Forecasting Health Care Costs

Along with the problem of the uninsured, rising health care costs are the largest challenge facing the U.S. health care system today. Health care costs rose steadily during the latter half of the 20th century, from 5 percent of GDP in 1950 to over 15 percent today. Experts agree that costs will continue to rise over the next half century, putting pressure on government, businesses, and individuals, although there is no clear consensus on how high costs might go.

A new working paper by Robert Fogel, "Forecasting the Cost of U.S. Health Care in 2040" (NBER Working Paper 14361), examines several factors that are likely to be important in determining how fast health care costs rise in the future.

The first factor is trends in age-specific prevalence rates of chronic diseases and disabilities. Prevalence rates declined during the 20th century, and the rate of decline has increased in recent years, from about 1 percent per year between 1910 and 1980 to about 2 percent per year by the end of the century. Advances in health care have clearly contributed to the decline in prevalence rates, though it is difficult to determine what share of the decline is due to health care versus other factors such as improved nutrition.

To determine whether declines in age-specific prevalence rates will reduce health care expenditures, it is necessary to weight the existence of a particular chronic disease by the cost of treating it, which generally rises with age. The author shows that the financial burden of health care per capita (relative health care costs) rises slowly in the 50s and then accelerates at a faster and faster rate in each successive decade. The financial burden at ages 85 and above is 6 times higher than that at ages 50-54 and nearly twice as high as that at ages 75-79.

The critical question is what is likely to happen to the relative burden of health care over the next generation. One possibility is that the curve will shift downward, which would occur if prevalence rates declined by the same rate at all ages. A second possibility is that the curve will shift to the right, which would occur if the average age of onset of chronic conditions were delayed, say by five years.

Recent epidemiological studies support the latter theory. Moreover, when the author graphs relative Medicare expenditures by years until death, he finds that costs rise sharply in the last two years before death and that this pattern has remained unchanged over the past two decades. These findings suggests that the delay in the onset of chronic diseases is not likely to reduce health care expenditures- individuals will have more years in good health, but when they do eventually become ill they will incur large medical expenses.

Next, the author examines trends in life expectancy. Many experts predict that increases in life expectancy in the 21st century will be much lower than in the 20th - for example, the U.S. Census Bureau predicts an increase of 13 years this century, versus 30 to 40 years in the last century. One reason for the relatively low projection is the view that reductions in death rates under age 5 offer the best opportunity for large increases in life expectancy, and these rates are already very low in the U.S.

Yet as the author notes, other arguments point to a larger increase. Record life expectancy, the highest life expectancy experienced by any country at each point in time, has risen by 2.4 years per decade for women (and 2.2 years for men) over the past 160 years. If this trend were to continue, female life expectancy in the U.S. in 2070 would be between 92.5 and 101.5 years, substantially higher than what many predict. The accelerating decline in chronic disease prevalence and favorable changes in body size (such as the decline in waist-to-hip ratio, which measures abdominal fat) also suggest that gains in life expectancy in this century will be fairly large.

A third factor affecting future health care costs is the increase in the share of the population over age 65. As per capita health expenditures rise with age, the aging of the population will lead to an increase in health care expenditures. However, the author argues that this will be only a minor factor in the rise in health care costs over the coming decades.

A more significant factor is likely to be the rise in demand for health care that comes with rising incomes. The author calculates the long-term income elasticity of demand for health care to be 1.6. Applying this figure to projections of U.S. income growth implies that health care expenditures will rise from about 15 percent of GDP today to 29 percent of GDP in 2040. This increase isn't necessarily a bad thing if the value of the health gains that result from these higher expenditures is greater the expenditures themselves, as several recent studies suggest.

The author concludes, "Public policy should not be aimed at suppressing the demand for health care. Expenditures on health care are driven by demand, which is spurred by income and by advances in biotechnology that make health interventions increasingly effective. Just as electricity and manufacturing were the industries that stimulated the growth of the rest of the economy at the beginning of the 20th century, health care is the growth industry of the 21st century."

The author acknowledges funding from the National Institute on Aging (P01 AG10120).