Health Policy Reform 101—Health Care Costs

Understanding Two Key Terms: Medical Inflation and Cost Containment

Oct 17, 2009 Ellen Freudenheim

To get a handle on how to control rising health care costs, it's helpful to understand two key terms. One is "medical inflation" and the other is "cost containment."

Hopefully, health reform will result in more Americans being insured. But can the nation afford the current system of health care? The slice of the national economic pie being consumed by health care is steadily growing. As of 2009, health care costs accounted for over 17% of the nation's gross domestic product. For years ahead, politicians and pundits are going to be talking about health care cost containment, and puzzling about why Americans spend so much money on health care. Here are two basic terms that help clarify this important discussion, which will impact all Americans.

Medical inflation

Definition: This term refers to the annual increase in the prices of health care goods and services.

Inflation of health care costs can occur from a variety of sources. One is increased demand. Another is excessive profit taking.

Third, inflation of health care costs can be a result of inefficiencies in various parts of the system. These include inefficiencies in consumption (for instance, when services are inappropriately utilized). Inefficiencies in allocation of services can occur, for instance, when health services could be delivered in less costly settings without loss of quality. Similarly, inefficiency in production occurs when costs of producing health services could be reduced by using a different combination of resources.

Cost Containment

Definition: Cost containment, of course, is generally understood to be the process for reducing costs or limiting expenditures.

In health care, it also refers to efforts to control or reduce inefficiencies in the consumption, allocation or production of health care services in order to lower the level of health care costs, or slow the rate of increase in health care costs.

There are different strategies for containing escalating health care costs, among them:

• Strategies that rely on market forces. These strategies are most familiar to consumers. They include patient cost-sharing, taxing employer health insurance contributions, and increased competition among insurers and providers. The much-discussed "public option" and "exchanges" in the 2009 health reform debate promised to increase competition among insurers.
• Strategies to control prices. These include hospital rate-setting, and controls on physician’s fees.
• Strategies to control use of health services. For instance, this includes various limits placed on providers, through somewhat technical tools called utilization review, clinical practice guidelines, and capacity controls. One much-feared (and often misunderstood) way to control use of health services is implicit or explicit health care rationing.
• Strategies to control control expenditures. These might include imposing physician expenditure targets, capping hospital budgets, and limiting national, regional and local health budgets.

So, what is cost containment in health care, and how can it be achieved? Clearly a multi-pronged approach is needed. For citizens to understand what's at stake — including how it will impact them, and the nation at large—it's important to understand the basic terms of the debate.

The copyright of the article Health Policy Reform 101—Health Care Costs in Health Field is owned by Ellen Freudenheim. Permission to republish Health Policy Reform 101—Health Care Costs in print or online must be granted by the author in writing.

Health Care Costs Rising Faster than GDP

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Oct 19, 2009 8:12 AM

Guest :

I suggest two key areas you may want to further develop in your article. I would be interested in learning your position for these.
1) Where would external cost factors affecting the "bottom line" fall in your presentation. Two key factors I can think of include the costs driven by excessive and frivolous law suits, and the issues from payer bureaucracy that delays and sometimes inappropriately denies payment?
2) While a public option would definitely create some pressure for limiting insurance costs, couldn't it also drive competition away? My perspective of monopolies, whether government or otherwise, is that they can adversely affect pricing - and often adversely affect innovation.

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