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Thought Leaders: Provider Pricing Inflation

Alan Trimakas was featured in the January/February edition of MCOL Thoughtleaders newsletter. The question for consideration was:

“How significant do you anticipate health care provider pricing inflation, and / or health plan premium inflation, might be over the course of this year, and what issues and implications might arise as a result?”

Foresight is not about predicting the future. It’s about minimizing surprises. – Karl Schroeder


At the December 2020 meeting of the Federal Open Market Committee (FOMC), the median consumer price inflation estimate for 2021 was 1.8%. As we all know, inflation ended up ringing in at 7.0% for the year, the largest 12-month gain since June 1982. If we were able to accurately predict this uptick, many of us may have pursued different purchasing decisions (accelerating buying of a car, home, cryptocurrency, etc.), but obviously the developments of the past year were impossible to foresee.


Estimating and planning for potential health care pricing inflation is a wholly different beast, however. This is because in many ways, provider pricing inflation is a lagging indicator. The cost to deliver health care went up significantly in 2021 (precipitously in many cases), while most commercial payment rates remained on previously negotiated trajectories (i.e., normal inflationary environment). Though the federal government enacted legislation to soften the financial blow, many of these programs are expiring, and will result in an ever-widening gap between expenses and revenues for providers.


The CMS Market Basket (an industry-standard measure of cost inflation) has shown that annual cost increases at inpatient hospitals have averaged 2.7% nationally over the past 10 years. COVID-19 has shifted this curve upward by changing the underlying cost structure of providers, accelerating long-term inflationary pressures as well producing an exogenous, one-time permanent increase to the cost base. Key inflationary drivers include:

  • Contract labor – Health care labor is now a national market (particularly for nursing), leading to critical clinical labor shortages and exploding hourly contract rates at health systems across the country

  • Employed labor – Employed caregivers and administrators have increased compensation expectations as a result of consumer price inflation as well as a constrained labor market; provider organizations are attempting to meet these expectations through wage hikes

  • Equipment and medical supplies – Supply chain logjams impacted the availability of medical goods, leading to estimated annual increases of over 8% in supply costs and 12% in drug costs per adjusted discharge, according to Kaufman Hall

  • Demographic / payer mix trends – As the population ages, providers’ case mix continues to shift towards payer segments that struggle to cover costs (i.e., governmental payers becoming larger and larger share of the revenue pie). This places further strain on the traditional cross-subsidization model, requiring even higher increases from commercial payers

Taken together, these factors drove an estimated 6% to 10% increase in total health care delivery expenditures over the past year. Providers are now under enormous pressure to reopen negotiations with commercial payers as soon as possible to match reimbursement levels to this elevated cost structure.


However, it is unlikely that providers will be able to shift the entirety of these increases to payers, both because of payer resistance to significant payment increases and negotiation timing issues (many commercial payer contracts are only negotiated every 3+ years).

Despite the aforementioned pitfalls related to predictions, we believe the outlined data supports the estimate that on average, health care provider prices will rise 5% to 6%

in 2022.


Implications

Such outsized price increases will have ripple effects across the health care industry and the U.S. economy at large. Some key potential implications arising from these price increases include:

  1. Payers and providers will be heavily incentivized to transition care and payment models towards value-based structures, which reward effectively managing the total cost of care for populations

  2. Relatedly, health systems will devote appropriate resources to developing and improving their population health and care management infrastructures

  3. High-performance networks, where payers and providers collaborate to offer streamlined network products, will take hold and proliferate. As provider margins diminish, they will be incentivized to accept reduced rates in exchange for greater potential volumes

  4. Negotiations between providers and payers will become more contentious. As such, more negotiations will stall and 2022 may experience record numbers of providers exiting health plan networks

  5. Providers will increasingly seek to engage key local stakeholders (i.e., employers, brokers, etc.) to help them understand the challenges that providers are facing and the reasons for health care premium increases. As difficult negotiations unfold, it will be particularly important to explain that appropriate increases in health insurance contract rates help to preserve the long-term health of the local community.


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