When the California Public Employee's Retirement Systems (CalPERS), the nation's second largest buyer of health insurance after the federal government, announced an average HMO premium increase of 25 percent for 2003, employers and consumers nationwide braced for big increases in health care premiums. The bad news soon followed. Analysts projected a 15 percent increase for 2003.

The 15 percent increase in employment-based insurance in 2003 follows a 12.7 percent increase in 2002, which itself was the largest since 1990 and the sixth consecutive year of accelerating premium hikes, according to a study published by the journal Health Affairs. The study credits lower premium increases in the 1990s to strict cost control measures for hospital spending instituted by Health Maintenance Organizations (HMOs). The spike in premiums since 1998 provides "new and concrete evidence that costs are back to where they were before managed care began to dominate the health insurance landscape."

Rising Hospital Costs
Prescription drug increases grab the headlines, but 79 percent of health care costs result from hospital and physician expenses, the areas where HMOs dramatically reduced expenses in the 1990s. Hospital inpatient care is the largest single component in health care spending, so even small rates of cost growth cause dramatic increases in health coverage premiums.

What's driving the increases in hospital costs? According to a Blue Cross Blue Shield Association (BCBSA) study, the driving forces are investments in new technology and market consolidation.

To meet demand for the best and the latest, hospitals over-invest in expensive new technologies. "Clearly medical technology can and does benefit patients," said BCBSA President Scott Serota. "All this advanced technology will mean little, however, if no one can afford it. Investments in new technology must be made based on sound medical evidence."

Hospital consolidation   drives costs up, too. Another BCBSA study found that "in some cases merging hospitals is associated with price increases of 20 percent to 40 percent." Overall, BCBSA research shows that "every one percent increase in hospital market share from consolidation leads to an approximate two percent increase in inpatient expenditures."

Curbing unnecessary spending on new technology; encouraging competition and increasing the quality of care can reform the system.

Prescription Drugs
Prescription drugs account for only 1 in every 9 dollars spent on personal healthcare, but the amounts being spent are rising geometrically.

According to the Kaiser Family Foundation, spending on prescription drugs saw double-digit increases in each of the past seven years. A whopping 16 percent jump occurred in 2001.

Why so high, so fast? According to Kaiser, three factors are responsible: more prescriptions are being written; newer and more expensive drugs are replacing older less-expensive ones; and manufacturers are increasing prices.

Prescription drugs not only grew more expensive, more people used them more often. From 1992 to 2001, the number of prescriptions purchased increased by 68 percent, an increase from 7.3 to 11.1 prescriptions per person.

And drug companies are cashing in. Retail drug prices increased an average of 7.7 percent per year since 1991, more than double the average inflation rate of 2.7 percent.

Now, pharmaceutical manufacturers are the nation's most profitable industry, with a return on revenues in 2001 of 19 percent, compared to three percent for all Fortune 500 firms.

Kaiser predicts prescription costs will continue to rise, reaching 17 percent of personal health care spending by 2012. That's 1 out of every 6 dollars consumers spend, a fifty percent increase in a decade.

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