The medical care index is one of the Consumer Price Index’s (CPI) eight major groups, and it is broken into two primary components: medical care services and medical care commodities, each with multiple item categories. Professional services, hospital and allied services, and health insurance are the three categories that make up medical care services, which is the largest component in terms of weight in the CPI. Medicinal medications, medical equipment, and supplies make up the other significant component of medical care commodities.
This factsheet clarifies the following areas that are frequently misunderstood by the general public: expenditure methods, health insurance, prescription pharmaceuticals, professional services, and hospital services.
General CPI methodology
The CPI calculates inflation by following the retail prices of a constant-quality and-quantity commodity or service over time. CPI can track changes in out-of-pocket household expenditure over time by tracking retail prices. The numerous item indexes represent observed price changes each month, summing up to the CPI for all items.
Each item index is given a proportionate value, or weight, throughout the aggregate process. The Consumer Expenditure Survey (CE) is used to establish the weight of each item in the CPI. The CE collects information on buying habits (or expenditures), income, and household characteristics from the nation’s households and families. The most highly weighted goods and services will be those that people spend the most money on. The CE and CPI sections of the BLS Handbook of Methods have more information on CE and how weights are calculated and updated.
Medical care methodology
Consumer out-of-pocket spending on medical care is tracked by the CE and used to weight the medical care indices. Out-of-pocket medical expenses are defined by CE as follows:
- Patient payments for medical goods and services are made directly to retail establishments.
- consumer-paid health insurance premiums, including Medicare Part B; and
Parts of insurance premiums paid by the employer and completely tax-funded medical treatment (such as Medicare Part A and Medicaid) are not considered out-of-pocket, and so are not included in the indexes’ weighting.
While out-of-pocket spending determines the weight of each CPI medical care related index, price change reflected by the indexes measures overall payment to medical care providers. This covers payments made on behalf of consumers by private insurance companies, Medicare Part B, and Medicare Part D.
For example, in the physicians’ services index, the price of an office visit is calculated as the patient’s $20 copay plus the physician’s $80 insurance payment, for a total of $100. Any price change is calculated using the $100 figure.
The apparent disparity is due to difficulties the CPI has when pricing health insurance; this is discussed in greater depth in the health insurance section. Because customers do not make out-of-pocket payments to participate in these programs, Medicaid and worker’s compensation payer categories are not eligible for the CPI.
Note that because medical care’s relative importance is based only on out-of-pocket expenses, its percentage of the CPI is lower than its part of GDP and other national accounts indicators. Reimbursements that are fully paid for by public sources and employers are included in GDP, increasing the share of GDP devoted to medical care.
So, what exactly is medical inflation?
In the context of rising healthcare expenditures, there are numerous definitions of medical inflation. Some people describe medical inflation as merely the growth in the average or unit cost of a healthcare service over time, whereas others look at both usage and unit costs.
What is the primary cause of healthcare inflation?
Medicare and Medicaid, for example, have increased total demand for medical services, resulting in higher pricing. Furthermore, rising rates of chronic diseases such as diabetes and heart disease, particularly among the elderly, have had a direct impact on rising medical costs. Chronic diseases account for 85% of healthcare costs, and chronic sickness affects more than half of all Americans.
How do you calculate medical inflation?
The Consumer Price Index (CPI) and Producer Price Index (PPI) are the most generally used indices for evaluating medical inflation, or the rate at which medical prices rise annually.
What effect does inflation have on health-care costs?
The impact of inflation on the healthcare business might be devastating. Higher inflation could not only expand the gap between public and private reimbursement, requiring physicians to charge more from their private sector clients, but it could also lead to an increase in insurance rates. Fewer payers would be able to withstand increases in healthcare expenditures, resulting in fewer insured or underinsured people.
Insurance companies may strive to limit provider reimbursements, confine their networks, or restrict patient access to medical treatment as their market dominance grows. This isn’t even taking into account the pressure doctors and hospitals will face from both sides as they deal with rising office costs and decreasing revenue.
Few professions do well in a rising inflationary environment, so having the correct personal financial safety nets in place to counterbalance these potential professional setbacks is critical.
What are the three different types of inflation?
- Inflation is defined as the rate at which a currency’s value falls and, as a result, the overall level of prices for goods and services rises.
