Inflation could cut health care sector profits by $70B or more this year

Analysts predict rising prices, reimbursements, staff shortages could chip away at margins.

As inflation spikes in the U.S. economy, rising costs could lead to a drop of $70 billion or more for health care sector profits this year, a business consulting firm said.

Meanwhile, physicians and health care systems must develop operational excellence and be resilient to avoid eroding profit margins, said the report by McKinsey & Co. The global management consultant advocates for sustainable and inclusive growth and analysts Shubham Singhal and Aneesh Krishna published the study, “Consumer prices are rising fast, and healthcare isn’t far behind.”

From December 2020 to December 2021, inflation was greater than 5.8%, they said. As the overall inflation rate makes headlines across the country, the worst may be yet to come for the health care sector. Its price changes tend to lag behind the overall rate, the authors said, because in health care, prices, reimbursement rates, labor contracts and other costs usually are set two or three years in advance.

With inability to increase reimbursements quickly, and a nursing shortage driving up labor expenses, health care providers already are seeing cost increases – and consumers will soon, the study said.

The result: “A typical health system could see a 1.2 to 2.8 percentage point decline in profit margin, assuming that its ability to raise prices is typically limited to about 3%,” according to the McKinsey analysis.

Extrapolating health care inflation catches up to overall prices, implying a 1.5 percentage point increase on top of current levels, health care profit could decline by $70 billion, a decrease of 12%. A 3% rise could result in a $140 billion decline in profits, or 24%, the study said.

The study was published earlier this year before the June 14 U.S. Bureau of Labor Statistics (BLS) report that stated consumer prices spiked 8.6% from May 2021 to May 2022, the largest 12-month increase since the period ending December 1981. The next BLS report is scheduled to be published on July 13.

Potential solutions

The authors suggested health care organizations should lay the foundation for operational excellence through at least four ways:

  • Boost productivity by using technology to cut administrative costs.
  • Optimize labor by focusing on strategies such as workforce health and well-being and flexibility. Health systems typically factor in 3% to 5% annual improvements for productivity and will need to shoot for the top end of that range.
  • Optimizing supply chains with methods such as partnerships with distributors and vendor diversification.
  • Accelerating the transition to value-based care.

For ensuring resilience, health care systems should consider forming an “inflation nerve center,” a management group that oversees transparency, analytics, performance and governance over rapid decision making.