A Looming Budget-Buster: Health Insurance Costs [Governing]

Oct. 3—Most public-sector budget officials look to 2024 to be manageable but tight. Tax revenues, other than those flowing from shrunken capital gains income, are generally keeping up with expense inflation. So far, salary inflation is precariously balanced with revenues, although public-employee unions are closely watching their counterparts in the private sector for signals of public support for higher pay.

In the nearer term, however, the worst budget headache for most public employers may prove to be the reported 6.5 percent average premium increase now rolling out in the health insurance industry. Few governments have revenues increasing at that pace.

The reasons for this budget-busting cost escalator are only too familiar. Staffing shortages throughout the health-care industry require those employers to pay more than just an inflation adjustment, and many of those workers are demanding more. An expanding aging population needs more therapies and interventions, so the volume of insured events keeps increasing. And new medicines and devices often carry far higher costs than previous standards of care.

Covering escalating health insurance costs for today's public workers will be troubling enough. But the budget-busting impact is magnified for the large contingent of public employers that have made unsustainable promises to continue generous coverage for retirees without setting up a prepayment trust fund. Their underfunding practices now require many of them to pay medical insurance out of current revenues for a phantom second workforce population that has already retired.

Unless those jurisdictions' budget teams can find pixie dust revenues somewhere, this double burden of rising health insurance costs will require belt-tightening elsewhere. In some cases that leaves less for salary increases, which means that today's workers will indirectly bear the burden of unfunded medical benefits for today's retirees. That should be a wake-up call to everybody — policymakers, managers and unionists alike — that such unfunded post-employment benefits are not a free lunch.

One of the newer contributors to medical cost and insurance premium inflation is the recent release of drug therapies originally focused on diabetes that have been shown effective for weight loss. It's emblematic of a broader problem.

If these expensive chemical therapies were just one-time uses, the impact would be limited, but the benefits of some of these therapies are not sustainable if discontinued. Users are often hooked almost perpetually. So the net impact on the bill-paying insurance industry is a new layer of recurring costs that they now need to recover — with higher premiums. Maddeningly, the pharmaceutical industry is just beginning its big-budget marketing for these products, as anybody who grudgingly watches their repeated strings of corny singing TV commercial jingles can attest. The industry's pervasive Madison Avenue prime-time ad spending alone tells us that there's big money in these new drugs.

At some point, the Medicare system may be able to negotiate certain drug prices lower for retirees who are age-eligible, but that alone may not trickle down to those insured at their workplace. Even then, Big Pharma lawyers have already filed suit to challenge the provisions of the Inflation Reduction Act that authorized selective negotiations, so it's too soon to know how impactful Medicare managers can be in cost-cutting for expensive new drugs.

If you don't believe that fighting the drug industry to negotiate lower prices is warranted, worthwhile and achievable, take a peek at this independent study of the gap between U.S. and (negotiated) overseas prices for the same new drugs.

What the Feds Could Do

One place to start at the federal level would be a simple executive branch addendum to new government-funded research grants as they are awarded to early-stage biotech companies to permanently and contractually protect those taxpayer-subsidized products from price gouging, through obligatory negotiation or competition, even after they merge profitably into Big Pharma and Big Medtech. (The legal concept is called vertical privity — a contractual obligation that sticks with the product.)

This is a worthwhile long-term federal solution that all states should advocate. A White House executive order to the grant-giving agencies alone would send a message that enough is enough in the biotech pricing game. Congress could also attach this string to drug-discovery companies receiving grants from tax-exempt 501(c) organizations that are big funders of pharma research.

Another approach would be to require recipients of grant funds and their corporate successors to produce a material percentage of their patented drug products as lower-cost generic formularies for qualified consumers — including public employees. The ratio of mandatory generic production could be based on global pricing ratios or the percentage of founders' cash investments matched by grant funding. The companies could keep the lower, regulated profits on their proprietary sole-sourced generics as supplemental income and still keep their patent protection. This practice would also discourage "gray market" drugs with cut-rate prices but dubious efficacy, a win-win for consumers.

No doubt the drug industry will cry that such price constraints will kill the golden geese and that vital drug discovery will stop because their profits are crimped. But as an angel investor who's dabbled in several federally funded biotech startups, I can attest that such rules would not dry up precious investment capital for breakthrough drug discovery. It just throttles back the excessive profits from successful buyout exits that disproportionately enrich later-stage venture capital investors — and the acquiring Goliath drug companies — after the most crucial FDA human trials are completed successfully. The company founders and risk-taking early-stage angel investors who pay for the breakthrough research alongside the grantor agencies will still do quite handsomely, and the venture capitalists can still garner lucrative returns from their lower-risk piggy-back investments. Unchecked, the late-comers and buyout acquirers profit disproportionately, just like card-counters in Las Vegas who exploit Bayesian statistics after key outcomes are already known.

States: Just Say No

In California, the state pension system has shown some success in bargaining statewide for advantageous group insurance terms, but that effort won't solve the cost drivers cited above, which requires a national collaboration. The states will have to get involved collectively. Public pension funds commonly require a Most Favored Nations clause for money manager fees, preventing them from selling their services elsewhere for a lower price, and that would be the correct model for the states. Imagine the clout they would exert by setting the ground rules statewide for their employees' health insurance plans, so that employers ultimately pay only the same costs per dose as Canadian, Japanese and European consumers enjoy. This policy model is already percolating at the federal Center for Medicare and Medicaid Services, so the heavy lifting is already underway.

For example, the states and their insurance commissioners could unite to form a "buyers' union" to collaborate with their own health insurance carriers in the coverage of overpriced drugs so that pricing pressure can be exerted on the drug makers. Notably, the insurance industry is exempt from federal antitrust laws when states are the regulators and they craft their rules carefully.

Politically it's hard to imagine ostensibly pro-business red-state governors and treasurers cooperating vocally with their blue-state counterparts in a monopsony "buyers' cartel" platform, but their nonpartisan policy associations can provide air cover with a taxpayer-friendly mutual-interest collaboration. Otherwise, "I'll fight for you" is just an empty campaign slogan for politicians beholden to the donor-class price-gougers at the expense of state and local taxpayers.

Finally, the states have a key role to play in expanding the supply of health-care workers. Legislatures should approve student loan forgiveness programs and multiyear income tax deductions for graduating doctors and nurses who then take jobs in-state, along with tuition reimbursements to community college students taking classes in health and elder care. States can wisely award more earmarked dollars to their medical and nursing schools to expand the instructional capacity to train more such students. Those are genuine supply-side investments that will pay big dividends through insurance cost savings for taxpayers, both directly and indirectly, for years to come.

These efforts alone can't entirely fix the persistent medical labor force problem, but they are a place for health insurance buyers to start flexing their muscles. The bottom line: State and local officials, policy mavens and union leaders need to get their acts together to better manage these runaway costs.

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Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.

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