How to Reduce US Healthcare Costs 

(Published March 18, 2020)

Our healthcare costs keep increasing much faster than inflation, year after year. According to figures released in December 2019 by the U.S. Department of Health and Human Services (DHHS), the annual growth rate of healthcare spending was 4.6% in 2018, vs. 3.9% in 2017, 4.8% for 2016 and 5.8% for 2015. We spent $3.6 trillion in this area, or 17.8% of GDP.

Americans spent about $11,000 per capita  on healthcare in 2018, more than twice as much as of our direct economic competitors: This per capita healthcare spending was $4,700 in Japan; $5,700 in Germany; $4,900 in France; $4,200 in the U.K.; $4,800 in Canada; and an average of $5,300 for a dozen such wealthy countries, according to the Kaiser Family Foundation and OECD data.

Spending almost a fifth of our GDP on healthcare, compared to 9-11% for other large developed economies (and much less in China), is like having a chain tied to our ankles when it comes to our economic competitiveness.


To answer this question, we need to look in more detail at the largest areas of healthcare spending in America, and at the recent but also longer-term growth trends in these areas, using the annual statistics from the DHHS.

Administrative costs represent the biggest driver of rising costs in U.S. healthcare—and the biggest outlier as well when we compare our healthcare costs to those of other developed countries. The numbers in this area are tragic: $259B in 2017, with well above average cost increases of 6.5%, 5.6% and 5% in 2017, 2016 and 2015 respectively—and a whopping 65% over the last decade. We spent more on administrative costs than the United Kingdom spends on total healthcare.

Let’s do some quick math here: The dozen large developed economies mentioned above spend an average of 2% of total healthcare costs on administration, versus 7.4% in the U.S. All other things being equal, if we too spent 2% on admin. costs, we would save $190 billion per year, enough to insure pretty much all our uninsured at today’s costs. Unfortunately, this sad state of affairs is the reflection of the enormous complexity of our healthcare system, and as long as we cannot surmise the political will to do a complete overhaul of how we provide healthcare to our citizens, this will continue.

A potential sign of improvement in this area will be when technology innovations lead for the first time to a demonstrated ability to cut healthcare costs. Thus far, and unlike in any other industry, the opposite has proven true: Administrative costs have grown hand in hand with ever more complex electronic health records, patient accounting systems, the use of big data and other IT innovations. Complexity reigns supreme in U.S. healthcare, and even Silicon Valley is unable to do anything about it.

“In the land of free markets, competition and open markets are systematically thwarted in healthcare (We could also talk about the cozy duopolies private health insurers enjoy in many states, but this is a much more complex problem to address…), and this needs to end yesterday.”

Drug Costs: Drug spending over the last decade has outpaced total healthcare spending in America, principally in the 90s and early 2000s, where it grew in double digits annually. Americans spend about twice as much on pharmaceuticals per capita than residents of other rich developed countries.

Surprisingly, however, spending on prescription drugs in pharmacies and other retail outlets only grew at 0.4% in 2017, at $333B, and 1.2% in 2016. After increases of 9% in 2015 and 15% (!) in 2014, could galloping pharmaceutical prices be behind us? To have more certainty in this area, one would have to be able to track the aggregate costs of drugs used in hospitals (not reported in the DHHS statistics), often very expensive ones, in part because these costs are well reimbursed by both private and public health insurers.

Private Health Insurance costs ($1.2T in 2017) grew 4.2%, 5%, and 6.9% in 2015, 2016 and 2017 respectively. This is faster than total healthcare costs, in part due to the strong average cost increases that followed the implementation of the ACA (“Obamacare”) marketplaces and subsidies.

Unless there is a dramatic change in the way we handle healthcare reimbursements in our country, insurance costs are likely to continue to increase. The key driver here is the enormous complexity of the private insurance business model, with the myriad health plans on offer and patients’ widely different out of pocket cost, co-pays, deductibles, coverage limits etc., plus the inherently high administrative and marketing costs of health insurers.

