The Price of Good Health
Between the bubble bust, debt bomb, deficit dilemma, dollar collapse, oil question, and the possibility of war, there is plenty threatening the U.S. economy right now. But there might be even more than you think. According to a study released this week by the Centers for Medicare and Medicaid Services (CMS), our medical costs will double over the next 10 years.
In the U.S. in 2002, Americans spent $5,427 per person on health care, almost exactly double of what we spent in 1990. CMS projections estimate that we will spend $9,972 in 2012. Within another year or so after that, our medical bill will have doubled from what they are today. Keep in mind that the Baby Boom did not really get started until 1947…and so these costs do not begin to reflect the potential acceleration after 2012, as my generation gets older and begins to need ever more medical care.
In 1990, we spent 12% of our gross domestic product on health care. Today, that has risen to 14.8% and is projected to rise to 17.8% in 2012. Put another way, that is 3% of our economy ($500 billion) in 2012 that will not be spent on imported goods, cars, etc.
Rising Health Insurance Costs: A Shift in Buying Preferences
Sure, part of this figure will pay the salaries of people who will buy cars and imported gadgets. But the increase still represents a huge shift in buying “preferences”. It will not happen all at once, but the decade-long shift in buying patterns will present significant challenges for many consumer sales products.
The CMS does put forth that health care expenditures should rise more slowly in the coming decade than they have over the past three years – something they attribute to slower rates of growth in disposable personal income, medical price inflation, and Medicare spending. But the percentage of medical spending as part of GDP may be understated, as the CMS uses a higher estimate of U.S. economic growth than I would, and assumes we will have no recessions in the next ten years, which is highly unlikely. However, a recession would do little to slow down the rise in health care costs…which rose 8.7% in 2001, as an example.
In 2001 and in 2002, health-insurance costs were listed as the biggest barrier to adding workers in a poll of 120 chief executives of very large companies by the Conference Board. Almost 82% of 1,017 members surveyed by the Connecticut Business and Industry Association last year said rising health insurance costs were “an important factor” in decisions about whether to hire new workers. Survey after survey also shows that small businesses, which typically provide the bulk of new employment in the aftermath of a recession, are increasingly seeing health care as a reason to not hire…or are laying off workers as a result of higher health care costs.
Think about what this means to the proverbial middle class family of four, making $50,000 today. Today, the contemporary company cost of their insurance is roughly $6,000 or about 12% of their income. Let’s say their salary is going to grow by about 2-3% per year over the next ten years, to about $65,000. Their insurance costs are going to double to about 18% of their income, or they are going to have significantly less insurance. Can business absorb $500 billion a year in increased costs? Not without serious impact upon their profits.
Rising Health Insurance Costs: Up 70% in 5 Years
Hewitt Associates projects that the average cost for employee health insurance will be $5,134, up 70% just since 1998. Costs rose 14% last year, and will rise by double digits this year. What workers pay will rise even more. Projections are that employee out of pocket expenses will rise by almost 25%, as employers shift part of the rising expenses to employees.
Let’s look at how health care costs affects one particular industry. Today, the Big Three automakers spend roughly $1,200 per vehicle on health care, according to this week’s Fortune. Goldman Sachs estimates that the healthcare liabilities are $92 billion for just the three Detroit automakers, roughly 50% greater than their combined market capitalizations. This is three times their unfunded pension liabilities – if you allow them to project 9% stock market returns on their portfolios. A real-world analysis would paint a much darker picture.
There are several scenarios for the carmakers, none of them appealing. They could let the health care costs double as a portion of the price of their cars. This puts them at significant disadvantage to foreign firms which have established U.S. plants and do not yet have huge numbers of retirees. With such competition, the Big Three would have difficulty raising prices to cover the increase in costs, which of course would hurt their profits and result in lower stock prices.
Alternatively, they could pass on more of the costs to employees. That would mean big fights with unions, strikes, lost profits and lower stock prices. But were the carmakers to honor their commitments, they would lose profits and watch their stock prices fall anyway.
This is an industry I do not want to have in my investment portfolio, and ironically, the reason has nothing to do with the quality of their products or service. It is the real uncertainty surrounding their health care and pension liabilities.