- Demand-Pull inflation, Cost-Push inflation, and Built-In inflation are three forms of inflation that are occasionally used to classify it.
- The Consumer Price Index (CPI) and the Wholesale Price Index (WPI) are the two most widely used inflation indices (WPI).
- Depending on one’s perspective and rate of change, inflation can be perceived favourably or negatively.
- Those possessing tangible assets, such as real estate or stockpiled goods, may benefit from inflation because it increases the value of their holdings.
Is healthcare included in inflation?
Inflation in health care services was typically at or above 3% per year in the early 2000s, then fell from about 3% at the end of the decade to under 1% in 2015, before rebounding to slightly under 2% in early 2018. The low point in 2015 was near-historical, with price increase in health care services bottoming out at a rate not seen since 1961.
The low results in late 2014 and early 2016 were first viewed as cause for concern; inflation was running below target, and health care services account for a significant portion of the Price Index for Personal Consumption Expenditures (PCE) used to calculate inflation.
1 Low price rise in health care services was seen as a drag on overall inflation estimates by forecasters and policymakers.
Health-care inflation, on the other hand, has been steadily rising since 2015, rising from 0.55 percent to 1.83 percent in the last three years (see figure 1). This current surge in health-care-services inflation has piqued the interest of reporters and policymakers, similar to the prior decline. While the recent focus has been on the surge in health-care price growth, I suggest that what was exceptional from 2014 to 2016 were the extremely low levels. While overall health-care inflation has begun to rise again, it is still quite modest by historical standards.
Health care services inflation
We need to know what elements play a role in the evolution of this price series in order to determine whether the recent increase will be transitory, permanent, or the start of a longer-term trend. A succession of major legislative developments over the last decade have altered health care service prices, as many prices are decided administratively by Medicare and state-level Medicaid programs. Policies that put long-term downward pressure on health care service pricing and policies that are better understood as transient inflation shocks are the two kinds of policy changes. The patterns of these long- and short-term shocks combine to explain the very low levels of health-care price increases witnessed from 2014 to 2016, implying that the recent increase indicates a return to more-normal levels rather than a return to the high levels seen in the early 2000s.
In this Chicago Fed Letter, I explore the role and scope of policy in influencing health-care pricing, as well as specific policies that have influenced the evolution of health-care prices over the last ten years.
How are health care service prices determined?
The Personal Consumption Expenditures Price Index gauges the costs of goods and services used by American households. Those purchased out of pocket by consumers, as well as those paid for on their behalf by third partiesfor example, services paid for by employers through employer-provided health insurance or by governments through Medicare and Medicaidare included in the PCE deflator. Outpatient services (physician and dental services, home health care, and laboratory services) are included in the health care services component, as are services offered in hospitals and nursing homes.
What do health-care prices signify in the context of the PCE deflator’s health-care services component? There are effectively two components in this case. The first, and smallest, component is household-purchased health care. If an uninsured person goes to a retail clinic, the price recorded is whatever he or she pays directly to the facility. However, only 12% of Americans’ health-care spending is paid for out of pocket (Medical Expenditure Panel Survey, 2014). 2 Insurers purchase the second, and considerably larger, component of health care services in the PCE on behalf of households. When a patient with insurance visits a health-care provider, the patient’s insurance pays for the visit “The “price” is the amount paid to the provider by the insurer (Medicare, Medicaid, or a commercial insurer).
The prices paid by insurers in Medicare and Medicaid, which account for about 20% of total U.S. health-care spending, are set at either the state (Medicaid) or federal (Medicare) level. Furthermore, recent research has revealed that Medicare pricing are followed by a significant portion of the private market. 3 Because many of the prices paid by insurers to providers are either administratively established by Medicare and Medicaid or follow administratively set pricing, changes in policy have had a significant impact on price evolution in health care services during the previous decade.
Given Medicare’s prominence in market-wide price determination, analyzing the evolution of prices paid to providers by Medicare is especially significant for understanding trends in health care service prices. Inpatient hospital (about 50 percent) and physician (roughly 20 percent) expenditures are the two largest components of overall Medicare payments to providers. Because hospital prices have accounted for the majority of the recent increase in health-care inflation, I’ll concentrate on how Medicare determines hospital prices.
