Why Do Healthcare Costs Keep Rising

By Richard A. McGrath, CIC, LIA

While there has been much debate about what to do about it, practically everyone agrees that something should be done about the rising cost of healthcare.

In 2008, healthcare costs rose 6.9 percent – about twice the rate of inflation – but in past years double digit inflation has been common.  The $2.2 trillion spent last year on healthcare represents 17 percent of the gross domestic product.

The first step toward finding a practical solution to controlling costs is to understand why healthcare is so expensive.  There are many reasons for it, some of which are complex.

People are living longer.
The average American today has a life expectancy of 77.7 years, according to the National Center for Health Statistics.  In the early part of the 20th century, the average life expectancy was in the 50s.  Even as recently as the early 70s, life expectancy was under 70 for all groups except white females.

Longer life, unfortunately, has a cost.  Nearly a third of the Medicare budget, which is approaching a half trillion dollars a year, is spent on patients in the last year of their lives, according to Philip K. Howard, writing recently in The Atlantic.

People have unhealthy habits.  People may be living longer, but they are not living healthier.  Fast food, stress, smoking and drinking have been lifestyle choices for many Americans.  About half of the cost of treating chronic diseases, such as heart diseases, are attributable to obesity, smoking and other bad habits.  Chronic diseases account for 75 percent of all healthcare costs, according to The Atlantic.

Medical malpractice lawsuits.  It’s difficult to determine the impact of medical malpractice suits on the cost of healthcare, but it’s clear that tests and various medical procedures are sometimes ordered to ensure that if medical staff are later sued, they can document that they did whatever they could to ensure proper care.

While the cost of defensive medical practice is unknown, PricewaterhouseCoopers LLP estimated in a 2006 study that 10 percent of the cost of medical care is a result of malpractice lawsuits and defensive healthcare.  In addition, premiums for medical malpractice insurance are often as high as a quarter of a million dollars a year, which further adds to the cost of healthcare.

Jury Verdict Research recently found that the average jury award in a medical malpractice case is now about $3.5 million, a threefold jump since 1994.  Fifty-two percent of medical malpractice awards now top $1 million, with a handful of lawyers receiving close to 60 percent of that for contingency fees and expenses.

Misuse of healthcare.  More than half of all healthcare spending – about $1.2 trillion – is wasteful, according to a 2008 study by PricewaterhouseCoopers.  Some wasteful healthcare is the result of defensive medicine and some is directly attributable to consumers who, for example, go to the emergency room for routine care when there is no emergency.  The figure also includes administrative and other business costs, which do not affect healthcare.

Subsidizing federal programs.  Medicare and Medicaid both underpay healthcare providers, resulting in higher charges and higher premiums for others who use the system.  Cost shifting by Medicare alone was responsible for 12.3% of the increase in private health insurance costs from 1997 to 2001, according to a study in Health Affairs.

Other regulatory requirements.  Federal and state government regulations, such as the Health Insurance Portability and Accountability Act (HIPAA), also add billions each year to the cost of medical care.  A study by The Cato Institute in 2004 found that regulation of the healthcare industry, including health facilities, health professionals, health insurance, drugs and medical devices and the medical tort system, exceeds $339.2 billion a year.  Subtracting $170.1 billion in benefits resulting from those regulations, the study found the net cost to be $169.1 billion.

Drug trials.  A study published in Health Affairs in 2006 estimates that it costs anywhere from $500 million to $2 billion to bring a new drug to market.  Those costs, of course, must be borne by consumers who use them.

So how should healthcare be reformed?  There is no easy answer, but whatever approach is taken should address all of these factors.  Otherwise, it’s likely that costs will continue to soar and, as a result, fewer people will be insured.


Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass.  He can be reached at rmcgrath@mcgrathinsurance.com.

This article is written for informational purposes only and should not be construed as providing legal advice.

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