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Report| McKinsey Global Institute

Accounting for the cost of US health care: A new look at why Americans spend more

December 2008 | byDiana Farrell, Eric Jensen, Bob Kocher, MD, Nick Lovegrove, Fareed Melhem, Lenny Mendonca, Beth Parish

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Of the $2.1 trillion the United States spends on health care, nearly $650 billion is above expected, even when adjusting for the relative wealth of the US economy.

Outpatient care, which includes same-day hospital visits and is by far the largest and fastest-growing part of the US health system, accounts for $436 billion, or two-thirds of spending above expected. Fueling this growth are a number of supply- and demand-related factors, including (1) provider capacity growth in response to high outpatient margins; (2) the judgment-based nature of physician care; (3) technological innovation that drives prices higher rather than lower; (4) demand growth that appears to be due to greater availability of supply; and (5) relatively price-insensitive patients with limited out-of-pocket costs.

Interactive

An interactive graphic examines why the United States spends more on health care than any other nation, even adjusting for relative wealth.

Elsewhere in the US health system, drugs and health care administration represent additional areas where spending is above expected. Drug costs represent $98 billion, or 15 percent of spending above expected, driven by higher prices and the use in the United States of a more expensive mix of drugs. Health administration costs represent $91 billion, or 14 percent of total spending above expected, due partly to the system structure, but also on account of inefficiencies and redundancies that exist within the system.

While many might argue that higher health care spending is a consequence of demand due to the fact that Americans are sicker than people in other OECD countries, MGI analysis suggests that Americans are collectively slightly healthier than the citizens of these peer countries. Moreover, the evidence on whether the United States offers additional value for all the additional money spent on health care is mixed.

MGI's analysis of the underlying dynamics of health care economics in the United States highlights the principal issues that reformers should consider with respect to demand, supply, and intermediation. On the demand side, issues include the need to create an appropriate level of price sensitivity while equipping patients with the right information and incentives to enable them to become more value conscious consumers. Also needed are preventative efforts that present the largest opportunity to improve general health and thereby reduce costs. On the supply side, there is a need to address the cost inflation cycle resulting from high priced technologies while retaining the beneficial aspects of innovation in the US health system. In terms of intermediation, reformers should address the misaligned incentives resulting from fee-for-service reimbursement, the predominant payment method for outpatient care. Here, Medicare and Medicaid can create market leadership toward desired change in the system.

Reform won't be easy. But armed with facts about where and how much above expectation the United States spends on health care, and about the underlying economic dynamics at work in the system, policy makers have a better chance of curbing the growth of costs.

McKinsey Global Institute

McKinsey Global Institute

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