United Kingdom medical inflation for 2019 is estimated at an average of 6%, having averaged around 7% over 2018. Medical inflation is generally several percentage points higher than retail price inflation (RPI).

Medical inflation generally refers to the annual increase in the cost of medical treatment per insured life. It encompasses both changes in the average cost of treatment for the same basket of services and changes in the frequency of seeking treatment for a steady-state portfolio. It is impacted by anything that will change the cost per insured life for the same services, ranging from technological medical advances to shifts in costs and from social and national healthcare systems to private insurance payers. A change in the mix of services will impact the relative weights that each service contributes to the "basket' of goods (similarly to a calculation of RPI). Using risk adjustment as a true measure of inflation, the effects of a change in the mix of lives in a portfolio would be stripped out, although most cited measures do not remove this element and instead quote inflation inclusive of mix changes.

Continuing from our first blog, which focussed on the potential impact of Brexit on PMI market size, in this blog we examine factors that will impact the average cost of treatments through the supply of medical professionals, cost of drugs, changes in general inflation and the economic health of the UK.

The figure below summarises how the topics we cover impact medical inflation.

Restricted access to medical staff within PMI facilities

Brexit news headlines highlight potential shortages
in specialist medical staff, such as nurses and doctors, due to migration back
to Europe following Brexit. This is generally discussed from the viewpoint of
the National Health Service (NHS). However, the impact could extend to private
medical providers too.

If trained staff leave the UK, not only do healthcare providers face lower levels of staffing but they may also incur costs in retraining new staff. The impact on insurers may vary depending on the proportion of staff from European countries. Overall 12.7% of NHS staff have a non-British nationality, with 5.6% being EU nationals. Information on whether this is replicated in private hospitals is not readily available. Nonetheless, any costs of replacing trained staff in private hospitals will likely trickle through to costs of services and increase medical inflation.

Longer NHS waiting times due to lower NHS staffing levels could lead to an increase in demand for private medical insurance (PMI) policies, as people seek faster access to treatments. This could impact medical inflation for insurers as it would increase the frequency of healthcare services accessed from existing policyholders through the PMI industry. For example, fewer people may opt for NHS cash benefits and use their PMI cover instead of accessing care through the NHS.

The Royal College of Nursing has reported a 91% reduction in EU nurses joining the Nursing and Midwifery Council register since 2016, though this is believed to be partly offset by a rise in non-EU joiners. Given the offset, future staffing levels could be equalised with similarly qualified personnel from either the UK or other countries. This will help to limit the impact on medical inflation, as supply may not reduce severely. However, there will be less free movement and the effects will depend on the future immigration system, both within Europe and internationally. For example, salary thresholds and increased costs from immigration processes may be a factor to consider, as higher spend on recruitment will need to be reflected in the cost of services.

Increased cost of drugs

Pharmaceutical companies also face uncertainties. The European Medicines Agency (EMA), the Europe-wide medicinal products watchdog, moved from London to Amsterdam in January this year. This move may indicate a future need for companies to duplicate product testing which may be associated with additional regulatory requirements. The overall impact of this will depend on how integrated the UK and the EU remain within this industry. If the UK decides to create its own version of the EMA, there may be further costs associated with this initially, though future requirements may be curbed based on the structure and regulatory requirements.

Until there is more certainty, the
additional costs to pharmaceutical companies are unclear, but zero costs are unlikely.
Costs could even occur from additional import taxes, or other expenses that are
currently inapplicable to the UK in this industry. Increases in the cost base
for pharmaceuticals could mean increased costs of new and current drugs going
forward, causing additional medical cost growth and a rise in medical inflation.

Changes in regular inflation measures

As of now, inflation has not spiked and we are not in a recession. In fact, so far in 2019 the consumer price index (CPI) is at its lowest point in the last two years. If the CPI were to rise, this would likely further put upwards pressure on medical inflation. This would also incorporate potential negative impacts to inflation from unfavourable exchange rate movements between the pound and euro. The resulting increase in costs of goods imported to the UK would raise general inflation rates as necessity goods become more expensive.

Impact of a recession

There is a lot of speculation of a
potential recession and the shrinking of the UK market driven by changes due to
Brexit, both of which would impact medical inflation rates within the UK.

A recession is linked to knock-on effects such as higher inflation, lower disposable income and higher levels of unemployment. A study into the impact of the 2008 recession on the US economy found that a '1 percentage point increase in the unemployment rate was linked to an increase in reports of poor health by between 7.8 and 8.8 percent.'

A recession may lead to higher stress levels and a deterioration in lifestyle behaviours. This could result in PMI policyholders requiring a greater number of treatments than they currently do, which would in turn result in a rise in medical inflation. The affordability of PMI coverage could be compromised, which may cause a reduction in portfolio sizes. Further, there may be a short-term increase in utilisation from those who fear losing their PMI benefits. Insurers' overheads will be forced to be distributed over a smaller base from a reduction in portfolio size, which will result in higher medical inflation.

Conclusion

Increased costs of services due to expenditure on recruiting, retaining or replacing staff could increase the cost-base for insurers, as could costs related to changes taking place within the pharmaceutical industry. Though much of this is uncertain and so does not have an immediate direct impact, uncertainty itself could lead to insurers holding additional margins for potential adverse experience, for example to reflect potential increases in expenses or in claims from anti-selection or selective lapsing.

We are not yet in a recession or facing
high CPI levels. However, the potential impact of both can be significant and consumers'
reactions may be exaggerated in anticipation of these events.

There are currently no extreme movements in
the economy or in 2019 medical inflation estimates for the UK, as we remain in
limbo. This may all change depending on the final outcomes of Brexit and the
resulting change in direction of cost and utilisation of services and the
general economic environment. For example, a no-deal Brexit will most likely
lead to a devaluation in the value of the pound and to higher inflation"however,
if an agreement is sustained, the impact to the pound may be smaller, or exchange
rates may move in a completely different direction.
In our next blog we turn towards the impact of potential
changes in regulation following Brexit for the PMI industry.