The Hidden Costs of Health Care

 | Oct 28, 2011 | 4:00 PM EDT
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Health care employment has grown twice as fast as that of overall employment over the past year (2.2% for health care vs. 1.1% for total employment), while real hourly earnings fell by -1.9% during the same period. It turns out these phenomena might be related.

When the overall economic pie is growing by only a modest amount, for one slice of pie to increase, other slices must decrease. In other words, those funds to pay for phlebotomists, lab techs, medical billing and coding specialists, and yes, doctors and nurses, have to come from somewhere. There is no magic IV bag in the sky dripping dollars into the health care sector's veins.

It turns out that employers are actually paying their employees more -- sort of. The Bureau of Labor Statistics has a wealth of data to examine. In this morning's release of the Employment Cost Index, we can see that total compensation for private industry workers grew year over year for the quarter ending in September in nominal (not real) terms by 2.1%, vs. 2.0% at this time last year. The wage and salary component (a function of both hours worked and hourly pay) increased by just 1.7% in nominal terms, just a bit higher than the 1.6% gain a year ago. But the real increase was in benefits, which grew by 3.3%, up from 2.8% for the 12 months ending in September 2010.

Health insurance accounts for a bulk of these benefit costs, and benefits make up about 30% of the typical employee's total compensation, with wages and salaries accounting for the rest. As benefit costs continue to grow faster than core inflation, as measured by the CPI (which advanced by 2.0%), the offset to higher benefit costs must come from shrinking the slices of the pie in other areas.

Employers can either cut hourly wages, they can absorb the hit to profit margins (which they don't seem to be doing), or they can cut benefit costs, which can conceivably allow them to give their workers more pay increases -- but which could also require employees to pay more for medical services out of pocket.

In the most recent quarter, we see that benefit costs increased by a far smaller amount than they had done in the past year. In nominal (not inflation-adjusted) terms, we see benefit costs for private employers increased by just 0.1% for the third quarter (not annualized), as compared to 1.6% for the second quarter. Employers hadn't diverted those funds to employees' paychecks, however, as wages and salaries increased by 0.4% in the third quarter, vs. 0.5% in the second quarter.

Year over year, for just health benefits, employers trimmed those costs from a 4.8% annual increase as of September 2010 to 3.4% in the year ending September 2011. These increases are still much more than the rate of core inflation, as measured by the Consumer Price Index (CPI), but it does show that employers are trying to cut their health insurance costs.

What does this attempt to curtail health care spending mean to the economy and to investors? I believe it indicates that employers probably won't divert those savings to wages and salaries, given the large supply of unused labor that will keep hourly wage costs down. That means employers' profit margins can benefit correspondingly to funds they can squeeze out of their health care costs.

To investors, it could mean that there might be fewer dollars available for health care spending. This expounds on my recent article, Where Health Care Cuts Will Hit. Since my focus is on economics, I will leave it up to securities analysts to determine how cutbacks in both government spending on Medicaid and Medicare and private employer spending on health insurance will affect companies operating in that space. But it is important to note that this assumes that employees don't foot the bill for those expenses themselves.

And indeed, Thursday's GDP report shows that health care spending by consumers added 0.61 percentage points to GDP growth -- that's a quarter of the growth of the economy in the third quarter. Most other categories of consumer spending made only slight contributions to GDP growth last quarter. Today's Personal Income and Outlays report indicates that consumers' hospital expenditures grew nearly twice as fast in the past quarter as their spending in all other categories did -- that's a bigger growth rate than in the last quarter. Meanwhile, consumers' spending growth on preventative care was far less, with outpatient services spending growth in real terms less than a quarter of that on hospital visits. (The same report also notes that Medicaid reimbursements fell by nearly $40 billion at an annual rate in the last quarter, depressing consumer incomes by that amount.)

So, employers (and also the government) seem to be bent on trimming those high health care costs increases, and while it might be that health care providers could be on the losing side of that equation, it instead seems as though the real losers are consumers. They are facing both higher out-of-pocket medical expenses, but are also avoiding preventative care, spending funds instead on hospital visits when a perhaps treatable malady that they have neglected instead then becomes an emergency.

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