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Express Scripts Holding Company (ESRX), Community Health Systems (CYH), Pfizer Inc. (PFE): Why Health-Care Costs Are Likely to Rise

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Opinions rage about whether health insurance costs will rise or fall with implementation of the Affordable Care Act, commonly known as Obamacare. What gets relatively little attention, though, is that overall health-care cost growth has actually slowed down over the last few years. According to the Centers for Medicare and Medicaid Services, national health-care spending grew 3.9% annually from 2009 to 2011 — the lowest rate since the government began tracking the statistics over 50 years ago.

Don’t get used to slower health-care cost growth, though. There are several reasons why higher spending could soon rear its head again. Here are three that could drive health-care costs up in the near future.

Express Scripts Holding Company

1. Macroeconomic factors

The Kaiser Family Foundation, and the Altarum Institute’s Center for Sustainable Health Spending, created a statistical model that helps identify how U.S. health spending varies with several macroeconomic indicators. Their research found that two macroeconomic variables account for a whopping 85% of variation in health-care spending growth between 1965 and 2011.

Inflation was the biggest factor influencing health spending. Real gross domestic product, or GDP, growth was next — with particular focus on growth in the current year and the prior five years.

These two variables were uncannily predictive of national health-care spending growth rates. And, unless the model breaks down in the years ahead, that means that any uptick in inflation and/or GDP will result in higher health-care spending.

So far, the Federal Reserve has done a good job keeping inflation rates down. Actually, some are more concerned about deflation rather than higher inflation. GDP growth, though, should eventually increase. Take a look at the rolling six-year average real GDP growth rate since 1960.

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Source: U.S. Department of Commerce-Bureau of Economic Analysis

We’re experiencing the lowest GDP growth rates in decades. Unless we assume that the economy never fully recovers from the Great Recession, GDP growth should pick up steam at some point. When it does, health-care costs will increase in tandem.

2. Obamacare

While we can’t be sure how long it will take for GDP growth to get back to historical levels, there’s one driver of higher health spending that you can probably mark on your calendar now: implementation of Obamacare in 2014. Actuaries and economists with the federal government expect health-care cost growth to jump to 7.4% next year as a result of health reform implementation.

The reason for this projected increase is simple: higher demand for health services. If more uninsured Americans obtain insurance, they’re likely to use more health services. This increased demand will drive costs higher.

3. The patent cliff’s cliff

Pharmacy benefits manager Express Scripts Holding Company (NASDAQ:ESRX) says that spending on prescription drugs decreased in 2012 for the first time in two decades of monitoring. This slight drop stemmed from more low-cost generic drugs on the market. Several popular brand drugs lost patent protection in recent years in a wave often referred to as the “patent cliff”.

However, Express Scripts Holding Company (NASDAQ:ESRX)’ data points to what I have previously called the “patent cliff’s cliff. A big drop-off is occurring this year for prescription drugs becoming available as generics. While there will be a rebound from 2014 to 2016, another big decline is projected beginning in 2017. As pharmaceutical companies come out with newer and more effective drugs, it seems likely that prescription drug spending — the third-highest health-care cost in the U.S. — will go up.

Who wins?

While no one wants to pay more for health care, smart investors will try to determine how to profit from the likelihood of rising costs. I see two potential ways to play this coming trend.

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