While increases in health insurance premiums slowed dramatically during the 1990s, by the end of the decade signs indicated that health care inflation was again on the rise. What fuels rising health insurance premiums? Many people think that health insurance premiums drive up the cost of health care in the United States. But the opposite actually is true: premiums rise to keep pace with the increasing costs of health care goods and services. In fact, statistics show that, on average, 90 cents out of every premium dollar are paid back in benefit payments for health care services.

Health care spending trends

America's spending on health care, as well as the prices of related goods and services, continues to grow faster than the rest of the economy. A variety of factors ranging from the costs of particular benefits to demographic and legislative trends drive health care expenditures. A number of spending trends are apparent in the major health care cost categories including hospital services, home health care services, professional services and prescription drugs. All of these influence the general cost of health care.

Hospital services

Spending on hospital services represents, on average, the largest share of the nation's health care expenses. Over the past two decades, however, the percentage of the nation's spending on hospital care has decreased as other categories have grown more rapidly. Data on community hospitals show that the use of inpatient care declined during the 1990s as both the daily number of patients and the average length of stay dropped. At the same time, inpatient expenses have been rising. This may be due to greater unit prices, less severe cases moving to other settings or treatment concentrated in the first days of shorter hospital stays.

Home health care services

Shorter hospital stays have led to greater reliance on home health care services. As a result, home health care has been one of the fastest growing categories of health expenditures. Census Bureau reports of the rapid growth of home health agencies and personnel suggest significant increases in the use of these services during the past decade. This trend is likely to continue as insurers and employers shift away from more costly inpatient services toward outpatient care.

Professional services

Professional services include those provided by physicians, dentists, podiatrists, chiropractors, optometrists and other medical practitioners. Physicians' services represent the largest portion (almost two-thirds) of expenses in this category. Spending on physician services is second only to hospital care and continues to rise. In its 1998-99 Occupational Outlook Handbook, the Bureau of Labor Statistics (BLS) reports that, because of an aging population, the number of physicians will grow more rapidly than the average for all occupations through the year 2006.

Dental services spending has increased only moderately and is expected to continue rising at relatively modest levels. By contrast, expenses for other professional services (chiropractors, podiatrists, optometrists and other licensed medical practitioners) have increased more rapidly. One reason may be state mandates requiring coverage of non-physician practitioners and their services. According to the Blue Cross and Blue Shield Association, 41 states require some type of coverage for chiropractors and psychologists, the most common form of mandate; coverage for optometrists and dentists is required in only 35 states.1

Spending for professional services also could be influenced by increasing coverage of complementary and alternative medical treatments, and by consumers taking advantage of these benefits.

Prescription drugs

Prescription drug spending has grown more rapidly over the past few years than all other major categories of health care and represents a significant portion of national health care expenditures. The Health Care Financing Administration (HCFA) projects that spending on prescription drugs will grow an average of 11% per year through 2008.

Numerous factors have contributed to this rise. An aging population requires more frequent and often expensive drugs. The introduction of drug therapy-intensive disease management programs has meant increased prescription drug use. In addition, drug advertising directly to consumers puts new pressure on providers to prescribe medications requested by their patients. Employer coverage of prescription drug costs - with limited employee cost-sharing - provides an incentive for increased use. Consequently, many believe there has been both an increase in the use of pharmaceuticals and a shift towards newer, higher-priced drugs.2

Demographic and social trends

Along with rising benefit costs, demographics are a major factor behind health care spending growth. As the population increases and ages, health care costs increase as more people consume greater amounts of health care services. A major trend contributing to greater health care spending is the declining proportion of people under age 35 and an increasing proportion over age 65, with the sharpest gains in the 85 and over range.

HCFA figures illustrate the disparity in spending levels between elderly and nonelderly. According to the HCFA, per capita Medicare spending is at almost 2.5 times that of the non-Medicare population.

Along with demographic shifts have come changes in attitude. Rising incomes and expectations about medical advances result in increased use of health care. For instance, awareness of health problems associated with excess weight and general health awareness may now send individuals previously considered “well” into doctors' offices for check ups, tests and prescriptions. New medications, such as cholesterol-lowering drugs, as well as early or periodic interventions, may result in longer, disease-free lives. Such ideas and new consumer attitudes mean increased health care spending.

New technologies

Americans' increasing reliance on new medical technologies also has an impact on the cost of health care coverage. Some developments offer less expensive or more efficient methods of treatment. Other technologies have the potential to significantly increase costs per patient.

Some new technologies are simply more expensive. Costs also can rise because sophisticated new techniques that reduce unit costs may, in turn, mean greater use of services and increased overall costs. In addition, while some technologies offer more efficient, less costly alternatives, the general pattern is to provide new rather than replacement procedures.

One example of a new, more effective technology that is substantially more expensive is the latest test for early signs of cervical cancer. While this new test is about three times the cost of the conventional screening, it increases the chances of early detection and, consequently, early treatment.

On the other hand, laparoscopic procedures (a small incision using fiber optics rather than more invasive surgery) that were thought to reduce costs may, in fact, not save money. These procedures often mean increased physician training and skills, higher associated professional fees and more post-surgical complications.