While the finer points of Medicare’s Prospective Payment System (PPS) pricing determination are intricate, the system is simple at its foundation. A base level of payment is the beginning point for deciding how much Medicare pays providers. This amount is then adjusted based on the patient’s diagnosis (to account for the fact that some services are far more complex and resource consuming than others) and the patient’s geographic location (to take into account that inputs are more expensive in some areas than others).
There are two elements that influence the evolution of Medicare prices over time. The first is the Centers for Medicare and Medicaid Services (CMS) annual modifications to the base payment level to account for increases in input prices. These modifications are referred to as “They’re called “market basket updates” and follow a strict formula. The Employment Cost Index’s (ECI) estimate of the rate of change in hospital wages and benefits is the most important component of the market basket update for hospitals; the ECI directly accounts for around 70% of the price index used to alter hospital base payment rates.
The second factor in the evolution of Medicare hospital prices is legislative adjustments, which are either added to or withdrawn from the market basket update to calculate final payment changes. Figure 2’s first panel depicts the difference between the final Medicare hospital payment update, which was issued following legislative revisions, and the originally proposed market basket update. Because of the requirements of several pieces of legislation, such as the American Taxpayer Relief Act (ATRA) of 2012 and the Affordable Care Act (ACA) of 2010, the final payment update may differ significantly from the initial market basket update.
Long-term factors
Inflation in health-care services peaked in the early 2000s before plummeting in late 2010. This decrease reflects Medicare payment decreases enacted as part of the Affordable Care Act (ACA), which took effect in fiscal year 2011. The difference between the effective update and the market basket update is decomposed in the second panel of Figure 2 into components of individual pieces of legislation, the most notable of which are different cuts mandated by the Affordable Care Act. These cuts to Medicare hospital payment rate updates have been in effect every year since 2011, and while some components will eventually expire, the most important component (the hospital payment rate updates) will remain in place “Under current law, the “multi-factor productivity” adjustment will continue indefinitely.
To the extent that the evolution of Medicare prices has both a large direct and indirect effect on overall health care pricesand one that will remain in place for the foreseeable future under current lawthese legislated cuts to Medicare payment growth can be an important restraining force on overall health care inflation. Health-care inflation declined dramatically once the Affordable Care Act’s Medicare changes were phased in (figure 1). For several years, inflation remained constant at the new lower level, until prices were impacted by a series of one-time policy shocks, which are addressed in the next section. If we consider the average inflation rate for this stable time (the dashed line in figure 1) to be the post-ACA inflation rate, “After years of extremely low inflation, we have only recently returned to this level.
One-time policy changes
In addition to the ACA’s Medicare payment cuts, there were three major market shocks from 2014 to 2016 that likely contributed to the extraordinarily low levels of health-care inflation. 4 Unlike the cuts to Medicare provider price updates, which lower price rise year after year, they are all one-time shocks to health care service costs that would have held down year-over-year price increases at first, but subsequently tapered off, allowing health care inflation to return.
First, the Budget Control Act of 2011 included a package of automatic spending cutbacks that kicked in when the Joint Select Committee on Deficit Reduction of the United States Congress failed to establish a bipartisan agreement on spending cuts. As a result, the act mandated automatic cuts in federal expenditure (known as “sequestration”), which took the form of a 2% fall in Medicare payments across the board. The changes took effect in April 2013 and affected both hospital and doctor payments under Medicare. Figure 1 shows a substantial decline in health-care inflation that corresponds to the Medicare payment cuts, which has been attributed to the Medicare sequestration cuts. 5
The sequester cutbacks, unlike the Medicare payment cuts imposed in the Affordable Care Act, were a one-time payment reduction with no influence on the increase of Medicare payment rates. While prior research has shown that changes in Medicare costs have a long-term impact on the private sector, the effect is front-loaded and diminishes dramatically after the first year. 6 As a result, much of the impact of sequestration cutbacks on health-care inflation should have faded by 2014.
Second, the Affordable Care Act’s Medicaid expansion took effect in 2014, resulting in a significant increase in Medicaid membership. Medicaid payments are smaller and grow at a slower rate than other payers’ payments. As a result, in states that extended Medicaid, the composition of payments moved downward as a result of the ACA expansion. Starting in 2014, state-level adoption of the Medicaid expansion was exceptionally rapid, but has since declined. Currently, 36 states and the District of Columbia have ratified the expansion. 27 of these expansions went into effect in 2014, three in 2015, two in 2016, one is currently enrolling people for coverage that will go into effect in 2019, and four were approved by ballot initiative but are not yet in effect.
