*Please note a change in terminology in this report, as compared to previous versions. Until now we’ve referred to total health services demand as the product of units and pricing, which is ambiguous with respect to mix effects. To be clear, mix effects are contained in what we have previously referred to as units – thus our terminology change to ‘intensity’, which we believe better conveys the change in demand attributable to BOTH the number of healthcare encounters AND the amount of care provided in an average encounter. None of our calculations or methodology are changing, thus current and future mentions of ‘intensity’ may be viewed as synonymous with past mentions of ‘units’

We expect 4Q13 health services demand growth (y/y, nominal) of 3.5%, the product of 2.3% growth in intensity demand and 1.2% growth in nominal pricing (Exhibit 1). Our nominal pricing forecast is up just 10bp from last quarter’s multi-year low, while our estimate of y/y growth in unit demand is 30bps above 3Q13. Separate from our growth rate forecast, we run an independent model which handicaps the odds of a trend break in demand. This model suggests a strong likelihood (93%) of accelerating (4Q13 v. 3Q13) demand. None of our projections have changed from the interim model that we published last month

The pricing trend has been extremely weak since the 2% across the board cut in Medicare provider payments began on April 1 (Exhibit 2). The trend has not really moderated since the April shock (Exhibit 3). Further, the bipartisan budget compromise passed by Congress last month extended the Medicare sequester cuts through 2023 (despite providing varying levels of relief to a number of other sequester cuts, including defense and the NIH)

The projected improvement in intensity is a function of rising momentum in both wages and hours for health workers, which offset another dip in overall GDP growth forecasts in the Philadelphia Fed Survey of Professional Forecasters

Our estimates of demand dynamics for health services rely on several measures of underlying economic activity; included among these variables are measures of general economic activity and health-system specific activity, as well as forward expectations about US economic conditions

Exhibits 4, 5, and 6 provide time series of actual v. projected unit demand, price growth, and total demand, respectively

2013-2014 Flu Season

Since mid-December, the flu season has turned significantly more intense than it looked over the first 12 weeks (Exhibit 7). However, 2012-13 remains such an outlier in terms of severity that we need to temper this recent uptick with some context. We’ve repeatedly argued that a return to an ‘average’ flu season in 2013-14 would translate into a +/- 30 bps headwind for total y/y health services demand growth during 4Q13. If we assume that the relative trajectory of the past 4 weeks is sustained (which seems very aggressive given that the level already seems to be plateauing at a post-peak level of ILI[1] cases per 100,000 doctor visits), then the headwind becomes +/- 20-25 bps. In other words, last year’s flu season established a baseline spend level that even a very intense season is unlikely to equal

National Health Spending in 2012

We have consistently argued for several years that the slowdown in U.S. healthcare spending is predominantly a cyclical story[2] – having more to do with the lingering impact of the great recession than a structural reframing of the delivery of care. Recently CMS’ Office of the Actuary published its annual review of National Health Spending trends in Health Affairs[3], and their analysis on CY2012 data supports our thesis. In addition to arguing that private health insurance spending remained near historic lows “largely influenced by the nation’s modest economic recovery and its impact on enrollment,” the paper concludes that

… mixed trends produced the fourth consecutive year of low overall health spending growth and led to a relatively stable health spending share of GDP. However, this pattern is consistent with historical experience when health spending as a share of GDP often stabilizes approximately two to three years after the end of a recession and then increases when the economy significantly improves. Recently, however, the question has arisen about whether a more fundamental change is occurring within the health sector and whether this stability will endure. From our perspective, more historical evidence is needed before concluding that we have observed a structural break in the historical relationship between the health sector and the overall economy

We continue to believe that without a wholesale improvement in employment (as opposed to just the unemployment rate), meaningful acceleration in health spending in unlikely. This subjective view obviously continues to find support in our intraquarter demand model