Soaring inflation has set the stage for heated negotiations between providers and insurers.
In May, year-over-year price increases for consumer goods and services outpaced health care inflation, bucking the historical trend. The consumer price index rose 8.6%, the biggest increase since December 1981. Medical spending rose 3.7% in May, the biggest year-over-year increase since September 2020, according to the most recent data from the Bureau of Labor Statistics.
The spike in inflation will affect the entire health sector. This may cause more suppliers to cut services or seek merger partners as supply costs rise, wages rise, and access to capital diminishes. The Federal Reserve raised interest rates by 0.75 percentage points to rein in consumer spending, raise borrowing costs for healthcare systems and likely slow capital projects – and a similar increase could come in July.
Inflation has already influenced contract negotiations between providers and insurers, health care advisers said.
“There’s going to be a terrible cycle of bloody renewal that we’re starting to see the first manifestations of now,” said Jeff Goldsmith, founder and chairman of consultancy Health Futures.
Providers typically negotiate their contracts with insurers on three-year cycles. Those currently renegotiating may use inflation as leverage, as the day-to-day operations of physician groups and hospitals are tied to the rising cost of gas, food and other goods. Hospitals and doctors will also argue that more patients should skip or delay care as their monthly bills rise, ultimately costing providers more as they enter the system sicker.
But suppliers and insurers who renegotiated last year or in 2020 will have to absorb more of the hit to their bottom line. Providers will get little help from private and public payers. Insurance companies are unwilling to negotiate reimbursement levels that offset inflation, and reimbursement levels for government payers will lag spending growth, industry watchers have said. Health insurers, especially smaller ones with less influence, will manage rate increases through network cuts, reduced benefits and increases to their commercial premiums, experts said.
“Until your contract is renegotiated, you’re locked in. There will be more talk about margin versus mission,” said Kevin Holloran, senior director of Fitch Ratings. “They would like to maintain these mission-oriented services, but they may not be able to afford it. It will hurt and be unpopular, but some will have to do it to rally around.”
Accounting for inflation
Hospital reimbursement was cost-based during the last wave of inflation in the 1970s and early 1980s. Providers could pass on cost increases to government and private payers.
This scenario changed in 1982 when the California legislature legalized selective contracts, allowing insurers to negotiate prices with providers and exclude clinicians from their networks without worrying about violating antitrust laws. This was the start of the managed care movement nationwide.
Today, Medicare’s forward-looking payment system automatically incorporates adjustments to economic conditions, but there’s a lag, said Paul Ginsburg, professor of health policy at the University of Southern California and principal investigator at USC Schaeffer. Center for Health Policy and Economics.
“Projections for this year and probably next do not reflect the inflation that has occurred,” he said. “It’s going to be a challenge for hospitals because Medicare reimbursement won’t increase as much to offset inflation.”
Inflationary pressures are most severe for physician groups, most of which may seek merger partners in hospitals, insurers or private equity firms, Ginsburg said.
“There’s been very little increase in doctor’s pay rates over the last 20 years, so doctors are in a terrible position now with inflation accelerating,” he said. “There is very little prospect of a Medicare rate increase. As the policy stands now, it needs to be reviewed soon because with inflation at 6% to 8%, the policy makes no sense and is extremely damaging.”
Despite doctors’ arguments citing mounting cost pressures, medical practices have only been offered small increases in rates negotiated with insurance companies, far from matching the increase in inflation, Andrew said. McDonald, practice leader of business solutions for physicians at consulting firm LBMC. Groups of doctors are threatening to take their practices off the networks, he said.
“To date, there haven’t been many (of these threats), but we’re starting to see more movement in that direction,” McDonald said. “Physicians have basically taken a pay cut due to inflation and the increased cost of running their practice.”
The American Medical Association approved a policy at its recent annual meeting of the House of Delegates to push federal and state governments to incorporate inflation adjustments into minimum wage laws. The 6.2% inflation rate in 2021 outpaced the 3.8% rise in doctors’ pay last year, according to a 2021 survey of 160,000 doctors by digital health tool Doximity for providers.
“Vendors are feeling more pressure as staff want more money because there is a shortage, supply costs are rising and they have not been able to negotiate higher payment rates “said Dr. Robert Pearl, professor of organizational behavior at Stanford University and former CEO. of the Permanent Medical Group. “Doctors are hurting too. Doctors want to see payout increases and insurers aren’t backing down.”
OU Health, Oklahoma’s only academic medical center, fell off the grid with UnitedHealthcare, the nation’s largest insurer, earlier this month after the two failed to agree on rates that account for the rising cost of labor and supplies , OU Health officials said. UnitedHealthcare argued that OU Health was the most expensive health care system in the state and asked to lower its rates.
Government payers are not expected to compensate for the mismatch between expenses and revenues on the commercial insurance front. Medicare offered a 3.2% increase in inpatient payments in 2023an amount that is far from covering hospitals rising costs, trade groups said. That could put pressure on negotiations with commercial insurers as providers seek to make up the difference, industry observers said.
“There will definitely be more pressure from our health care systems to drive higher rate increases from commercial payers. We’ve already started to hear that,” Holloran said. “Commercial payers are also facing labor inflation pressures themselves, so getting them to raise rates materially is going to be a tough sell.”
Hospitals will have lower margins over the next two years. But that won’t matter, especially for higher-rated hospitals that have more financial leeway, Holloran said. However, health systems will have less room for maneuver because their stock returns plummetanalysts said.
“Between staffing costs, supplies, shortages and inflation, many vendors would love to merge and be part of a larger system,” Holloran said.
As consumer prices rise, consumers will likely delay or skip medical care or stop paying their health care bills.
Clinicians who rely more on elective procedures and visits as revenue generators will also see a decline in patient appointments, independent healthcare consultant Paul Keckley said.
The primary means used by hospitals to control costs is to reduce their labor costs, which have been eat more than their budget due to the COVID-19 pandemic. National hospital labor spending jumped 13.6% in May year-to-date, according to the latest data from Kaufman Hall. Rising labor costs may spur automation, layoffs, or lobbying for policies that increase labor supply, such as easing immigration regulations for skilled healthcare workers , said Nathan Ray, partner in the health care and life sciences division of the consulting firm West Monroe.
“The problem is, you can’t just produce healthcare workers out of thin air,” Ray said. “We need more people, we need more talent.”
Among insurers, smaller organizations are more vulnerable to acquisitions, experts said. Those without the power to negotiate more favorable rates will likely be targeted by private equity investors, creating more integrated systems, Keckley said.
Vertical integration between these large insurers will give them greater influence over health systems when it comes to negotiations, leading to more disputes over public contracts and out-of-network providers, he said.
“The strength of the insurance industry is accelerating faster than the strength of these large integrated health systems,” Keckley said. “It’s kind of like sumo wrestlers in the ring. They’re going to keep bumping into each other until one of them says, ‘I’m going to knock you out.'”