Third, the Medicaid primary care rate increase expires in January 2015. The Affordable Care Act included a provision requiring states to boost Medicaid payments to doctors to equal Medicare levels for primary care services. The rate rise was effective in 2013 and 2014, but efforts to make the payment increase permanent were unsuccessful, and most states returned to their prior substantially lower payment rates in 2015. Figure 3 depicts the significant impact of the primary care rate increase’s implementation and expiration; in many states, compensation to doctors for primary care services doubled in 2013 and subsequently halved in 2015.
Medicaid primary care payments to doctors decrease sharply in 2015
While the sequester cutbacks appear to have mitigated the effect of the primary care rate hike, the dramatic fall in Medicaid payments to primary care doctors in 2015 corresponds to the lowest period of health care services inflation in figure 1.
Conclusion
Each of the three policy measures outlined here may be expected to reduce health-care inflation for a time, and the fact that they largely overlapped may explain 2015’s very low inflation levels. We will observe a turning point in health care inflation in January 2016, when the effect of the fee rise expires and no further substantial policy changes affect health care service prices. While the effects of these regulations have faded, the Affordable Care Act’s mandated reduction to Medicare hospital payment updates have largely remained in place. As a result, the return of health-care inflation to the initial level seen following the Affordable Care Act’s adoption could herald a return to a post-ACA “new normal” for health-care inflation.
However, there is a caveat: legislation plays a significant effect in the evolution of health-care service pricing. The analysis presented here is based on existing legislation. Anticipating the prices of health-care services necessitates forecasting health-care policy, which is far more challenging. While legislation has kept health-care costs in check for much of the last decade, the Bipartisan Budget Act (BBA) of 2018 takes a different approach. This bill repealed an ACA-created advisory board to regulate Medicare expenditure, postponed Medicaid Disproportionate Share Hospital (DSH) payment reduction for two years, and repealed a provision that reduced physician compensation. Furthermore, the 21st Century Cures Act, which was signed into law in December 2016, included a 0.46 percent increase in Medicare hospital payment updates in fiscal year 2018 and a 0.5 percent increase in fiscal year 2019 to partially restore cuts made by the American Taxpayer Relief Act years earlier. Following a lengthy period of policy restraint in the health-care sector, these minor policy shifts could imply a tiny relaxing of that posture.
In the United States, what are the two main sources of health insurance coverage?
Private insurance (either through an employer or obtained on one’s own), Medicare, and Medicaid are the three main sources of health insurance in the United States. Other public health insurance plans are also available in some states. The graphs on this page show the percentage of citizens covered by each type of health insurance, as well as variations in coverage between 2000 and 2012 and the change in the uninsured rate between 2013 and 2014.
What are the various costs of health care?
Recognizing this, the cost of a health-care intervention can be broken down into three categories: direct costs, indirect costs, and intangible costs.
What is a medical pricing index, exactly?
- To calculate retained profits, deduct total benefits paid out in year T from total premiums income in year T.
- The ratio of retained earnings to benefits is calculated by dividing retained earnings by total benefits.
- The retained earnings ratio is calculated by dividing the retention-benefit ratio for year T by the retention-benefit ratio for year T-1.
The annual rise in the retained earnings ratio is 1.09666 percent, or 9.67 percent. In other words, assuming that benefits paid out remain constant, the health insurance firm has kept 9.67 percent more premium revenue than the prior year.
- The twelfth root of the retained earnings ratio is used to spread this annual change evenly over 12 months.
The monthly retained earnings relative is 1.007719 percent, or 0.77 percent.
Health insurance index aggregation
The monthly retained earnings relative is multiplied by the index relatives of the other nine non-insurance medical indexes in the retained earnings method’s third phase. This enables the CPI to account for the impact of changes in medical prices on health insurance rates. Physicians’ services, dental services, eye care, other professional services, hospital services, nursing homes, home health care, prescription pharmaceuticals, and medical equipment are among the nine indices.
