Cost of Caring: Key Drivers of Growth in Spending on

Hospital Care

Executive Summary

Presented to:The American Hospital Association and the

Federation of American Hospitals

February 19, 2003, Washington DC

©2003 PricewaterhouseCoopers. PricewaterhouseCoopers refers to the individual member firms of the world-wide PricewaterhouseCoopers organisation. All rights reserved.

Key Findings

“Acute industry shortages for certain clinical specialties have resulted in manpower inflation in excess of reimbursement trends.”

Carl Schindelar, CEO, Franklin Square Hospital, Baltimore

3

Key Findings

• Spending on hospital care is a declining share of National Health Expenditures (33.6% in 1997 to 31.7% in 2001) and private health insurance payments (31.8% to 30.7%).

• Of the total increase in spending on hospital care from 1997 to 2001:– 55.4% can be attributed to increases in the number of services

provided to patients.– 44.6% can be attributed to increases in the costs of goods and

services hospitals purchase to provide care, with wages as the most important factor.

• Payment rates have not kept pace with rising costs, and hospital total margins fell from 6.7% in 1997 to 4.2% in 2001.

• The federal government believes that the growth in spending on hospital services peaked in 2001 and will slow to an average of less than 6% for the remainder of this decade.

Background and Methodology

5

The recent acceleration in the growth of healthcare spending and premiums has gained national attention.

Annual Percentage Change in Health Insurance Premiums and National Health Expenditures, 1989-2002

18.0%

8.5%

0.8%

8.3%

11.0%12.7%

4.8%3.7%

0%

5%

10%

15%

20%

1989 1993 1996 1998 1999 2000 2001 2002

Health Insurance Premium National Health Expenditures

Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits: 2000, 2001, 2002; KPMG Survey of Employer-Sponsored Health Benefits: 1993, 1996; Centers for Medicare and Medicaid Services (CMS), Off ice of the Actuary, National Health Statistics Group, National Health Accounts.

6

While spending on hospital care has grown more slowly than other types of healthcare spending…

Cumulative Annual Percentage Change in National Spending for Selected Health Services, 1991-2001

0%

50%

100%

150%

200%

250%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Ind

ex

(1

99

1=

0%

)

Hospital Care

Administration & Net Cost of Private Health Insurance*

Prescription Drugs

Nursing Home & Home Health

Physician & Clinical Services

* Administration for government programs and the net cost of private health insurance (premiums less benefits) w hich reflects underw riting gains/losses.Source: Centers for Medicare and Medicaid Services (CMS), Office of the Actuary, National Health Statistics Group, National Health Accounts.

7

31.7%

22.0%10.4%

9.3%

9.9%

10.4%

6.3%

2001100% = $1,424 B

36.7%

23.0%

8.5%

9.6%

5.9%

5.3%

11.1%Hospital Care

Physician and Clinical Services

Other Professional Services

Nursing Home and Home Health

Prescription Drugs

Administration & Net Cost of PrivateHealth Insurance*

Other (other medical products, publichealth activity, investment)1991

100% = $761 B

…it is the still the largest—though shrinking— percentage of a quickly growing pie.

Percent of Total National Health Expenditures by Category,1991 versus 2001

* Administration for government programs and the net cost of private health insurance (premiums less benefits) which reflects underwriting gains/losses.Source: Centers for Medicare and Medicaid Services (CMS), Office of the Actuary, National Health Statistics Group, National Health Accounts.

8

After a period of relatively low growth in the mid-90s, a recent uptick in spending on hospital care has occurred.

Annual Percentage Change in National Spending for Selected Health Services, 1991-2001

0%

5%

10%

15%

20%

25%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: Centers for Medicare and Medicaid Services (CMS), Office of the Actuary, National Health Statistics Group, National Health Accounts.

Prescription Drugs

Physician & Clinical Services

Hospital Care

9

This study looks in depth at the sources of growth from 1997-2001—when growth began to accelerate—and then looks forward to 2003.

• Analyzed data from public and private sources.– Centers for Medicare and Medicaid Services data:

– National Health Expenditures by category, historical and projected

– The Market Basket Index (measures the amount that hospitals pay for the goods and services they purchase to provide patient care)

– U.S. Bureau of the Census data on population, demographics, hospital construction

– Bureau of Health Professions data on the nursing shortage– Bureau of Labor Statistics data on wage rates and employment trends– National Center for Health Statistics (CDC) data on hospital utilization

rates– American Hospital Association data on hospital volume (admissions,

days, outpatient visits) and finances– Other publicly available surveys, data, literature, and media reports

• Supplemented data analysis with interviews of hospital leaders.

Major Findings

“Between 1997 and 1998, we started to see the spike in utilization. Every one of the insurers in our community dramatically reduced their

utilization management activities.”

Greg Poulsen, Vice President of Strategic Planning, Intermountain Health Care, Salt Lake City

11

From 1997 to 2001, the most important source of growth was volume—more people using more hospital services.

*Net of increases in efficiency.Source: PricewaterhouseCoopers calculations, February 2003.

