Georgia Zachopoulos

MPHP 429


Current Trends in Health Care Costs


Chapter Outline

I. Introduction – explanation of trends in cost

II. Shift to Managed Care

III. New Medical Technology

IV. The Rise of New “Blockbuster Drugs”

V. Increasing Consumer Demand and Supply

VI. The Aging Population

VII. Mandates and Litigation

VIII. Conclusion: Containing Health Care Costs




How much should you pay to save a life? Ethically, this is a question that should never be asked yet in the United States, even though indirectly, it is asked constantly. The average cost for cancer treatment is near $60,000 (1). Triple drug antiretroviral cocktails used to treat HIV average $12,000 per year (2). The accumulation of costs for a heart attack victim from hospital admission to discharge is $23,000 (3). In this country, healthcare is a big business. The ability of local hospitals and providers to cover health care costs for those who do not have the means to pay does not exist. As a result, health care services are guaranteed for and received by those who can afford them and can show how medical costs will be paid. From an economic perspective, the health care arena is a market- and demand-driven industry where the patient is the consumer. One of the top reasons for personal bankruptcy is an inability to cover the costs of health care expenditures (4).

Currently, approximately 13% of the US GDP (Gross Domestic Product) is spent on healthcare (5). As a result, healthcare is distinctly the largest industry in the US economy. One trend is that the expenditure on healthcare in the US has continued to grow over time as evidenced in Table 1. The table shows that the National Health Expenditure (NHE) in 1960 was $26.9 billion, or 5.1% of the GDP, and escalated to $1.149 trillion, or 13.1% of the GDP, in 1998 (5).













Table 1



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In relation to other countries, the US spends the most on health care, in both dollars and in the total share of economic activity. According to the Organization for Economic Cooperation and Development, while the US spends roughly 13% of its GDP, Switzerland spends 10.7%, Germany spends 10.6%, Canada spends 9.1%, Japan spends 7.8%, and the United Kingdom spends 7.3% (6). Even though the high expenditure in the US may be equated with superior medical treatment, in terms of life expectancy and infant mortality, the health of the average American is below that of other industrialized nations. Data from the WHO in Table 2 show that in 1997, the US ranked 37th in health system performance in comparison to other major nations (5). The health system performance rank is an indicator of health service provision. It assigns all of the world’s 191 countries a rank beginning with 1 according to a summarized comparison of health systems performance and attainment of health systems goals for each nation1.












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Furthermore, the Congressional Budget Office (CBO) estimates that in the year 2008, the NHE will reach $2.055 trillion. This estimate amounts to encompass 14.4% of the GDP. Table 3 summarizes the CBO projections on health expenditures (5).




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All the data presented thus far lead one to ask why has spending on healthcare increased so drastically over time while the quality of and reception of care provided has not increased in parallel? The intent of this chapter is to outline the main factors that have contributed to increases in the costs of medical services and spending. By presenting these factors, it will help one to understand how they interplay with one another and help to answer the question posited. The factors contributing to the increases in spending on health care that will be presented in this chapter include 1) the shift to managed care, 2) new technology, 3) the rise of new “blockbuster drugs”, 4) increasing consumer demand and rising incomes, 5) the aging population, and 6) increasing mandates and litigation. Important to note is that one may bring about the point of general inflation in the economy, yet over the past 40 years there has been a significant drop in the average annual rate of inflation by decade. For instance, in the 1960’s the average inflation rate was 5.46% while in the 1990’s it was 1.57% (16). The impact of these factors on the costs of health services far overrides that due to inflation alone2.



Shift to Managed Care


            Although the federal and state governments finance programs such as Medicare, Medicaid, TRICARE, and VA systems, the majority of healthcare in the US is delivered by the private sector. Although roughly between 40 and 45 million Americans are uninsured in a given year, the 250 million remaining are. Most Americans have changed over from traditional fee-for-service health plans to managed care health plans in the form of PPO’s or HMO’s that are sponsored by employers. Although strict managed care plans were initially introduced to drive down medical related expenditures, consumers rebelled against restrictions such as those on choosing doctors and hospitals within networks. There was a resultant drop in spending in the early and mid 1990’s with the introduction of managed care as depicted by the annual change in spending by the private health sector per capita, dropping as low as 1.1% below the average (8). However, a subsequent increase in spending has occurred in successive years, currently climbing up to approximately 3% above the average3.

