Benefit Flexibility
| Feb 03 2022

Planning for Medical Inflation: The Clock is Ticking

Sunit Patel
Partner, Chief Actuary, Mercer
Rich Fuerstenberg
Senior Partner, Health, Mercer

In many sectors of the economy, inflation is hitting levels not seen in 40 years. While we can hope high inflation will be transitory, companies must prepare for the possibility that it will be long-lasting. HR and benefit departments are being asked how inflation could impact benefit program costs and strategic direction – and how it might affect employees. Health benefits are a particular focal point as they typically represent a large expenditure with high trend, but dental, vision, and life, accident and disability (LAD) benefits will be affected as well, although in different ways. Assuming a scenario where inflation is persistent (lasting greater than 18 months), let’s explore the potential implications of inflation on both medical, dental, vision, and LAD benefits.

Employers: Take advantage of the medical inflation “grace period”

Medical inflation has been relatively modest since 2020, as deferred and cancelled care due to COVID has offset other costs. Assuming that utilization returns to normal levels in 2022, we can expect that underlying wage pressures, labor shortages, and increased provider consolidation will result in accelerating cost growth. But when? Because health care provider contracts are generally multi-year (and often tied to Medicare reimbursement levels), it’s likely that inflation-driven cost increases will phase in gradually as contracts are renewed over the next three years. This provides a unique opportunity for employers to get in front of impending cost pressures. To gauge the potential magnitude of cost growth, a good place to start is with health care service sector wage inflation, which is currently running at 5.0%+. Of course, we have to assume that additional upward pressures stemming from non-wage inflation will impact cost as well.  

Higher inflation is likely to heighten interest in new, and perhaps more aggressive, health benefit cost management strategies. Tactically, if employer health plan sponsors don’t index cost-sharing amounts to inflation (e.g., for copays, deductibles, and OOP maximums), it will result in benefit cost increases that are even higher than the underlying medical trend. At the same time, employees may struggle to afford health care if medical costs rise faster than their own wages. We learned during the last financial crisis that health care is an economically sensitive service and that some people will forego important care when they feel they can’t afford it. Thus, the downstream implications of affordability will need to be balanced with more immediate cost management concerns. Reining in cost growth without shifting cost may require trade-offs, such as offering employees lower-cost plans with smaller provider networks. Virtual services can improve access and save employees money by eliminating the cost of transportation, childcare, or time off from work when seeking care. 

Dental and vision

As with medical, dental trend is lagging behind inflation. While dental providers are not immune from cost increases, especially in the area of employee pay, we’re seeing many opt for internal efficiencies to help offset cost increases, at least for now. As for vision, recognize that outside of eye exams, all vision claims are for a physical good – lenses, frames, contacts. Those items are subject to general inflation and are seeing cost increases in the 3% range. If your plan, like many, has a fixed allowance for these products, you may want to revisit the allowed amounts to mitigate cost shifting to employees.

A mixed picture for LAD costs

One of the factors driving inflation is increased labor costs as employers step up hiring to meet customer demand and pay higher salaries to attract and retain talent. With LAD benefits, employer costs go up when premium rates go up. But because LAD benefits are typically based on a percentage of pay and are also linked to headcount, LAD costs will rise – regardless of rates and fees – whenever employers raise wages and add staff.

If you pay administrative fees for disability and leave administration to vendors, your next renewal may bring higher increases than in past years as vendors seek to cover additional COVID-related costs, such retention bonuses, increased staffing (to manage a higher volume of leaves), and higher IT costs (needed to allow employees to work from home). As for insured premiums, carriers may look to increase the expense portion of premium rates for the same reasons as well as for any claims-related increases due to COVID.

On the more positive side, a period of inflation could also put downward pressure on rates. Inflation and higher wages are signs of a growing economy, which typically means lower disability incidence rates and shorter durations. Further, inflation generally brings higher interest rates, which should also serve to dampen insured LTD premiums. From a plan design standpoint, if high inflation persists, employers may want to consider adding cost of living adjustment riders to disability policies, which typically are fixed for the duration of the claim.

Buckle up, we’re in for some volatility

Medical inflation is only one of several factors adding volatility to benefit cost projections. Disrupted utilization patterns have made it difficult to establish credible baseline data; new high-cost gene therapies are reaching the market; long COVID may or may not add significant claims expense – these and other dynamics add to the likelihood that budget projections will deviate from expectations. Monitoring actual costs vs. budgets more often, introducing or increasing margins, and communicating the uncertainties qualitatively or through the use of confidence intervals, all become more important when the forecast calls for higher inflation.

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