The healthcare industry's resilience to surging inflation may weaken

Although prices for groceries, energy, and other goods and services have soared this year amid record-high inflation, the healthcare industry has largely been insulated from direct price increases. Industry experts say that immunity is beginning to fade.

Data from the U.S. Bureau of Labor Statistics shows that the overall consumer price index rose 8.5% year over year in July, a 40-year high, but medical costs rose only 4.8% over the same period, according to tracking data from the Kaiser Family Foundation and the Peterson Center.

This stems from the unique way the healthcare industry operates: hospitals and doctors provide services first and then receive reimbursements from insurance companies. Insurers set rates in advance, which means high inflation takes years to fully show up in healthcare costs.

Still, this expected lag is already putting financial pressure on healthcare providers, as they face higher expenses but cannot yet recoup those costs.

Providers are the first part of the industry to feel the effects of inflation because their spending on supplies, equipment, and labor has increased.

Throughout the pandemic, labor costs have been a recurring obstacle: exhausted employees have left for higher-paying travel nurse positions or chosen to retire, sparking widespread recruitment and retention problems.

"Whether it's private practices or hospital groups, everyone is competing for staff," said Scott Hines, chief quality officer at Crystal Run Health, a physician-owned multispecialty group with 17 locations in the lower Hudson Valley of New York.

Hines said that despite raising salaries, a shortage of MRI and ultrasound technicians forced the group to suspend imaging services at some locations on certain days this summer.

"Add to that the rising costs of everything from test tubes and medications to office supplies," he said.

Just recently, over a weekend, the group was forced to close one of its urgent care sites due to understaffing.

Payer-provider contracts

Industry observers note that once providers receive fuller reimbursements, payers will try to pass on rising costs to employers and consumers, which could make health insurance more expensive.

"But the real big question is—how much of these costs can be passed on, and how quickly," said Eric Jordahl, managing director at Kaufman Hall, a healthcare management and consulting firm.

Because payers set rates in advance, renegotiated contracts may take years to more fully reflect inflation in healthcare costs. Additionally, since providers sign multi-year contracts, they cannot quickly change the rates insurers pay them.

Aneesh Krishna, a partner at consulting firm McKinsey, noted that contracts between providers and commercial payers typically last three years, meaning it takes about three years for all existing contracts to be renegotiated.

Krishna said commercial payers have historically agreed to rate increases of 2% to 3%, but new contracts could see increases of 4% to 5%.

Krishna added that while contracts expire and payers gradually adjust rates, insurers will try to pass on some of the cost increases to employers and consumers, and they have already begun to do so.

However, some hospitals are already having difficulty negotiating higher contract rates with insurers.

Mike Slubowski, chief operating officer and president of Trinity Health, a nonprofit health system spanning 25 states with 88 hospitals, said during a September 15 call with the American Hospital Association that payers have not included inflation and labor shortage costs in contracts.

"We're a large system, but we're only getting increases of 2% to 3%," Slubowski said, "and some contracts are locked in for years, and they won't reopen negotiations."

Additionally, the Centers for Medicare & Medicaid Services (CMS) sets government rates annually, and for fiscal year 2023, CMS finalized a 4.3% increase in inpatient payment rates, up from the initially proposed 3.2%. Provider organizations such as the American Hospital Association said the increase is "still far below what hospitals and health systems need."

"This includes the extraordinary inflationary costs of care that hospitals are forced to absorb, particularly those related to supporting their workforce, while they also face severe staffing shortages," the American Hospital Association said in an August statement.

Healthcare prices are about to rise

According to a Kaiser Family Foundation survey, people purchasing Affordable Care Act (ACA) marketplace plans are expected to face significant premium increases next year, after several years of stable premiums, with insurers targeting a 10% increase in median premiums. In 2021 and the prior year, average family premiums rose 4%.

According to another Kaiser Family Foundation report, for those with employer-sponsored insurance, premiums rose faster than wages between 2011 and 2021: average family premiums increased 47%, while wages rose only 31%.

"Over the past generation, healthcare costs have really eroded income," said John Romley, a senior fellow at the USC Schaeffer Center for Health Policy & Economics. "And even before the unexpected surge in inflation, wages were not growing strongly."

According to an August report from employment services firm Aon, employer health costs are expected to rise an average of 6.5% next year, exceeding last year's 3.7% increase.

Some experts predict that once inflation is more fully reflected in healthcare costs, patients may seek less care, and employers may reassess benefit plans if health plans become too expensive.

Kaufman Hall's Jordahl said that a future decline in care utilization would pose "a considerable risk, especially given that consumers are facing pressure from rising costs across their entire lives."

He added that if patients cannot afford it, they may choose not to manage non-life-threatening conditions and forgo elective surgeries and other nonessential care.

"It's a good question: whether inflation, in some ways like COVID, has a dampening effect on utilization, because people either can't afford their deductibles or simply don't have the extra money to deal with it," Jordahl said.