            Such managed care plans remove the patient as the major decider in financial and medical choices that are instead made by others in the name of the patient. Even Medicare, Medicaid, and tax laws provide incentives for individuals to have employers pay for medical care through private insurance. Because an increasing portion of medical bills are paid by third-party payers, (insurance companies and governments) patients overuse medical resources because they appear to be free or next to free as all they have to worry about are small co-pays and only pay a portion of prescription drug costs. When these consumers do not have to pay the entire cost of the medical services they use, they rationally respond with overuse. They demand more brand name drugs and new costly medical procedures and life-saving treatments. As a result, insurance premiums for employer-sponsored health benefits are increasing. Hewitt Associates approximate that the average amount companies will pay per employee in 2003 to provide health care is $6,925 (9). This figure has increased $839 since 1998.

            There are a few strategies that have been suggested for employers to implement to contain insurance costs. The first is to educate their employees on the true costs of health coverage beyond the average $15 co-pays through education on the use of generic drugs and enhanced self-care and prevention. Another strategy is for employers to provide health promotion programs. Yet another strategy is to share the cost with employees and increase employee health care premiums. The psychology behind this strategy is to encourage workers to become more aware of medical costs and minimize unnecessary medical visits.





New Medical Technology


            Innumerable breakthroughs have resulted from scientific research in recent decades. There are obvious and unquestionable benefits from the discovery of new diseases, conditions, and medical treatments that have extended the lives and improved the quality of life for countless individuals. For instance, advanced imaging tests such as ultrasounds and MRI’s allow for the recognition and treatment of previously untreatable conditions. Minimally invasive surgical techniques allow for less trauma and healing time to the patient. Innovative drugs such as superstatins used to treat hypercholesterolemia allow patients to tolerate medications or therapies with greater efficacy and fewer side effects. Yet, as biomedical technology continues to advance at an accelerated pace the cost and demand for each one of these technologies skyrockets. Both consumers and physicians need to be mindful of the cost-effectiveness of sophisticated medical procedures.

On the other side of the token, oftentimes new test procedures or interventions are not necessary or more effective than what is standard. Ductal lavage is a new test that is used to analyze a woman’s breast cells to provide at best a rough estimate of her risk for developing breast cancer. The cost of this procedure is $700 (10). A new drug has been introduced to treat leukemia called Gleevec, yet at even a cost of $12,000 it is not a cure (10). An artificial heart being developed by Abiomed intended for patients who are in end-stage heart failure has a price tag of $100,000 for the apparatus alone (10). A study conducted by physicians at Johns Hopkins University School of Medicine published in The Journal of American Medical Sciences analyzed the cost and efficacy of the use of spiral computerized tomography (CT) to scan for lung cancer. The spiral CT scan works by radiating spirals of low-dose x-rays around the body of a patient traveling through a metal tube. Although studies have shown that CT scans better detect small and easily treatable tumor, they are also less specific and produce more false positive results. The study found that if current or former smokers were scanned once a year beginning at the age of 60 over 20 years there would be 553 fewer deaths but there would also be 1,186 unnecessary biopsies (11). The price of a CT scan is $500 in comparison to $50 for a routine x-ray and thus there is no societal benefit for the use of spiral CT to screen for lung cancers in terms of cost (11).


The Rise of New “Blockbuster Drugs”


            Doctor’s offices and are not only crowded with sick patients but also with drug-company sales representative known as detailers that leave drug samples and waiting room tables overflowing with pamphlets highlighting brand-name drugs. The IMS Health drug-market research firm in Westport, Connecticut determined that in the year 2000 pharmaceutical companies spent $4.8 billion on detailing, detailers made 61.4 million office visits, and the pharmaceutical industry spent $2.5 billion to advertise directly to the consumer through television and magazine ads (12).

The National Institute for Health Care Management Research and Educational Foundation based in Washington D.C. conducted a study on prescription drug spending. The study found that a mere 50 of the 9,482 drugs on the retail market are responsible for the greatest proportion of the increase in prescription drug spending which rose from $131.9 billion in 2000 to $154.5 billion in 2001 (13). Some of the drugs that top the list include Prozac and Celex to treat depression, Lipitor and Zocor to treat cholesterol, arthritis drugs such as Vioxx and Celebrex, and Oxycontin as a pain reliever.  The average cost of one of these 50 best selling prescribed drugs is approximately $70 while the average price of the remaining drugs is approximately $40 (13). Therefore, the increased use of these few and expensive “blockbuster” drugs lead the rise in pharmaceutical expenditures.

