Understanding Medical Inflation

Like all spending on goods and services, medical spending can be decomposed into two primary components–how many units of something do you buy and how much does each unit cost.  This report from Milliman gives you a primer on how to understand and track medical inflation.  First note that what the government uses as the medical prices component of overall inflation understates actual growth in medical prices.  Why is beyond my limited understanding, but in this day you have to suspect political machinations.  Over multiple decades, medical prices have generally tracked the trends in overall prices, but at a higher level and with a lag.  The tracking is not a surprise, since the inputs to medical services and goods are other goods and services and the lag is due to the time it takes for the change in input prices to work into medical services and goods.  For services in particular, there are often annual contracts with insurers that limit price increases to once a year, usually in January.  The fact that it is higher than general inflation is likely due to the increased market power of producers of medical services and goods–pharma companies have monopolies that allow them to dictate prices, hospitals have consolidated horizontally and vertically.  And insurance and government programs generally insulate consumers from the direct effects of higher prices.

The paper discusses in more detail the factors behind and trends in medical inflation.  If you want to understand this important area of the economy and your own personal finances, it is an easy read and well worth it.  (Milliman Paper)