This yields nine health insurance index products, each of which takes medical care price variations into account. The remaining earnings weight in the Health Insurance index is used to weight each index product. The overall Health Insurance index is generated by multiplying the weights of these nine index components.
Reassigning health insurance index weight
The retained earnings method’s fourth and final stage involves reassigning the previously separated Health Insurance index weight to the other nine non-insurance indexes. Keep in mind that medical care reimbursement and retained earnings are weighted equally in health insurance. What gets transferred to the other indexes is the weight signifying medical care reimbursement. This weight is then divided by health insurance type (commercial and Medicare) and redistributed to each medical non-insurance index in proportion to how much each health insurance type pays for that medical good or service.
Let’s say Medicare accounts for a third of the reimbursement weight in the health insurance index, and half of Medicare spending is spent on physician services. This would imply that the physicians’ services index would receive half of one-third of the weight from the health insurance index.
This process is repeated for each form of health insurance and non-insurance medical index until all of the weight representing reimbursements has been redistributed. The percentage each health insurance type pays for each medical item is calculated using industry data.
Non-insurance medical care indices carry the weight of both out-of-pocket expenses and insurance reimbursements for medical care after benefits are reallocated. As a result, each of these non-insurance indices must track the total reimbursement’s price relationships (insurance reimbursements as well as the out-of-pocket patient copays). Continuing with the previous example, if the CPI were tracking the cost of a Medicare-covered yearly physical, we would track both the patient co-pay and the amount Medicare pays.
Recent Changes
Commercial insurance data was previously derived from A.M. Best’s Insurance rather than NAIC and DMHC until September 2018.
In October 2020, premium and benefit expenditures for Medicare Advantage became part of the retained earnings calculation. These Medicare Advantage costs had previously been excluded.
Prior to April 2021, rates and benefits data from a national nonprofit health insurance carrier were factored into the retained earnings calculation. The National Association of Insurance Commissioners has taken over this data (NAIC).
Prescription Drugs
The prescription medications index tracks changes in the cost of drugs obtained with a prescription from a retail, mail-order, or online pharmacy. The tracked price is the total payment to the retailer for a single prescription from the patient and all eligible payers. Any entity that reimburses health care providers for the cost of medical services and/or goods is referred to as a payer. Patient self-pay (cash), commercial or private insurance, and Medicare Part D are all eligible payer categories for prescription medicines.
The hospital services index includes prescription medications that are mostly consumed and paid for during hospital visits. Here’s a more in-depth look at the BLS methodology for dealing with prescription medicines.
Item sampling
The prescription pharmaceuticals index uses a streamlined sampling procedure, with each pricing unit, or quote, being a single prescription for a single drug. We collect a list of the previous 20 prescriptions dispensed and assign each prescription a percentage denoting its likelihood of being sampled when sampling drugs to price at a pharmacy. The percentage is calculated by dividing the price of each prescription by the total price of all 20 prescriptions. A prescription is chosen based on these probabilities; this method is known as sampling by probability proportionate to size (PPS).
The “size” in this situation refers to the total reimbursement to the pharmacy for the prescription (patient payment plus payer reimbursement). The higher the price or popularity of a drug, the higher its sales numbers will be, and the more likely it will be chosen. This item selection approach is the preferred method, and it is used at each pharmacy that has been chosen for pricing. We work with respondents who are unable to offer the essential information in order to devise a feasible sample procedure, which may include choosing a medicine based on equal probability or other simplified ways.
Special patent loss procedures
When the patent protection for a brand-name drug in the sample expires, people frequently switch to the less expensive generic drugs that have become available. The CPI will resample all previous instances when the brand was chosen since no generic was available at the time in order to accurately reflect the market. Then, using corresponding probabilities proportionate to the share of prescriptions sold at the pharmacy in the previous three months, we resample between brand and generic versions of the previously sampled medicine.
The CPI waits typically six months following patent expiration before conducting the resampling technique to allow the market to completely acclimatize to the new generics. There is only one resampling. If a generic is chosen, any price difference from the brand is treated as a price change, and the difference is reflected in the index for the month in which the resampling was done. If the brand is chosen again, we just price the brand again.