Overall, pharmaceutical costs account for 10% of healthcare spending (5). Over the past decade, the pharmaceutical industry has reported profits that are three times the size of those reported by other fortune 500 industries. Patients are captured by the advertisements for these drugs and demand them from their doctors. The pharmaceutical industry has so effectively advertised that doctors often fear for their reputations if they decline to prescribe these drugs and are hence often compelled to succumb to requests for these drugs in place of alternatives. The end result is that doctors are writing more prescriptions for the most expensive and heavily marketed drugs. Although consumer advocates and politicians criticize this trend, economists and pharmaceutical makers claim that these drugs save both lives and dollars. One stance they take is that these medications allow people to live longer lives of a better quality out of hospitals leading them to beneficially contribute to society. Another claim they make is that more people are being treated for diseases that have been under-diagnosed, reflecting the increase in spending. Lobbying groups such as the Pharmaceutical Research and Manufacturers of America (PhRMA) state that of the 17 million people suffering from depression only 6 million receive treatment and 28 million are not receiving needed medication for high cholesterol (14). They also state that new drug therapies eliminate the need for more expensive care and that employers and government officials who are responsible for paying the majority of medical bills should realize that spending on costly medication is an investment that ultimately results in fewer worker sick days.

As these blockbuster drugs are vital to manufacturers’ profits, drug companies extend patents and introduce new drugs that are similar to their predecessors to continue to profit. Instead of taking costly risks to develop new drugs, companies are creating “me-too” drugs based on predecessors that have gone off patent. One example of such a drug is Clarinex manufactured by Shlering-Plough and modeled after the antihistamine Claritin. Another example is Nexium that AstraZenca spent $126 million to promote prior to the patent expiration of its predecessor heartburn medication Prilosec (14).

In an attempt to curb the high costs and spending on medications, states across the US, such as Florida, Alabama, Arkansas, Maine, and Michigan, are partaking in counter-detailing efforts. These efforts educate physicians on prescribing more generic than brand-name medications. They also include scans of millions of doctor’s prescription records to hone in on who is heavily relying on prescribing blockbuster drugs.



Increasing Consumer Demand and Supply


            On the exterior, the health care industry resembles every other industry in regards to profit margins, investments, and losses. However, it is very unique in that demanding consumers do not pay directly for services received. Instead a third party such as the government or insurance provider covers a portion of the costs. The supply of health care is also unique in that consumers rely on information given to them from providers who are heavily regulated. A greater demand for health services than supply of health services is directly responsible for increasing the costs and prices of health care. A major factor in the shift of the demand curve for health care services is rising incomes. From the perspective of economists, health care spending per capita increases proportionately with increases in per capita income. Rising incomes increase accessibility and expectations regarding medical services and advances. With higher incomes, consumers have more freedom and power in the market and therefore begin to demand the latest high cost drugs and procedures. Also, consumers are more frequently turning to alternative treatments not previously covered by insurance plans.

 Although the supply curve has also mimicked the increasing trend of the demand curve for health services, the rate at which this increase is occurring is less than that for demand. One reason for this is that physicians represent nearly 0.2% of the population while they direct approximately 10% of the spending in the US (5). The supply of doctors remains relatively constant because of the high barriers to entry into medical schools, the length of time required to receive training, and the financial burden of receiving a medical education. Another reason is that the provision of health care services is extremely labor intensive and requires specialized workers such as nurses and technicians. In order to increase productivity, hospitals need to hire more trained staff and purchase more medical supplies, which increases the amount of money hospitals spend on labor, wages, and extra costs. Indeed hospital spending is on the rise, as it increased to 16.3% in 2001 from 11.2% in 2000 and from 8.9% in 1999 (15). Ultimately, the costs for health services are driven upwards to cover these expenditures, causing a rise in hospital inpatient spending.

