Vertigo: Effect of Spiking Healthcare Costs on Consumers

A burgeoning topic of conversation during Q&A sessions at my recent client events has been elevating healthcare costs and their impact on the consumer and the economy. It’s surely driven not just by the increasing attention being devoted to the growing concerns around the Affordable Care Act (ACA), but also of course by the actual impact on households.

Many in the pro-ACA camp have cited the subdued inflation in healthcare costs over the past several years. But something went awry this past summer when healthcare inflation shot higher. As of September 2016 the Consumer Price Index (CPI) for medical care is growing at a near-5% pace- up from 2% in 2014—and at a post-2008 high.

As highlighted by Cornerstone Macro, there is another common measure of inflation—Personal Consumption Expenditures (PCE)—which is showing a more subdued move up in healthcare inflation. However, it includes government spending, which has been held down by cuts in Medicare and Medicaid reimbursement rates. This is why the CPI is arguable more relevant as it represents out-of-pocket spending by consumers.

Unprecedented spike in healthcare inflation

As you can see in the chart below, the spike to near-5% is unprecedented over the past 20 years. It can be explained by increased demand, and the broadening of the insured base, courtesy of the ACA; and also less competition courtesy of the rash of mergers; e.g., drug stores and hospitals.

Cornerstone notes that in the early years of the ACA Marketplace, many insurers underestimated enrollees’ costs and set premiums too low. Many are now planning ACA exchange exits, with those remaining under pressure to raise prices. This will be particularly impactful on the “non-group” category of insured households (see first chart below). As a result, the cost of the most popular plan (see second chart below) is expected to increase by 9% in 2017 vs. 3.6% this year.

50% increase in family plans’ costs

As seen in the first chart above, about half the U.S. population is covered by employer-sponsored plans. As seen in the chart below, since the “great recession” ended in 2009, the average family payment has grown from about $3,500 to nearly $5,300 today—an increase of 50%. Those costs now represent over 9% of median household income, an all-time high.

Breaking down the increasing costs into their key components, the higher inflation is being driven by three categories, as seen below: hospitals (26% of total medical care), prescription drugs (22% of total medical care), physicians’ services (20% of total medical care).

Healthcare is not the only place we’re seeing upward pressure on inflation. With oil prices having rallied sharply off their lows, energy inflation is rising as well. Both healthcare and energy are components of my proprietary Consumer Stress Index (CSI), seen below. As a reminder, as an index of stress, a rising line means a rising level of stress.

An additional rub was highlighted in John Mauldin’s Thoughts from the Frontline this week. Healthcare comparisons over time have limited meaning. Rarely do individuals buy the same plan as they did in prior years. And the Bureau of Labor Statistics (BLS)—the folks calculating CPI—do not apply “hedonic adjustments” to health care. In other words, even though the price of health care is rising, they don’t adjust for deductibles or coverage reductions. If you take those into consideration, the spike in healthcare inflation would be even higher than today’s published figures.

The net

Households remain in relatively good shape, with wages and incomes rising and debt levels/debt servicing costs low. But this upward pressure on the inflation components bears watching. Remember, consumer spending drives nearly 70% of US economic growth. When inflation is rising alongside a robust economy, it doesn’t tend to choke off growth. But if it’s rising alongside a sluggish economy it puts pressure on the consumer, which in turn pressures the economy.