Rising Health Insurance Costs: Can Things Be Improved?
Getting back to the macro side of the issue, what about federal and state expenditures? Of course, their health care costs will double, too…rising from $700 billion to $1.4 trillion! Federal government costs will rise by roughly $500 million ANNUALLY. And that’s without any increase in Medicare coverage, prescription drug programs, etc. With 41,000,000 Americans uncovered by health insurance, a growing cohort of retirees who want (and will get) a federally subsidized prescription health care plan, the probability is high that health care costs will rise even more than these projections.
Could things be improved? Of course. Simply passing tort reform will reduce health care costs by about 4% a year. Could we hammer out some increased efficiencies in the system? Sure.
But the main driver behind rising costs is simply the availability of new and better processes, drugs and equipment. Two weeks ago, I was operated on using equipment and procedures that did not exist ten years ago. Did it cost more than the old-fashioned system? You bet, but the cure rate is significantly higher, the procedure was less painful and the results were far more certain. I was offered the choice for the old procedure. I opted for new, better and more expensive.
The point is that health care costs are going to rise dramatically over the next decade, no matter how we end up paying for them. And this is going to shift consumer spending habits in ways we do not yet understand.
for the Daily Reckoning
February 25, 2003
It was another GUDD day on Wall Street. Gold went Up, the Dow went Down. The Trade of the Decade – sell stocks, buy gold – still looks good.
Ben Bernanke is back in the news. You remember him. He’s the Fed governor who warned foreigner investors: “we have…a printing press”. The euro and gold both soared when the foreigners realized what Bernanke was saying – that the Fed was ready to ruin the dollar rather than allow consumer prices to fall.
Bernanke now says the U.S. economy is in good shape and that the recovery will be increasingly robust in the months ahead. Businesses are not doing well, he notes, but the household sector is stronger than it was a year ago, thanks to widespread mortgage refinancing.
True, consumers are more deeply in debt, but 90% of the household debt added last year was mortgage debt, he continued, and much of it was used to pay down other, higher interest, debt.
Of course, a lot of the cash-out refinancing booty was also used to pay for new decks, TVs and vacations; this was the spending that kept the economy out of recession.
And now consumers are going broke at a record rate…and businesses are defaulting on their loans at a record level, too (Eric has more details below). State governments face their biggest deficits since WWII…and oil prices are rising…
But don’t worry about any of that, say Bernanke and the Wall Street shills. Once we get this war behind us, the economy and the stock market will both be fine, just like they were after the last war against Iraq.
Just one problem…
In 1991, the U.S. economy was about to enter the final and most gratifying stage of a 50-year post-WWII consumer-led boom. Today, we are in the 4th year of a major bear market…and possibly on the downhill slope of that half- century expansion. Instead of boosting up the markets, war could have the opposite effect – accelerating the decline.
But here’s Eric with the latest news:
Eric Fry, reporting from New York…
– Well, it looks like the short-sellers aren’t panicking just yet. To the contrary, they continue feasting on the vanquished bull market like lions around a wildebeest. Most investors, meanwhile, are cowering in the shadows like scrawny hyenas.
– The Dow slumped 160 points yesterday to 7,858, while the Nasdaq dropped about 2% to 1,322. The stock market’s losses accelerated during the afternoon, following reports that Saddam Hussein had challenged President Bush to a live debate. Saddam also flatly denied that his “Al Samoud 2” missiles violate U.N. restrictions and said he had no plans to destroy them any time soon.
– The Iraqi leader’s newly expressed defiance sent investors scurrying once again into the sanctuary of gold, oil and government bonds. Gold for April delivery jumped $4.60 to close at $356.40, while oil surged 90 cents to $36.48, a new multi-year high. The jump in crude oil was nothing compared to the blast-off in natural gas, which rocketed 38% to $9.137 per million BTUs. Suddenly, America’s cheap energy has become very, very expensive.
– Low and falling long-term interest rates might help the economy somewhat. But not nearly as much as high and rising energy prices will hurt. The soaring prices of crude oil and natural gas are sure to take a big bite out of the consumer’s depleted pocketbook.
