Game Changer: Health-Care Spending Defies Almost Everyone


The five most common words in forecasting may be "no one saw this coming." Forecasters tend to look for patterns of the past and extrapolate them into the future. But the future doesn't work that way. Things change, and trends that once looked unbreakable break.

For years, every long-term federal budget forecast and projection of income growth has painted a dire view of America's future based on one key assumption: Health-care costs would continue to rise precipitously, as they have for decades.

But something incredibly important has happened lately: They haven't. Growth in health-care spending across the board -- from the private market to Medicare -- has slowed dramatically, well below even the lowest projections.

As Annie Lowrey wrote in this weekend's New York Times, nationwide growth in health-care spending hit a five-decade low in 2009 and 2010. "After years of taking up a growing share of economic activity, health spending held steady in 2010, at 17.9 percent of the gross domestic product," she wrote.

Much of the decline is due to the recession, as workers lose employer-provided health insurance and falling incomes hit families' ability to shoulder costs. But there's more to it than that. "The recession just doesn't account for the numbers we're seeing," Lowrey quotes Harvard health economist David Cutler as saying.

Spending on government health programs like Medicare should be immune from the effects of a recession, for example. Yet growth in per-enrollee costs have plunged. Over the last four decades, Medicare's per-enrollee costs have outpaced broader economic growth by an average of 2.6 percentage points a year, according to a recent report in the New England Journal of Medicine. In 2010 and 2011, however, cost growth roughly matched economic growth. That's the lowest Medicare growth rate on record. Five years ago, the Congressional Budget Office forecast the government would spend $587 billion on Medicare in 2011. The actual number was $485 billion -- one of only a handful of times in history the government has overestimated its ability to spend.

"On the whole, we do not believe that the recent slowdown in Medicare spending growth is a fluke," the Journal wrote. "There has been a long-term trend toward tighter Medicare payment policy, and policy changes that began in the middle of the 2000s have continued that tightening."

There can be dozens of other explanations for the broader decline in health-care spending. One of the biggest is that fewer businesses offer health insurance to employees. According to the Kaiser Family Foundation, 69% of businesses offered workers health insurance in 2000. By 2009, only 60% did. The growing popularity of high-deductible insurance plans also discourages unnecessary treatment. Health-care providers are becoming more accountable for errors and waste. With big pharmaceuticals like Pfizer (NYS: PFE) and Merck (NYS: MRK) facing patent expirations, generic drugs have surged to nearly 80% of all prescriptions filled, from 63% in 2006, according to the IMS Institute. Add it all up, and the forces that most analysts predicted would keep health-care spending on the rise are waning fast.

So what's it all mean?

One of the biggest changes falling health-care growth could bring is falling deficits.

The Congressional Budget Office has for years warned that out-of-control growth in health-care spending would derail the federal government's finances. Indeed, health-care spending was virtually the only factor worth paying attention to in the debate over long-term deficits. Of the massive increase in real government spending forecast over the next 75 years, CBO estimated in a 2009 report that "almost all" was due to Medicare, Medicaid, and Social Security. Of those three, "Medicare and Medicaid are responsible for 80 percent" of the projected growth between now and 2035, and 90% of the growth between 2035 and 2080.

Part of the growth is due to the demographics of an aging population. But by far the largest projected contributor to the growth is per-enrollee Medicare costs growing faster than GDP. By a lot. CBO published this chart in 2007, showing the projected rise in Medicare spending:


Source: CBO.

But the assumptions that go into this chart are now being called into question. In January, CBO cut its own budget-deficit forecast by $69 billion over 10 years to reflect slower Medicare spending growth.

With per-enrollee costs now growing far slower than anyone envisioned, it's worth asking how many more of those revisions we'll see. Even small changes to the growth estimates add up remarkably fast. As Lowrey notes: "If the growth in Medicare were to come down to a rate of only 1 percentage point a year faster than the economy's growth, the projected long-term deficit would fall by more than one-third."

Then there's the impact falling health-care growth has on wages. Average wages have stagnated over the last decade, yet compensation costs for employers have risen at a good clip as employer-provided health insurance premiums surged. Wages made up about 73% of total compensation in 2000. Today, it's 69.4%. Ten years ago, insurance made up 6.4% of total compensation. Today, it's nearly 9%. Employees have been denied salary increases in no small part because they were crowded out by rising health insurance costs.

That trend may also come to an end if growth in health-care costs keeps falling. If it does, workers may experience something that's been a dream for a decade now: larger paychecks.

A few years doesn't a trend make, and the health-care surge may resume just as fast as it ended. But the recent decline is a good reminder of two important facts. One, nothing can grow faster than the overall economy forever. And two, almost every long-term budget forecast has ended up disastrously off-base. Is this time any different? Remember: No one ever sees it coming.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

At the time thisarticle was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.Motley Fool newsletter serviceshave recommended buying shares of Pfizer. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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