Medicare costs ($706B in 2017) grew 5.1%, 3.5% and 3.5% in 2015, 2016 and 2017 respectively. Over the last decade, they grew 37%. Good news, Medicare cost increases lag total health cost increases. Bad news, the 5.1% cost increase in 2017 is high.

What will we have in the next 5-10 years? Unfortunately, Medicare costs will likely increase faster than total health costs, due to the aging of the U.S. population, and this trend will continue at least until the last “Baby Boomer” reaches the Medicare eligibility age of 65.

Medicaid costs ($582B in 2017) only grew 2.9% in 2017 and 4.2% in 2016. On the other hand, with the ACA’s Medicaid expansion, they grew 9% in 2015 and 11.8% in 2014, as several new states expanded Medicaid under the Obamacare guidelines.

Following the November 2018 Midterm elections, three newly elected Democratic governors promised to bring Medicaid expansion to their constituents. This has already been done in Maine, with Kansas and Wisconsin next. Plus, the citizens of Idaho, Nebraska and Utah will also get Medicaid expansion, following the success of ballot initiatives during the recent Midterms.

In total, around 800,000 people are poised to gain access to Medicaid for the first time in these six states. The impact on overall healthcare spending will be mitigated, though, by fewer visits to expensive emergency departments from people without health insurance. Overall, it is worth noting that Medicaid remains most cost-effective way to insure people in the U.S.

Hospital spending ($1.1T in 2017) and Physician and Clinical Services costs ($694B in 2017) have grown in line with the overall healthcare costs, in recent years as well as over the last decade.

With increased merger activity among healthcare delivery providers, their pricing power increases with industry concentration, and it is unlikely that we will see spending in these areas grow much more slowly than total health system costs.


The aging of the population, Baby Boomers reaching the Universal Care promised land (called Medicare in the U.S.), will ensure continuing growth of Medicare costs; hospital costs will grow further as well due to further industry concentration and increased pricing power by the largest provider systems. Private insurers will increase their fees to reflect these higher hospital costs.

Overall, it is hard to project an outlook that does not see at least a 2-3% annual increase in U.S. health care costs for the foreseeable future. The extraordinary complexity of our healthcare system is the main driver of rising costs. Think of the incredible mosaic of complicated interfaces between Medicare; the 50 States’ Medicaid plans; the government administrated Veterans hospitals; private insurers such as United Health; Academic, Community, Faith-based, Public, Private and Research hospitals; Integrated health systems like Kaiser, and many more actors in this giant system. Unless we somehow reach a political consensus to completely reform our health system, focusing on simpler and more effective ways to give health coverage to all Americans, rising healthcare costs are here to stay.

But let’s not despair! There are three areas where significant cost savings can (and should) be achieved in the short-term, helping us to at least contain overall healthcare cost increases to much more modest levels. These three areas involve the federal government, industry and several states.

Reduce prescription drug costs. Because it has become such a political rallying cry, we could very well see some bipartisan legislation, not just to contain but reduce prescription drug costs in our country. We all know what should be done: First, eliminate the absurd clause within Medicare Part D that does not allow Medicare, the largest purchaser of drugs in the country, to negotiate prices directly with pharmaceutical companies. 

Have you ever heard of any other large industry where the principal purchaser of products is not allowed to exercise its negotiating power? I think not. Second, allow the import of lower-priced drugs from reputable countries such as Canada, Germany and Japan. This would end the protectionism, leading to price fixing, that our pharmaceutical companies enjoy today in the U.S. Think about this: A dose of insulin from our very own Eli Lilly cost $65 in Germany, whereas in the U.S. we have to pay at least $250 for the same product!

In the land of free markets, competition and open markets are systematically thwarted in healthcare (We could also talk about the cozy duopolies private health insurers enjoy in many states, but this is a much more complex problem to address…), and this needs to end yesterday.

Any partial movement in this direction, such as the recent proposal by the Trump administration to allow the import of lower cost pharmaceuticals in certain areas for Medicare, and new legislation proposed by the House of Representatives in September 2019, would lead to a significant reduction in prescription drug costs for U.S. patients—this cannot happen too soon. Good news, the Trump administration has a strong incentive to do something meaningful in this area prior to the November 2020 elections, and Democrats also have incentives to help make initiatives in this area become reality.