– Already, evidence abounds of a nationwide consumer retrenchment. Federated Department Stores, which operates Macy’s and Bloomingdale’s, said it expects February same- store sales to decline by as much as 7.5% to 8.5%, compared with an earlier forecast of a 4% to 5% fall. Numerous other retailers reported terrible same-store sales for February.
– Meanwhile, the news on Main Street goes from bad to worse. Personal bankruptcies soared to a record 1.51 million households in 2002 – 5.7% more than in ’01. The good news – we always look on the bright side here at the Daily Reckoning – is that 105.6 million households did NOT declare bankruptcy. And there’s more good news: the solvent 98.6% of American households are saving more money than they used to.
– The personal-savings rate jumped from a low of 2.3% in calendar year 2001 to 4.3% by the end of last year. Saving money, while prudent for each individual saver, is not so great for the economy at large…at least not over the short term. If consumers don’t consume, corporations don’t produce profits. And if corporations don’t produce profits, they reduce capital spending. After a while, all of this non-spending adds up…and what it adds up to is a vicious cycle of slowing economic activity. Where it ends, no one knows. But if it doesn’t end soon, today’s record corporate defaults will become even more record-setting.
– Fitch Ratings reports that the U.S. junk bond default rate soared to a record 16.4% in 2002. Default rates among investment-grade borrowers also jumped last year. Incredibly, based on dollar value, more defaults occurred over the past two years than over the previous two decades. Default rates will likely remain high in 2003, says Fitch, ending the year between 7% and 8%. For perspective, between 1980 and 2001, the average annual default rate was about 3.4%.
– “Meanwhile, businesses are finding that various costs have been stubbornly rising,” observes Andrew Kashdan of Apogee Research. “Richard Berner and Shital Patel, of Morgan Stanley, note that corporate America is experiencing a ‘perfect storm’ with regard to cost pressures. While wages, which make up the majority of costs, have remained relatively flat over the last few years, costs have accelerated for health and pension benefits, insurance, worker’s compensation, security services, materials and energy.
– “For example,” Kashdan continues, “health care insurance premiums for large-cap companies are rising at a 13% rate this year, wholesale energy prices are up 75% from a year ago, and pension contributions, says Berner, will eat up about $20 billion of operating profits in 2003. Our expert grasp of accounting (profits equal revenue minus costs) tells us that a problem could be brewing.”
– Perfect storm indeed…If only it were possible to stay out of the water for a while.
Back in Baltimore….
*** Commentators blamed yesterday’s stock decline on Saddam Hussein’s challenge to George Bush. The Iraqi dictator suggested a “live debate” between the two men. Most people were appalled by the idea. But why not? Why shouldn’t each side put forward its champion…and let them fight it out with words, rather than with weapons of mass destruction? Better yet, let the two tough hombres meet in a grappling match…no holds barred! That would be a show better than the bombing of Bagdad. What a spectacle. Oh, for a piece of the box office.
If Bush won, he would get his “regime change” in Iraq at no expense in American lives or money. And if he lost – well, President Cheney could still bomb the hell of them!
*** The trouble with war is that you never know what will happen. The American press assumes that the war will be as quick and easy as a drive-thru burger joint. So confident is the nation, that detailed attack plans are given away on the front page of USA today. Iraqi military intelligence units don’t have to do any snooping around; they just have to buy a paper!
And why not give away the strategy? Everyone knows Iraq can’t really fight back. Which must be what makes the war so popular in the homeland; it seems to have all the drama of real war…but none of the risks. It is like a butt- kicking contest with a one-legged opponent.
But as Gibbon said of the Roman Empire at the height of its glory, it had little to gain from foreign wars and much to lose. When you are in a position of overwhelming power, all luck is bad luck. And there is a lot of luck involved in war. Right now, America is on top of the world. When you are on top of the world, your situation can barely improve, while every mistake, accident and change in the weather eats away at your authority. And there you have both the major nuisance and the principle charm of this slippery old ball we live in: it turns.
*** Yesterday, the Canadian currency, the loonie, rose above 67 cents. Your editor found yet another way to hedge against the falling dollar. While in Nicaragua, he was offered an opportunity to buy land in Nova Scotia. He took it. What the heck. It may go up. It may go down. But it won’t go away.