Adding to the expenditures of hospitals are technological advancements that increase the quality and quantity of health services provided. While the number of administrators has increased an astounding 40% over the past few decades, the number of physicians has disproportionately increased by less than 10%. In addition, another category of excess cost is enwrapped in administrative and paper work costs. These costs have no benefit on the quality of health care but have emerged because of the network of third-party payers and their efforts to control costs by keeping a watchful eye over the behaviors of doctors and patients. In an effort to contain costs, counterproductively these activities continue to force costs up. Physicians have been under the watch full eye of administrators because they frequently order unnecessary tests and perform extraneous procedures to help insulate themselves from malpractice lawsuits. In tandem, the cost of medical malpractice insurance is outrageously high. For instance, a cardiothoracic surgeon earning $2 million a year pays around $500 thousand per year for malpractice insurance, or 1/4th of the earnings, yielding malpractice premiums another source of increasing medical costs.



The Aging Population


            The system of healthcare in the US has in a sense become a victim of its own success, for the simple reason that people are living longer. In 1900, individuals 65 years of age and older comprised 4.1% of the population (17). This figure grew to 8.1% in 1950 and 12.8% in 2000 (17). By the year 2050, this figure is projected to approach 20.4% (17)4. The aging population contributes immensely to the expansion in health related spending. As the US population has continued to age over the past few decades and will continue to age, the elderly consume the majority of health services to help stay alive. In order to exemplify the unintended consequence of extending life expectancy on health costs consider a patient having suffered from heart failure using ACE inhibitors and beta-blockers to improve survival. During this patient’s extended years of life, the patient will necessitate more care not only for heart disease but for other diseases that will develop with age that cost more money. Also, as a larger aging population requires more services, demand and costs escalate up.

In being the nation’s major health service consumers, senior citizens are projected to spend up to $105 billion in 2004 on health care (14).  Additionally, people with chronic diseases are living longer. There are currently 77 million baby boomers in their middle ages. In comparison to individuals between the ages of 18 to 44, people aged 45 to 64 more likely to have a disability by threefold, six times more likely to have high blood pressure, and 15 times more likely to die of cancer. In summation, an aging population increases the quantity of services necessary as they consume more days in hospitals, more outpatient services, more prescriptions, and more advanced medical technology which are all factors that contribute to skyrocketing medical service costs.



Mandates and Litigation


            From the perspective of policy analysts, state mandates or regulations contribute to the rising costs of medical services. Many states, such as Washington which has at least 47 mandates governing health care, require insurers to cover more and more specialized health problems such as mental, drug abuse, and chiropractic problems that further increase insurance premiums, adding to the pool of individuals uncovered by insurance because they can not afford it. A study that was conducted by the global management consulting and information technology service PriceWaterhouseCoopers found that government mandates and regulations are major drivers of rising health care premiums. They accounted for 15% of the overall increase in 2001 (18). According to the report each mandate adds its own cost, so collectively all mandates contribute significantly to overall healthcare cost. Examples of government regulation at both the state and federal levels that increase the costs of healthcare include: 1) Mandates that cover specific benefits such as minimum hospital stays for births; 2) Regulations to change the operations of healthcare plans - for example, requiring appeals procedures when benefits are denied or reducing the ability of insurers to reject applicants with preexisting conditions; and 3) taxes on health insurance premiums. States often regulate the charges for insurance premiums for health policies by requiring that premiums charged to small firms fall in between specified limits. This type of regulation frequently is conceptualized to keep premiums affordable for employees in those firms. High-risk groups of individuals have lower insurance costs because of the upper premium limit. Yet the lower premium limit is generally higher than insurers would charge to those at low-risk because people who are healthier are less likely to use health services. As a consequence, the low-risk group tends to drop their coverage, which raises the average cost of insurance for those who remain in the high-risk market.

Adding to this rising cost of health care in addition to excessive government mandates are trial lawyer lawsuits. The purpose of the legal system of the United States is to protect the rights of citizens to file legitimate lawsuits in instances when they feel they have been harmed. However frivolous lawsuits and excessive jury awards have frequently been allowed to overwhelm the legal system, and all citizens pay the price. Lawsuit abuse as a result makes living and healthcare more costly and less competitive. To highlight the effect of such suits, a recent report by the American Tort Reform Association showed that in Ohio in 2002 medical malpractice lawsuits alone cost every man, woman and child $636 (19). This amounts to $2,544 for a family of four and totals $7.2 billion statewide.



