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Health care is not recession-proof

It is often accepted as conventional wisdom that health care is recession proof.

People get sick regardless of economic cycles, and the publicly funded safety net programs insure that people who need care get it. Yet if you look around the health system, what you see looks suspiciously like a recession: low single digit pharmaceutical cost growth, a collapse in high tech imaging and cardiovascular sales and clinical volumes, declining hospital admissions and rising bad debts. Is it possible that health care isn’t recession proof after all?

The reality is that health care has never been recession proof. It is simply that the system is so immense that lag effects in changed health care payment conceal the cyclicality. Recessions shrink tax revenue growth, and since Medicare and Medicaid are the balancing items in state and federal budgets, Medicaid and Medicare constrict payments a predictable 18-24 months after revenue problems surface.

Medicaid cuts are making their way through state budgets as I write, affecting a strategic segment of the health system — urban public hospitals, teaching hospitals and rural sole community providers.

Employers, who through their private health plans provide the industry most of its positive cash flow, also have a predictable response pattern to declining cash flow. When corporate cash flow dries up, health benefits get restructured. The last serious recession in the country, 1990-91, clobbered the NorthEast and California, and set off non-incremental growth in managed care enrollment in those markets. 

This growth, and anxiety over the abortive Clinton health reforms, catalyzed both a panicky wave of consolidation in the health system and a bidding war among health providers to avoid being excluded from managed care panels. The effect was both provider price and margin compression and then a downturn in health plan earnings.

What we are seeing now is different, and a sign of a different health economy. While it is still not clear that we will actually have a recession (measured by two consecutive quarters of negative GDP growth), the U.S. economy is in the worst shape we’ve seen in seventeen years. The most significant changes in health coverage have been a shrinking of employer based coverage and a more than doubling of employees’ health premium contributions. Moreover, these increases have largely ignored the ability to pay; lower-income workers have far greater exposure to rising out of pocket costs than their better paid superiors.

As Brian Klepper showed a few months ago in an important THCB posting, last fall workers’ after tax earnings moved into negative territory — the productof ruinous increases in the costs of food, energy and housing. As people are more exposed to the cost of health care, they have responded predictably- by searching for generic drug alternatives when available, and postponing elective health care use. Moreover, when they do need and use healthservices, they have much more trouble paying the bills. When they do get large health care bills, they put them at the bottom of the pile to be paid last.

In other words, the restructuring of private health insurance coverage in the past decade have made the industry much more recession-sensitive, and exposed the industry to price and use sensitivity we have not seen before. In a sense, this was the intended consequence: people spend their own money more carefully than they spend their employers’ money. But the inequity of exposure to health costs by income class, and the likelihood that people are postponing seeking needed care for conditions that will worsen without treatment raises fundamental questions about the use of cost sharing as the principal braking mechanism for health costs.

This analysis suggests that health industry cash flow will continue to narrow in the coming 18 months, and that the layoffs we’ve seen in pharmaceutical and device sectors will be shortly joined by hospital system force reductions. The recession insulation provided by health insurance no longer protects this privileged 16% of the US economy. Welcome to the real world!

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10 replies »

