Surging inflation has set the table for heated negotiations between providers and insurers.
In May, year-over-year price increases of consumer goods and services outpaced healthcare inflation, bucking the historical trend. The consumer price index rose 8.6%, the steepest gain since December 1981. Medical expenditures grew 3.7% in May, the biggest year-over-year jump since September 2020, according to the most recent data from the Bureau of Labor Statistics.
The inflation spike will ripple throughout the healthcare industry. It may push more providers to cut services or seek merger partners as supply costs rise, wages grow and access to capital drops. The Federal Reserve raised interest rates by 0.75 of a percentage point to curb consumer spending, increasing health systems' borrowing costs and likely slowing capital projects— and a similar increase could come in July.
Inflation has already influenced contract negotiations between providers and insurers, healthcare advisors said.
"There is going to be a terrible bloody renewal cycle that we're beginning to see the first manifestations of now," said Jeff Goldsmith, founder and president of the consultancy Health Futures.
Providers typically negotiate their contracts with insurers in three-year cycles. Those that are currently renegotiating can use inflation as leverage, given that physician groups' and hospitals' daily operations are tied to the rising cost of gas, food and other goods. Hospitals and physicians also will argue that more patients are expected to skip or delay care as their monthly bills increase, ultimately costing providers more when they come into the system sicker.
But the providers and insurers that renegotiated last year or in 2020 will have to absorb more of the hit to their bottom line. Providers will get little relief from private and public payers. Insurance companies are unwilling to negotiate reimbursement levels that offset inflation, and government payers' reimbursement levels will lag expense growth, industry observers said. Health insurers, particularly smaller ones that have less clout, will manage rate hikes through network cuts, pared-back benefits and increases to their commercial premiums, experts said.
"Until your contract is up for renegotiation, you are stuck. There will be more margin-versus-mission discussions," said Kevin Holloran, senior director for Fitch Ratings. "They would like to keep those mission-driven services going but they may not be able to afford it. It will hurt and be unpopular but some will have to do that to rally."
Accounting for inflation
Hospital reimbursement was cost-based during the last wave of inflation in the '70s and early '80s. Providers could pass on the cost increases to government and private payers.
That scenario changed in 1982 when the California Legislature legalized selective contracting, allowing insurers to negotiate prices with providers and exclude clinicians from their networks without worrying about violating antitrust laws. It was the start of the managed-care movement nationwide.
Today, Medicare's prospective payment system automatically incorporates adjustments for economic conditions, but there is a lag, said Paul Ginsburg, a health policy professor at the University of Southern California and senior fellow of the USC Schaeffer Center for Health Policy and Economics.
"The projections for this year and probably for the next did not reflect the inflation that has come to pass," he said. "This is going to be a challenge for hospitals because Medicare reimbursement won't go up as much to offset inflation."
Inflationary pressures are more dire for physician groups, more of which may seek merger partners in hospitals, insurers or private-equity firms, Ginsburg said.
"There has been very little increase in physician payment rates over the last 20 years, so physicians are in a terrible position now with inflation having picked up," he said. "There is very little prospect of Medicare rate increases. The way policy stands now, it has to be revisited soon because with 6% to 8% inflation, the policy makes no sense and is extremely damaging."
Despite doctors' arguments citing rising cost pressures, physician practices have been offered only slight increases in rates negotiated with insurance companies, nowhere near matching the increase in inflation, said Andrew McDonald, the practice leader of physician business solutions at the consultancy LBMC. Physician groups are threatening to pull their practices out of the networks, he said.
"To date there hasn't been many (of those threats), but we're starting to see more movement in that direction," McDonald said. "Physicians have in essence taken a cut in pay because of inflation and the cost of managing their practice going up."
The American Medical Association approved a policy at its recent annual House of Delegates meeting to push federal and state governments to incorporate inflation adjustments in minimum-wage laws. The 6.2% inflation rate in 2021 outpaced the 3.8% bump in physician pay last year, according to a 2021 survey of 160,000 physicians by Doximity, a digital health tool for providers.
"Providers are feeling more pressure as staff want more money because there is a shortage, supply costs are rising and they haven't been able to negotiate higher payment rates," said Dr. Robert Pearl, Stanford University professor of organizational behavior and former CEO of the Permanente Medical Group. "Doctors are hurting too. Physicians want to see payment increases and insurers are not giving in."
OU Health, Oklahoma's only academic medical center, fell out of network 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 system in the state and asked to cut their rates.
Government payers aren't expected to make up for the expense-revenue mismatch on the commercial insurance front. Medicare proposed a 3.2% increase for inpatient payments in 2023, an amount that doesn't come close to covering hospitals' rising costs, trade groups said. That may pressure negotiations with commercial insurers as providers seek to make up the difference, industry observers said.
"There unquestionably will be more pressure from our health systems to drive higher rate increases from the commercial payers. We've already started to hear this," Holloran said. "Commercial payers are also facing labor inflation pressures themselves, so getting them to increase rates materially is going to be a tough sell."
Hospitals will have lower margins over the next couple years. But it will not be dire, particularly for the higher-rated hospitals that have more of a financial buffer, Holloran said. Still, health systems will have less of a cushion as their stock market returns wane, analysts said.
"Between staffing costs, supplies, shortages and inflation, a lot of providers would like to merge and be part of a bigger system," Holloran said.
As consumer prices rise, consumers will likely defer or skip medical care or stop paying their healthcare bills.
Clinicians that are more dependent on non-urgent procedures and visits as revenue-drivers will also see a decline in patient appointments, independent healthcare consultant Paul Keckley said.
Hospitals' primary way of controlling costs is by decreasing their labor expenses, which have been eating into more of their budget due to the COVID-19 pandemic. National hospital labor expenses 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 the supply of workers, such as easing immigration regulations for skilled healthcare workers, said Nathan Ray, a partner at the healthcare and life sciences division of consultancy West Monroe.
"The problem is that you can't just produce healthcare workers out of thin air," Ray said. "We need more people, we need more talent."
Among insurers, the smaller organizations are more vulnerable to acquisitions, experts said. Those that don't have the clout to negotiate more favorable rates will likely be targeted by private-equity investors, creating more integrated systems, Keckley said.
Vertical integration among these large insurers will give them greater leverage over health systems when it comes to negotiations, leading to more public contract disputes 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 butting heads until one of them says, 'I'm going to take you out.'"