Payroll May Be Healthcare's Biggest Cost Driver

What is driving healthcare inflation?

We hear about voracious trial lawyers and defensive medicine, new-fangled "must have" medical technologies, ballooning executive salaries, institutionalized inefficiencies, and expensive and overused imaging. To say nothing of outright fraud and incompetence. There are scores of explanations, and no doubt they all contribute in some way to healthcare inflation, which always seems to be growing at least three times faster than overall inflation.

One obvious driver, however, that we don't talk about much is the more than 14 million people who work in healthcare. Healthcare is labor-intensive, and labor is the highest single budget item for most healthcare organizations, grabbing about 60% or more of the budget at hospitals. Compensating 14 million people doesn't come cheap.

Last week, Standard & Poor's Healthcare Economic Indices reported that the average per capita cost of healthcare services covered by commercial insurance and Medicare grew 6.19% over the 12 months ending in February. (The Consumer Price Index showed that overall inflation grew by 2.1% for the same period.) What's interesting is that the rate of growth in healthcare inflation has been steadily decelerating since it hit a high water mark of 8.74% for the 12-month period ending May 2010. Since then the rate of cost growth has declined by 2.5 percentage points.

"What appears to be moving the index? The answer appears to be employment," David M. Blitzer, chairman of the Index Committee at Standard Poor's, tells HealthLeaders Media.  "It is a reminder that this is a labor-intensive industry, which suggests that it is going to be very hard to tackle costs. Most labor-intensive industries tend to have prices that rise faster than the CPI. It is easier to get a faster computer to replace an older, slower one than it is to find a new doctor who is faster than the old one."

In his report last week, Blitzer noted that "while growth in hospital wages has remained relatively stable over the past year, in the range of 3% - 4%, hospital employment growth has slowed significantly. Between 2008 and early 2009, annual hospital employment growth rate was in the 2%- 3% range; however, since the middle of 2009, the rate has been consistently below 1%."

Blitzer explains that some of the slowing growth in healthcare costs reflects "a long-term undercurrent of trying to do more with less, and to push any particular task down to a less expensive and presumable less-skilled person."

"In some places this is very successful. Physician assistants (are) doing things that previously only doctors did. There are things that licensed practical nurses do compared with what registered nurses used to do as an effort to move tasks to less-expensive people," Blitzer says. "There are a lot of cases where this is perfectly fine. In fact you may have improvements because people are better utilized. The highly skilled surgeon just does the things that require his skill. One could argue that computerizing medical offices is a big step in that direction."

From a common sense perspective, Blitzer's points are valid.

There are some minor sticking points, however. For example, healthcare grew 280,000 new jobs over the 12-month period that ended in February, 2011, compared with 229,000 new healthcare jobs in the 12-month period that ended in February, 2010. How much will the addition of 50,000 healthcare jobs bend a curve in a $2.5 trillion industry? If you look at BLS data, the trending slower growth of healthcare costs that started last May does not necessarily match monthly trends in overall healthcare employment growth.

However, it'd be a mistake to draw too fine a linkage between specific healthcare employment data on any given month and the relative growth of healthcare inflation. There is a lot of fluidity in the healthcare industry. What's important is that Blitzer appears to be right on a key point: healthcare employment growth is a driver in healthcare inflation.

For healthcare human resources executives, the challenges now will be to address staffing needs in an era of chronic workforce shortages, while simultaneously reconciling the impact of rising labor costs on shrinking budgets. Let me know how that works out for you.