Expand Medicaid under the ACA guidelines to the 16 States that have not yet done so. Medicaid is not much in the limelight, because it really represents 50 different state-wide programs, each one with its own eligibility and reimbursement rules.

This complexity makes it hard to analyze and understand well. Nevertheless, there is one fundamental fact: Medicaid is by far the most-cost effective healthcare coverage program we have in this country, if one looks at the total cost of the overall Medicaid program relative to its total number of its enrollees.

The average healthcare cost for a Medicaid enrollee stands at about $7,500 per year, or about one third less than the average cost per capita in the U.S. That is quite an achievement! One logical consequence is that the whole country would benefit in terms of healthcare costs if every state adopted Medicaid expansion under the ACA, or Obamacare rules. Today 34 states have adopted this Medicaid expansion, many of them with republican governors. And indeed, if you are a State Chief Executive, this expansion is financed by the federal government, allowing the state to insure more of its citizens at no cost to local budgets. The only reasons to refuse such a proposition are ideological ones…National pressure should increase on those 16 holdouts, all led by republican governors, to expand Medicaid, not only for the sake of their local populations, but also because Medicaid is proven useful damper on national healthcare costs.

Encourage insurance companies and hospital systems to use “capitated” payment models(as opposed to fee for service).Any move to value-based pricing for hospitals helps contain costs.

Today, most services provided by U.S. physicians are under a fee-for-service regime that encourages overtreatment. In contrast, there are emerging “capitated” (i.e. with a not-to-exceed ceiling) reimbursement models revolving around primary care physicians, who act as the “gate keepers” to other care givers such as specialist physicians.

In these models, for example applied to senior populations, Medicare pays a fixed amount per “life insured” to Medicare Advantage plans who then work with independent physician organizations managing patient populations. These coordinated care models, where doctors are empowered with data, technology and nursing teams, produce the best patient satisfaction and cost efficiency, managing global risk for commercial, Medicare Advantage and dual eligible populations. They also optimize expensive resource healthcare utilization, enabling empowered nurses to make scarce physician time more effective; and allowing cost effective primary care physicians to control and optimize the use of much more expensive specialists.

Unfortunately, these models only cover today a small fraction of Medicare Advantage enrollees—themselves representing about one third of total Medicare enrollees. Therefore, these capitated models would have to grow by at least an order of magnitude to start having an impact on total U.S. healthcare costs. But this capitated pricing and related processes are a proven formula to reduce costs and increase patient satisfaction and should be expanded aggressively by both hospital systems and health insurers. This proven track record stands in contrast to the well-publicized hospital “Accounting Care Organizations,” or ACOs, which have not been able to achieve much in terms of tangible results thus far.

Avoiding extremely costly hospital short-term readmissions is also an effective way for hospital to control costs, but…today their incentives to do so, principally under fee-for-service reimbursement regimes, are limited. However, when the CMS cuts or discontinues outright Medicare reimbursements for 30 days readmissions, private insurers will likely follow suit, and hospital systems will have to act in a much more comprehensive manner. But we are not at that stage yet.

The excess costs of our U.S, healthcare cost are systemic in nature, driven by the enormous complexity of our $3.6T system, as best evidenced by the absurd amount of spending we spend just on administration, a lot of it literally “paper pushing.” Fundamental reform, demanding a political consensus we have been unable to achieve thus far, is the only path to achieve significant cost reductions—and better outcomes, such as a life expectancy more in line with other developed countries.

However, in the absence of a political consensus that may be years in the making, there are steps that can and should be taken at the federal government, industry and state level, in the areas of prescription drug costs, Medicaid expansion and value-based care, that can put a dent in these galloping cost increases and at least help us stabilize the current spending at around 18% of GDP—as opposed to let it mushroom towards 20-25% of our economy. These are sobering, but still worthy short-term objectives.

Tags: , , , , , , , , , , , , ,