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Measuring Healthcare and Non-Healthcare Inflation

The Consumer Price Index (CPI) is the standard benchmark used to measure inflation and deflation, and the CPI for All Urban Consumers (CPI-U) is informed by the prices that consumers pay for goods and services in urban areas. Expressed as a percentage, the CPI is updated monthly to reflect changes in prices over the preceding 12-month period.

The CPI consists of 8 market baskets based on out-of-pocket consumer spending, 1 of which is medical care. The medical care market basket includes 2 main components: services and commodities. According to the Bureau of Labor Statistics’ latest monthly report, CPI increases during the 12-month period ending April 2022 (inclusive) were 3.5% for medical care services and 2.1% for medical commodities, compared to 8.3% overall inflation. Analysis of year-over-year inflation during the last decade does not reveal a clear or consistent relationship between general inflation and inflation in healthcare (Figure 1).

Sources: US Inflation Calculator. “Current US Inflation Rates: 2000–2022” and “Health Care Inflation in the United States (1948–2022).” May 2022. The data points for 2022 represent the 12-month period ending in April 2022 (inclusive) rather than an annualized rate.

Healthcare Inflation and Physician Payment Rates

Measures of inflation have an indirect impact on physician payment rates. Reimbursement for a given Current Procedural Terminology code is determined by multiplying the Medicare Physician Fee Schedule (MPFS) conversion factor by the number of relative value units (RVUs) assigned to that service. There are 3 types of RVUs: (1) work RVUs, which account for the time and intensity of physician labor; (2) practice expense (PE) RVUs, which account for nonclinical labor and office-related expenses; and (3) malpractice (MP) RVUs, which account for malpractice insurance expenses. Each RVU component is weighted by a geographic practice cost index (GPCI).

Since the Medicare Access and CHIP Reauthorization Act (MACRA) was passed in 2015, annual changes to the conversion factor have been set in statute. However, the conversion factor is still subject to adjustments that account for budget neutrality and other factors, meaning that the real increase is often less than that prescribed by statute. For example, the value of the conversion factor decreased from 2015 to 2016 and increased by less than the intended 0.5% for each of the following 3 years. Had conversion factor increases occurred as described by MACRA, the current value of the conversion factor would be $36.6577—yet the conversion factor is currently $34.6062, 5.6% lower than projected by MACRA. The way the Centers for Medicare & Medicaid Services (CMS) calculates and adjusts the conversion factor and RVUs thus corrects for inflation rather than reflecting it.

Although medical inflation has outpaced overall inflation for the past 30 years, the conversion factor has remained virtually unchanged since its introduction in 1992. In fact, the value of the conversion factor decreased by 4.9% between 1998¹ and 2021, while medical and general inflation were 116.9% and 72.5%, respectively. If the conversion factor had tracked general inflation since 1998, its current value would be over $57.

In summary, although the cost growth of medical goods and services has consistently outpaced general inflation, the conversion factor underrepresents that inflation by such a margin that current rates represent a real decrease in consumer buying power and provider compensation over time.

Historical Trends and Near-Term Projections

Healthcare inflation tends to persist even amid drastic changes in the broader market. For example, the only year since 1990 during which deflation occurred (as measured by a negative CPI for the entire year) was 2009, when the annualized CPI was -0.4%. That year, the annualized medical care CPI was 3.2%.

Without meaningful adjustment of the conversion factor, increased RVU values can drive up reimbursement. However, at a minimum, RVUs are reviewed every 5 years and GPCIs every 3 years, so a significant lag can still exist between a real increase in costs and any reflection of those costs in payment rates. Both RVUs and GPCIs were last evaluated in 2020. Accordingly, 2023 through 2025 should occasion piecemeal updates to various payment rate inputs that theoretically reflect inflation.

Cost increases are now occurring that may result in the delayed appearance of inflation.  Labor shortages, demand for increased wages, and supply chain issues are all driving up prices. Because current reimbursement rates are informed in part by pre-pandemic data, providers are being paid less on average than the current real cost of goods and services. In response to public comment, the CMS implemented in 2022 a 4-year transition process to phase in updated clinical labor pricing over time, aiming to stabilize payments and maintain beneficiaries’ access to care.

As RVUs and other inputs to payment rates are reevaluated, providers will create pressure to establish values that account for the acute rise in costs. As providers negotiate higher rates from insurers, some of those costs may be passed through to consumers in the form of rising insurance premiums. Even when commercial rates are not directly locked to the fee schedule, many multi-year commercial contracts are linked to proprietary fee schedules based on the MPFS. Physicians are expected to advocate for higher initial rates as new contracts or renewals are negotiated, whether or not those rate increases have been reflected in the MPFS.

Other Payment Systems

Other payment systems incorporate inflation in different ways. For example, the CMS annually updates the Inpatient Prospective Payment System (IPPS), which sets payment rates for diagnosis-related groups under Part A. The 2023 IPPS proposed rule includes updates to fee-for-service payment rates for inpatient and long-term care hospitals. To account for any discrepant COVID-19-related data, the rule proposes to use charge inflation factors and cost-to-charge adjustment factors to better estimate the increase in costs between 2021 and 2023. The IPPS proposed rule thus contains measures aimed at addressing inflation, but the rule’s provisions may change after the comment period. Overall, payments to facilities have tended to correspond more meaningfully to inflation than have payments to physicians (Figure 2), a discrepancy that both reflects the trend of provider consolidation and suggests its continuation.

Source: American Medical Association. “Medicare Updates Compared to Inflation (2001–2021).” October 2021.

MEI: Medicare Economic Index.

Conclusion

The CMS expects national health expenditures to grow by 5.4% annually, on average, from 2019 to 2028. By 2028, it expects healthcare to account for 19.7% of GDP, an increase of 2% over the preceding decade. These pressures will be especially relevant to facility-based providers, who—in addition to rising wages—will need to finance increasingly expensive overhead, capital, and maintenance costs to remain in practice. Providers’ limited ability to respond to rising costs leads to chronic underpayment relative to inflation. Pressure currently felt by providers will not be reflected in rates and reimbursements until 2-3 years from now, when the fee schedule includes data from this period of inflation and as providers renegotiate contracts to better align payment rates with costs. As general inflation eventually moderates, the new baseline established by renegotiated rates will help close the gap between costs and reimbursement, but stakeholders should expect steady healthcare inflation to persist.

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