MoreServicesProvided

55.4%

IncreasingCosts to Provide

Care44.6%*

Total National Spending on Hospital Care(in billions)

1997 vs. 2001

Share of Growth in Spending on Hospital Care

1997 to 2001

$367.6

$451.2

1997 2001Source: Centers for Medicare and Medicaid Services (CMS), Office of the

Actuary, National Health Statistics Group, National Health Accounts.

$83.6 Billion

12

Increasing volume reflects both population growth and increased use rates (number of services used per capita).

Population Growth• From 1997-2001 the U.S.

population grew by about 5%

Increased Use Rates• Backlash: easing of managed

care restrictions on access• Aging population• Technology: healthcare can do

more things for more people

21.0%

34.4%

Share of Growth in Spending on Hospital Care1997 to 2001

Source: PricewaterhouseCoopers analysis, February 2003.

MoreServicesProvided

55.4%

13

Compensation—wages and benefits—is the most important driver behind increasing costs of goods and services purchased by hospitals.

Wages

Benefits

Pharmaceuticals

Other supplies and services

Other• Increased efficiencies• Declining margins• Unmeasured growth factors

31.9%

6.9%

20.7%

-18.3%

3.4%

Rising labor costs due to workforce shortage 38.8%

Rising expensesfor devices, drugs, liability insurance 24.1%

Share of Growth in Spending on Hospital Care1997 to 2001

Source: PricewaterhouseCoopers analysis, February 2003.

IncreasingCosts to Provide

Care44.6%

14

The impact of labor is not surprising. Nearly 60% of hospital costs go to the wages and benefits of caregivers and others.

Percent of Hospital Costs* by Type of Expense

Other Products (excluding Rx drugs)

13.0%Capital8.0%

Wages and Benefits56.7%

OtherServices17.4%

Prescription Drugs5.0%

Telephone Services0.4%

Utilities1.2%

Postage0.8%

All Other: Labor Intensive

5.0%All Other: Non-Labor

Intensive4.2%

Professional Liability Insurance

0.8%

Professional Fees5.0%

*Based on CMS Medicare Hospital Market Basket Index w eights from 1997.Source: Centers for Medicare and Medicaid Services (CMS), Office of the Actuary: Data from the National Health Statistics Group; Federal Register, Medicare Program: Changes to the Hospital Inpatient Prospective Payment Systems and FY2003 Rates, 67(148), August 1, 2002.

15

Growing volume should be good for hospitals, but payment rates have not kept pace with rising expenses; and financial performance has declined.

• “Margin” is the difference between the amount collected from payers, patients, and other sources and the amount hospitals spend to provide care.

• Some margin is necessary for a hospital to remain open at all.

• A sufficient margin allows hospitals to keep investing in their people and facilities—technology, equipment, and space—to meet the escalating needs of patients.

Hospital Total, Operating, and Patient Margin, 1997-2001

-6%

-4%

-2%

0%

2%

4%

6%

8%

1997 1998 1999 2000 2001Source: American Hospital Association (AHA) Trendw atch Chartbook 2002.

Total Margin

Operating Margin

Patient Margin

Breakdown of Recent Growth in Spending on Hospital Services, 2001-

2003

“We’re going to be dealing with a progressively older and older population. This is going to be a time when hospitals make significant

investments in plants and equipment to meet demand. That’s quite appropriate if we’re going to meet the demand we’re already seeing.”

Jack O. Bovender, Jr., Chairman and CEO, HCA, Nashville, Tenn.

17

Current estimates show that growth in spending on hospital care is moderating.

• According to the latest forecasts, growth in spending on hospital care declined from 8.3% in 2001 to 7.4% in 2002, and is expected to be 5.5% in 2003. 1

• Hospitals’ share of national health spending is estimated to decline from 31.7% in 2001 to 30.8% in 2003. 2

• Labor costs will account for the largest share of growth in hospital spending from 2001 to 2003.

1. Centers for Medicare and Medicaid Services (CMS), Office of the Actuary, National Health Statistics Group, National Health Accounts.2. Ibid.

18

Labor costs are expected to account for 38% of the increase in hospital spending from 2001 to 2003.

Share of Growth in Spending on Hospital Care2001 to 2003 Projected

Source: PricewaterhouseCoopers analysis, February 2003.

Population Growth20%

Increased Use Rates16%

Labor Costs38%

Pharmaceuticals3%

Other Supplies & Services18% Technology

5%

Regulatory Changes4%

Construction1%

Other- 5%

Latest Government Forecasts

“Unless people have access to a primary care physician, they’ll utilize the ER. And, with 40 states reporting budget deficits, we’ll see more

people become uninsured through the loss of Medicaid.”

Ronald Anderson, M.D., President and CEO, Parkland MemorialHospital, Dallas

20

The latest government forecasts predict that growth in spending on hospital services will hover around 6% throughout the next decade.

Annual Percentage Change in National Spending for Selected Health Services, 2001-2012*

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*Projections for 2002-2012.Source: Centers for Medicare and Medicaid Services (CMS), Office of the Actuary, National Health Statistics Group, National Health Accounts.

Prescription Drugs

Physician & Clinical Services

Hospital Care

For Information Contact:

Sandy Lutz

Research Director, National Healthcare Practice

(214) 754-5434

Jack Rodgers, PhD

Director, Health Policy Economics Practice

(202) 414-1646