  1. Actually, it’s an industry I follow closely. Health insurers have been adding to reserves the past five years at an unprecedented rate. This has been the most prosperous period in the history of the industry. Kaiser, historically undercapitalized, launched a $26 billion building program to replace and retrofit its hospitals. The for-profits bought new jets and paid fat bonuses to their execs. Cash flow is narrowing now and these companies have taken a real haircut in equity valuations in the past three months, but it has been an amazing run.
    Don’t think of Blue Cross as Wal-Mart, please. Wal-Mart never had to beg to regulators for protection from its competitors. It just went out and out-merchandised them. Blue Cross achieved its hammerlock on markets by colluding with providers (who dominated their Boards) and successfully used the regulatory system to keep competitors out. It was for many years a provider dominated monopoly and in many states (Tennessee, Mississippi, Pennsylvania, Hawaii, Virginia, Montana, New Jersey, Maryland) is basically THE single payer (since they also pay Medicare and in some cases Medicaid claims).
    Premium increases subsided in the past five years in major part because of consistent OVERestimates of health cost trends, which are subsiding for three reasons: a collapse in pharmaceutical cost growth, a surprising moderation in hospital admissions and a decline in use of elective health services- the result, I believe, of consumers running of out of cash (the topic of the this post). The first two can conceivably be traced to the increase in out of pocket exposure (e.g. rewards for using generics and increased use of ambulatory health services), but also can be traced to internal problems in the respective industries.
    Do you really believe that health plans are aggressively competing on price right now? Go talk to the benefits managers of major corporations or hard pressed small business people. It just isn’t happening. There is no incentive for an investor owned company to savage their top line growth to grab market share, and since an increasing percentage of Blue plans are publicly traded, there has been far less incentive for them to break out on prices. The better managed Blue Cross plans-Highmark/Independence, Tennessee, Healthcare Services Corp (Illinois, Texas, etc) are as aggressively managed as if they were for-profit. They ain’t giving nothin’ away. Get away from New York and look again at how much choice and how much competition there is for small employers and sole proprietors. It’s basically Blue Cross or the highway in most places.
    Who said universal health care is coming? I sure don’t believe that. With a $500 billion federal budget deficit, you’ve got to be a dreamer to believe we’re going to have any significant reduction in the number of uninsured, unless Congress can stick employers with the cost (like the Wyden bill effectively does). Congress will punish the health insurance industry because it was one of the Republicans’ pets during the past eight years. Congress will take away the 12% subsidy from Medicare Advantage as well as cut back the private fee for service plans. It will also tighten both payment and oversight over Part D, and try to skim off the better risks by creating a government sponsored plan. There will be a ton of hearings on executive comp, and challenges to the tax exempt status of the remaining Blues plans. That’s what I meant by a butt kicking.
    Do you really think you can have Medicare negotiating better prices w/o a Congressionally meddled with formulary? The only way the VA could do it was by dumping a ton of expensive drugs, and blood will be shed before Medicare ever does that.

  2. tcoyote,
    I’ve seen you write some insightful things in the past, so I got the impression that you were pretty informed about healthcare and health insurance. But this last post is a mishmash of misconceptions. I will only address a few of them.
    There isn’t just one reason why premium increases were lower from 2003 to 2007 than in the preceding 5 years. Reduction in surplus reserves is just one reason, and it came in towards the end of that period. The question is not whether it mattered, but how much it mattered.
    In the NYC area, there are half a dozen viable choices in the small group market, but I grant that this is not typical. Usually, there are 2 or 3 major competitors, one of which is a Blue. To have just one serious competitor, as you apparently do, is rare. Are you in a rural area?
    In any case, the situation you describe seems to be one in which price competition matters, it’s just that one player offers prices so much lower than others that they consistently lose out. When Wal-Mart sells things 30% cheaper than mom and pop stores, you don’t conclude that price competition is a “sham.” What you conclude is that one player plays the price competition game much better than the rest. And I’m not suggesting that this is a good situation or fair, only that your description of it seems off unless you have evidence of some collusion among insurers or premium price insensitivity in the marketplace.
    Uwe Reinhardt is a very smart man, but don’t rely on what he “showed” many years ago when referring to a dynamic situation. I will bet you pretty much anything you wish that even if it was once true, the average insurer margin on small business coverage today is far less than 40%. In fact, I’m confident that it is less than 10%. I don’t know if you read Charlie Baker’s blog, but this post fits with my experience in managed care.
    I’m curious what it means for the industry to have its “butt kicked.” I agree that universal healthcare is coming, and the industry welcomes that because it is convinced (rightly, I think) that it will be in the form of a multipayer model.
    If tight regulations on MER (medical expense ratio) are instituted, the for-profit insurers would be mighty peeved and you can expect their stock to fall. In the most “radical” realistic scenario I can imagine, all insurers may be required to be non-profit. But they’re not going away. Not in our lifetimes, and certainly not during an Obama presidency.
    So the best course of action is to devise market incentives and payment schemes that create efficiencies, and give government a more active role in controlling costs. To give just one example, Medicare needs to be given the power to negotiate drug prices, and should not have its formulary controlled by Congress.

  3. Health insurers days are numbered. In the next few years, the so called Govt controlled insurance option would be available for the public. It means, the current grossly inefficient insurers simply can not compete as more and more employers and individuals will opt for the ‘public’ insurance.
    Recently, I have sold all my stock in health insurance industry.