Legislative and regulatory trends

Legislative and regulatory requirements placed on insurers and health benefit plans are another factor driving costs higher. Within the small group and individual health insurance markets in particular, attempts at market reform intended to improve access to coverage may actually increase average costs and reduce the number of people covered by health insurance.

For example, research by the Heritage Foundation shows that “guaranteed issue” requirements, coupled with restrictions on premiums, tend to increase costs and reduce overall coverage levels.3

According to the Health Insurance Association of America (HIAA), the number of mandates states have placed on health insurance plans increased at least 25-fold between 1970 and 1996.4 In recent years the federal government also has begun requiring that plans include specific benefits. Such requirements for benefits that plan sponsors and individuals might not otherwise choose to purchase increase the cost of coverage.

Managed care has been the primary tool for health benefit sponsors as they strive to control coverage costs. However, in recent years, there has been growing political pressure for regulation of managed care programs. To the extent that the legislative and judicial backlash restricts the use of managed care techniques, HIAA believes the cost of coverage is likely to rise.5 This would have significant societal drawbacks. Research suggests that, without the cost savings of managed care, the number of uninsured Americans would likely be between 3.1 and 5 million higher than it is today.6

Consumer services, benefits administration, profits and

other expenses

Finally, a number of insurance company costs are factored into the price of health care. Contrary to public and legislative opinion, these actually represent a tiny proportion of the total cost of health care.

Health benefit administrative and other “nonbenefit” costs include claims administration, general program administration (for example, enrollment, billing, legal, actuarial and other management expenses), marketing expenses, state taxes (premium taxes, licences, and fees), federal income taxes and profit. The percentage of health insurance premiums represented by these expenses is generally lower for employer-sponsored group health plans than for individually purchased health insurance. For group plans, expenses tend to decrease with larger groups. Administrative costs also vary by health delivery system.

Historically, commercial health insurers' profit margins have represented a small percentage of overall premiums. HIAA data shows that the net after-tax profit for commercial insurers was 0.4% in 1998.

Average profit margins for health maintenance organizations (HMOs) have declined from 8% in 1994 to less than 1% in 1997. Low margins for commercial health insurers mean that increases in the underlying benefit costs have a significant impact on premiums.

Despite evidence to the contrary, public opinion surveys show that Americans believe the health insurance industry in general, and in particular those insurers using managed care, is highly profitable.

One recent survey found that 95% of Americans believe that insurance industry profit margins exceed 10% and over 40% believed that profits exceed 25%.

The future of health insurance premiums

While the health insurance industry has identified the factors contributing to rising premiums, there is a great deal not known about the forces underlying these cost drivers. It is also impossible to precisely predict how policymakers and regulators will respond to the expected growth in health insurance premiums or underlying benefit costs. Rising premiums, changing health coverage options and shifting consumer expectations all raise significant public policy questions.

The cost of health coverage is an important national issue. Today 44 million Americans are uninsured; the rising price of health benefits has a direct impact on that figure. Recent HIAA data confirm that increasing health care costs relative to family income remains the single most significant factor driving the rising number of uninsured Americans.7

Over the years, Americans have made it clear that they value access to health care. The public frequently demands the newest, most advanced medical technology, and highest quality care available. Often, this also is the most expensive care. It seems likely that overall health care spending will grow in response to the public's demands and desires.

However, because most consumers are insulated from the true costs of health care, demand for greater access often is not weighed against the cost of that care. The insurance and medical communities need to do more to increase public awareness of these costs and the impact of increasing health spending. Even with improved public understanding, it seems likely that consumers will continue to demand more health care and overall health care spending will grow.

Clearly, more research is needed in a number of areas. Until more current data are available on these underlying factors, data-driven discussions of health care spending will have to be limited to explaining the past rather than the present.

This article was produced by the Health Insurance Association of America.


1 Data from the Blue Cross and Blue Shield Association, as reported by Gail A. Jensen and Michael A. Morrisey, Mandated Benefit Laws and Employer-Sponsored Health Insurance (Health Insurance Association of American, January 1999).

2 Factors Affecting the Growth of Prescription Drug Expenditures (National Institute for Health Care Management, July 1999).

3 Jill Marsteller et al., “Variations in the Uninsured: State and County Level Analyses,” (The Urban Institute, 11 June, 1998). Melinda Schriver and Grace-Marie Arnett, “Uninsured Rates Rise Dramatically in States with Strictest Health Insurance Regulations,” The Heritage Foundation Backgrounder #1211 (The Heritage Foundation, 14 August, 1998). William S. Custer, Health Insurance Coverage and the Uninsured (Health Insurance Association of America, January 1999).

4 Jensen and Morrisey (January 1999).

5 ‘Medical Necessity' and Health Plan Contracts (Health Insurance Association of America, March 1999). Sheila Smith et al., “The Next Decade of Health Spending: A New Outlook,” Health Affairs, Volume 18, No. 4 (July/August 1999).

6 John F. Shiels and Randall A. Haught, Managed Care Savings for Employers and Households: Impact on the Uninsured (The Lewin Group, June 1997).

7 Custer (January 1999)