Inflation, Labor Costs Will Increase Healthcare Spending by $370B

Inflation and rising labor costs will increase US national healthcare spending by $370 billion in the next five years, according to a McKinsey report.

Consumer prices are rising faster than healthcare inflation, but general inflation has recently driven up healthcare supply input costs.

Between 2019 and 2022, labor costs per adjusted hospital discharge rose 25 percent, pharmaceutical costs increased by 21 percent, supplies grew 18 percent, and services rose 16 percent. These costs have somewhat stabilized in 2022, but they remain high above the norm.

Significant labor costs and the ongoing clinical labor shortage are the main contributors to the projected $370 billion increase in healthcare expenditures by 2027. McKinsey researchers estimate a shortage of 200,000 to 450,000 registered nurses and 50,000 to 80,000 doctors by 2025.

In addition, clinical labor costs are expected to grow by 6 to 10 percent over the next two years, which is 3 to 7 percentage points higher than the prevailing inflation rate.

Workforce shortages will likely get worse due to increasing demand and decreasing supply, the report noted. The annual demand for registered nurses may increase by 7 to 10 percent between 2021 and 2025. Attrition rates and retirements will also exceed the number of new licensures.

Clinical labor shortages may account for $170 billion of the healthcare spending increase expected by 2027. Labor shortages could also negatively impact care access due to potential closures or increased wait times.

Due to clinical labor shortages, nonclinical workers, such as personal care aides, may be burdened with additional tasks. This could make it harder for practices to retain nonclinical staff, the report said.

Researchers predicted that nonclinical wages would be 3.1 percentage points above baseline expectations over the next several years. While wages should return to baseline expectations by 2025, these increases could still result in a $90 billion increase in healthcare expenditures by 2027.

Supply chain issues will likely continue in the US, causing nonlabor costs to increase by up to $110 billion in the next five years.

The rising costs due to inflation are mainly affecting providers currently. Due to contracting and renewal cycles, public and private payers may not experience impacts for a few years.

For example, providers’ ability to pass on increased costs to employer-sponsored health plans is governed by contracting life cycles that typically last for three years. Thus, higher costs associated with commercially insured consumers will not reach payers for one to three years.

When the costs reach payers, employers will either have to bear the expenses themselves or pass them on to employees through higher premiums.

Public payers, including Medicare and Medicaid, will likely see increased costs in two to three years as standard methodologies use historical inflation rates to set next year’s prices.

CMS recently finalized a 4.3 percent increase in hospital reimbursement rates for 2023. Still, McKinsey researchers said they do not expect this update to entirely alleviate the projected and ongoing financial challenges health systems are facing.

Healthcare leaders expect inflation to have a substantial adverse effect on margins, the report found.

Payer and provider organizations currently have operating margins between 2 to 4 percent. Executives report that they expect margins to drop by 25 to 75 percent, leading to earnings potentially disappearing.

Tech-enabled organizations reported an expected decrease of 15 to 50 percent in operating margins due to payers’ and providers’ likelihood of relying more heavily on technology.

Some executives said they might have to turn to layoffs and address the clinical labor gaps through technology and skill-mix optimization.

“Healthcare executives will need a disciplined approach and fast action if they want to come out stronger from this period,” researchers wrote. “Well-known tactical actions exist that can spur the required improvements, just as a set of well-understood organizational measures can help companies thrive during a period of uncertainty.”