  4. Rate moderation began after 2003, so disgorgement isn’t a good explanation of what is now a five year plus trend. How many choices do you have in YOUR small group market. I have, basically, one (Anthem), and they are having their way w/ me. The providers around here blow everyone else off, so Wellpoint’s competitors’ policies are 40% more expensive.
    Uwe Reinhardt showed long ago that the profits in this market, which Blue Cross dominates, approach 40%, not 5%. In other words, a lot of these “competitors” break even on their large corporate accounts, or make 2% in ASO fees in order to fuck the little people. Then they masquerade as the protector of the little people when they go to state regulators to protect their billions in reserves.
    I’m not sure what business health insurers are in right now, but what it looks like to me, most of them, is: paying bills when they can no longer avoid it, niggling w/ their networks over rates where they can, and spending a ton of money propping up their positions w/ state and federal lobbyists. Some of the bigger insurers- Humana and CIGNA- seem to get that this isn’t viable and are getting aggressively into trying to coach their subscribers to be healthier. And they can’t get a lot of their employer customers to play along. Kaiser wants us to “thrive”; I wonder how that’s going.
    The entire industry is going to get its butt kicked by President Obama and a Democratic Congress, and they should have seen it coming a long way off.

  5. tcoyote,
    It is a tall order to defend this statement: “Price competition” in health insurance is a sham; it’s over.
    First, the Blues phenomenon you reference still exists. It doesn’t exist in as many markets as before due to WellPoint, but non-profits disgorging cash was absolutely a factor in rate moderation in 2006 and 2007.
    Second, price competition in the small group market certainly exists. At least, it does in NYC, which is the area I am most familiar with. Companies change insurers all the time in pursuit of a better price.
    Third, margins remain low in health insurance…in the 5% range. That is not an indication of an industry that has market power to pump up its profits easily.
    What evidence do you base your statement on?
    As for your paragraph about the bite of higher costs, we agree. No need for the word “while” to set off your points.

  6. The health insurance cycle was driven by Blue Cross plans being forced to “disgorge” what insurance commissioners in many states deemed excessive profits, leading to competitive rate moderation by non-Blue Cross players. Occasionally, health plans made foolish attempts to lowball renewal quotes to grow enrollments. With private health coverage no longer growing and so many plans publicly traded, there are zero incentives to cut rates. I think the vaunted health insurance cycle is history. The person who said in an earlier post that plans recover what they could get from you last year is the way it works now. “Price competition” in health insurance is a sham; it’s over.
    On cost sharing, while jd is correct that the percentage of health costs paid out of pocket by consumers has steadily declined for forty years, household budgets go through periodic tightening in real dollars. Right now, a lot of consumers are simply flat out of cash, and the absolute level of cash taken out of paychecks for premiums and cash actually spent on care have collided with other expenses which are rising more rapidly than health costs- food, energy and housing. I cannot remember all these things coming together in the way they have in the past eighteen months.
    We’re not in Kansas any more.

  7. By the time I wrote the last sentence, I had forgotten that you didn’t claim health care was ever recession-proof. But you did claim that something substantial has changed: “the restructuring of private health insurance coverage in the past decade have made the industry much more recession-sensitive, and exposed the industry to price and use sensitivity we have not seen before.”
    That’s why I think it’s important to point out that even with the recent changes you describe, we still have less out-of-pocket expenses for health care as a share of total health care spending than we did 20 years ago. Of course, in the meantime total costs have kept shooting up faster than incomes, so a slightly thinner slice of the pie is no comfort when the pie is three times as large.
    I think we still need to finger overall growth as the main issue here: the steady, crushing advance of total health care costs, particularly on those earning between 100% and 500% of poverty and the self-employed.
    For consider an alternative scenario: let’s say that cost sharing in terms of out-of-pocket costs wasn’t going up. Other things equal, that just means that more money would have to be taken from people in the form of reduced wage growth and/or higher taxes.
    You don’t get to reduce the deductible or coinsurance for free. If it cost doesn’t come out of premium, it comes out of reduced income growth.

  8. Health care cost growth has always been cyclical. For example, the health insurance industry used to follow a pretty reliable 7 year cycle. Improved actuarial techniques and the growth of for-profit insurance might be changing that, but the evidence is still out.
    It’s not clear that anything fundamental has changed (yet) in health care as a whole. We have had enormous growth in the industry in jobs and revenues in the last 10 years and it would not be surprising to see a retrenchment, but there is not yet any reason to think that we have fixed the long-term trend in which costs far surpass growth in GDP.
    It’s important to keep in mind that despite the shift to greater cost-sharing (higher deductibles, etc.) and higher rates of uninsured, these trends are relatively small and recent. The amount of cost sharing today is still lower than it was before the boom in managed care around 1994. In other words, if cost-sharing makes such a big difference, why was health care “immune” from recessions in the 70s and 80s when there was more of it?

  9. Good read on this subject: “Bad Money” by Kevin Phillips – “The reckless finance, failed politics, and the global crisis of American Capitalism.” Hang on for the ride.

  10. When they do get large health care bills, they put them at the bottom of the pile to be paid last.
    And that is exactly what they should do.

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