The long-term historical trend was that healthcare inflation outpaced inflation in the overall U.S. economy. Then the COVID-19 pandemic hit, driving financial and operational uncertainty while touching off a period of historic price hikes across the economy that made the inflation rate in the healthcare sector look positively tame in comparison.
Now trends are reverting to historical norms. The U.S. Consumer Price Index has registered a dramatic drop-off in inflation rates, while healthcare inflation is heating up. Here’s what our research says is going on and what we at L.E.K. Consulting expect for the future.
The leading driver is hospital-related services
The inflation rate of hospital-related services ordinarily exceeds that of healthcare commodities (think drugs and medical supplies) and professional services (such as physician and dental care). Hospital-related services have been particularly vulnerable to recent healthcare workforce challenges. The ongoing labor shortage forces hospitals to pay more for both clinical and nonclinical staff as they navigate the post-pandemic world without any more COVID-19 government funding.
Patients with private health insurance continue to bear the brunt
Prices have been rising across the board, including for Medicare and Medicaid patients. But those with private insurance have consistently faced the highest inflation rates over the past decade. Last year, private payers shelled out about 25% more for healthcare services than they did in 2014. That’s more than five percentage points higher than Medicaid or Medicare growth over the same period.
We expect higher inflation for healthcare relative to the overall economy
Healthcare inflation will likely remain elevated in the near term amid ongoing workforce challenges and contracting life cycles. Eventually, we expect it to revert to the long-term trend of remaining more stable at higher rates than overall inflation.
Although the labor shortage is the most significant factor, other forces are playing into medical cost inflation. Near-term supply chain pressures continue to affect the cost of medical supplies and equipment. Provider consolidation continues its march across hospitals and health systems. Then there’s the growing demand for high-cost treatments like GLP-1 medications.
It’s not all doom and gloom. Other trends could have a deflationary effect on healthcare costs. One is healthcare consumerism — more patients are aware of and interested in managing their healthcare options. Artificial intelligence (AI) and machine learning applications promise to reduce inefficient, error-prone manual processes, thereby lowering the underlying delivery costs. The growth in government-sponsored healthcare coverage, not to mention continued interest from employers in managing healthcare costs, is poised to make an impact over the longer term. Finally, vertical integration of payers and providers may drive costs down as they share the financial risks of care.
Industry participants can position themselves to come out ahead in an inflationary environment
Rate increases are not the only solution to coping with underlying cost pressures — and in many cases, the ability to pass through rate increases will be constrained. Provider organizations should identify potential cost efficiencies (e.g., AI for administrative workflows) to protect margins in case of rate pressure. Beyond offering flexible rates to providers in the near term, payers can improve their cost-containment offerings, establish centers of excellence and increasingly align financial incentives and capabilities with provider organizations. And healthcare suppliers can find opportunities in improving procurement and inventory management practices, enhancing production and quality assurance capabilities, establishing sophisticated partner networks, and more.
Explore our research findings for more insights on inflation in healthcare.
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