Conclusion: Containing Health Care Costs


            The provision of services to its citizens is the main function of a health system. A key component to effective communication between health providers and citizens is financing of health services. Health financing holds the purpose of making funds available to give incentive to health providers in order so that all individuals have access to personal and public health care services. As has been evidenced in this chapter, the reason as to why health care costs have risen so drastically is complex and multifaceted, and driven by technical, institutional, and political powers. So the next logical question to ask is what may be done to curb the high cost of health care services? Direct, out-of-pocket payment for health services restricts large pools of the population from ever receiving health care. In terms of mandates the Congressional Budget Office (CBO) analyzes the private-sector costs that are likely to result of proposed federal mandates on health insurers and health plans. These are a part of its duties under the Unfunded Mandates Reform Act of 1995 (UMRA). The act requires the CBO to estimate the amount that entities in the private healthcare delivery sector would have to spend to comply with the mandates. In recent years, work by the CBO has analyzed proposals for parity in the provision of mental health services, the assurance of insurance coverage, and the expansion of the rights of patients. Some argue that one main way to reduce individual health care costs is a focus on prevention. Approximately 8 out of 10 medical conditions may be treated at home and never need medical system intervention. Yet, the cost, supply and service issues that face the healthcare industry in the next few years require more than merely incremental fixes. Both payers and providers pf health services must implement long-term strategies that combat the sources of health care cost rise, such as those mentioned in this chapter. The wait to implement the necessary actions could push healthcare systems to crumble under the pressures being imposed.




1.        The methodology for the assessment of health system performance is controversial and as a result is being reviewed prior to reassessment. More information on the exact calculation of this rank can be found in the 2000 World Health Report at

2.   Inflation occurs when there is an increase in the amount of circulating currency that goes beyond the needs of trade. With inflation an oversupply of currency is created, and according to the law of supply and demand, the value of money decreases, driving the cost of goods and services up (deflation results from the opposite condition). More information on US inflation may be found at

3.        This data is derived from an interesting figure that plots the percent change in spending versus the annual change in private health spending per capita between 1961 and 2001 that can be accessed at

4.        For visual and additional statistical data on the US demographic trend of aging population growth at put out by the US Administration on Aging may be visited.





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      Ropiek, David. “Expensive Multi-drug Treatment for HIV

2.       Conclusion: Containing Health Care Costs is Cost Effective”. Harvard School of Public Health Press Releases. March 15, 2001.

3.       Dr. Fast Facts Cardiovascular Disease. 12/26/01.

4.       Health Care Access Resolution and Campaign Homepage. 3/17/03.

5.       GEOMEDICS ebook. US Health System. 3/15/03.

6.       Organization for Economic Cooperation and Development (OECD).,,EN-home-0-nodirectorate-no-no-no-0,FF.html. 3/15/03.

7.       Congressional Budget Office (CBO). 3/15/03

8.       Sourcebook for Journalists 2003: Health Care Costs – Will They Continue to Rise? 3/15/03.

9.       Hewitt Associates. 3/17/03.

10.   Arnst, Catherine. “A Cold Look at the Cost of Saving Lives”. Science & Technology February 10, 2003. BusinessWeek online.

11.   Parthiv J. Mahadevia, Lee A. Fleisher, Kevin D. Frick, John Eng, Steven N.                                                                      Goodman, and Neil R. Powe. Lung Cancer Screening With Helical Computed Tomography in Older Adult Smokers: A Decision and Cost-effectiveness Analysis
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12.   IMS Health. IMS Study: U.S. Physicians Responsive to Patient Requests for Brand-Name Drugs. October 9, 2002.

13.   National Institute for Health Care Management and Research Foundation. Prescription Drug Expenditures in 2001: Another Year of Escalating Costs. March 29, 2002.

14.   Connolly, Ceci. “A Few Heavily Advertised and High-Priced ‘Blockbuster’ Medication Drive 17 Percent Increase”. Washington Post. March 29, 2002.

15.   Health Affairs, September 2001

16. 4/12/03.

17.   US Administration on Aging. Demographic Trends and Projections.

18. PriceWaterhouseCoopers.

19. Informed Citizens of Ohio.