Drugs changing to over-the-counter
If a prescription drug goes over-the-counter (OTC), the CPI will continue to price any quotes in the prescription drug index until the drug rotates out according to standard rotation rules (a complete rotation occurs once every 4 years with one-eighth rotating every 6 months). The quote is kept in the prescription drug sample during this time, and any price changes are reported in the prescription drug index. Any quotes for that drug are not immediately transferred to the non-prescription drugs index, but it is eligible for selection in the non-prescription drugs index after it becomes accessible over-the-counter.
Recent changes
The prescription medications index’s estimation formula was updated from a geometric means formula to a Laspeyres formula in 2016. This was done after CPI study shown that when employing a geometric means calculation, the substitution effect for prescription medications is exaggerated.
Professional services
The professional services index includes services provided and billed by private-practice doctors, dentists, eye doctors, and other medical professionals. The physician and dental services indices account for the majority of the weight in this category. Patient self-pay (cash), commercial or private insurance, and Medicare Part B pricing are all included in the professional services index.
The dental services index does not accept Medicare Part B payments because most dental services are not covered by Medicare Part B, but it does accept patient self-pay and private insurance.
All professional services are started using the same process. A doctor’s visit is the pricing unit, which is defined by a specific medical service. We determine the practitioner’s speciality during the initial visit; if the practice is a group practice, one practitioner is sampled. Then, using PPS, a medical service is sampled. The term “size” refers to the overall amount of money paid out for each service in the preceding year. Current Procedural Terminology (CPT) codes are collected for Physicians’ Services to assist accurately define the item. Professional services samples, like most other CPI items, are cycled once every four years, with one-eighth of the sample rotating every six months.
The CPI began pricing services for Health Maintenance Organizations (HMOs) in September 2014; before, HMOs were not eligible.
To reduce the time burden on CPI survey respondents, the CPI began employing a carry forward process for some items in the physicians’ services index in June 2017. Many doctors only make minor pricing modifications each year, usually only when their annual contract with insurance providers is renegotiated. As a result, physicians’ offices may be eligible for less frequent price collection. The last collected price for each quote is carried forward for use in the current month index during non-pricing months. The majority of carry forward offices are priced between 2 and 4 months per year. The chosen pricing months are ones with the highest likelihood of price modifications.
For the Physicians’ Services Index, the CPI began collecting sub-indices at the payer type level in April 2018. The CPI weights the corresponding payer type indexes within a geographical area using the Medical Expenditure Panel Survey (MEPS). The CPI then adds these area payer-type sub-indices together to calculate the change at the national level. This change was intended to increase the index representativeness of the various payer categories by boosting the ratio of payments covered by private insurance against uninsured people and Medicare Part B payments.
Hospital services
The hospital services index keeps track of how much a hospital charges for services it provides. In addition to inpatient and outpatient medical services, room and board, lab testing, and other hospital services are included. If a physician is employed by the hospital, their services are included. It does not, however, cover services provided by physicians who are not employed by the hospital, even if they use hospital facilities. The professional services index captures these services. Patient self-pay (cash), commercial or private insurance, and Medicare Part B are all eligible payers for the hospital services index.
A hospital visit is the pricing unit, which is defined by a specific medical service as well as a specific diagnostic or medical condition. We collaborate with the respondent to choose a medical service utilizing PPS during the initial visit. The term “size” refers to the overall amount paid to the hospital. The medical service and specific processes of the hospital visit are then documented.
Hospital reimbursements can take the form of an itemized list or a lump sum payment. Reimbursement based on an itemized list, also known as fee-for-service or fee schedule, results in a distinct price for each good and service given. Lump sum reimbursements, such as Diagnosis-Related Group (DRG) costs, result in a single payment for all goods and services delivered, regardless of the diagnosis or operation done.
The hospital services sample will be rotated less regularly after the August 2018 sample. Outlets will be valued for an 8-year period rather than the typical 4-year period. The sample will be static for four of the eight years, after which it will rotate semi-annually for the next four years. The sample is currently at a standstill phase, with the next wave of fresh outlets being collected in February 2023.
Additional information
We frequently get inquiries about how to label potentially problematic items; table C offers a list of these items, as well as their spending category.
What is the current CPI for medicine?
Basic information. The Consumer Price Index for Medical Care in the United States is currently at 535.73, up from 534.80 last month and 523.03 a year ago. This is down 0.17 percent from the previous month and 2.43 percent from a year earlier.