utilization and employment that has been fueled by coverage expansion is beginning to slow as expansion levels off.  Much has been written about the significance of increased health care employment for the overall economy, some even referring to the Affordable Care Act as a “secret jobs program.” As the growth in health care employment slows, it remains to be seen whether there are broader effects on the labor market as a whole, particularly as we approach, or are already at, full employment.

There is immense cause for uncertainty in the near term. The health care sector has expanded to meet the demands of a population with a high rate of insurance coverage. Depending on the ambition and trajectory of federal health reform, coverage levels may actually decline significantly, as could federal and state spending on Medicaid and Medicare. Such changes would be expected to impact health care utilization and employment, and may also have implications for delivery system reform, depending on the degree to which alternative payment models are retained. The commitment to delivery system reform may itself be affected by changes in coverage, since providers may find it more difficult to transition away from fee for service in an environment where significant shares of the population are uninsured.