To Adjust or Not to Adjust: Health Care Cost Growth Target States’ Responses to Inflation  

Focus Area:
Sustainable Health Care Costs
Peterson-Milbank Program for Sustainable Health Care Costs
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The eight states with health care cost growth target programs each set annual targets for cost growth in consultation with their health industry stakeholders. When setting these cost growth target values, most states have leveraged the Potential Gross State Product (PGSP), a forecasted measure of growth in the economy, and/or projected or historical median household income growth as reference points. The idea is that health care spending should not grow faster than other economic sectors nor faster than resident income, acknowledging that for many health care is already unaffordable.  

States set their cost growth target values prospectively to influence payer and provider behavior to constrain spending growth. However, relying on long-term projections or historical averages that assume relative stability in economic indicators over time doesn’t account for unforeseen circumstances, such as the spike in general inflation that occurred between 2021 and 2023.  

Inflation and Health Care Spending 

One component of PGSP is a type of inflation referred to as Personal Consumption Expenditures, or PCE. The Federal Reserve Bank targets 2% as a healthy annual rate of growth in PCE. In 2021, PCE inflation began to accelerate from below 2%, peaking at 7% in 2022 before moderating to back under 3% in late 2023, per the Bureau of Economic Analysis.  

Research has shown that general inflation is highly predictive of growth in health care spending. However, the impact of inflation on health care spending lags by approximately two years because prices for health care services are set prospectively. Further, public payers rarely change their prices, including in response to changes in input costs, such as labor and supplies. Additionally, commercial payer prices are typically established via multi-year contracts that are not renegotiated during the contract period to account for inflation or other unexpected changes. 

As a result, increases in general inflation experienced in 2021-2023 will most notably impact health care spending, and thus health care cost growth target programs, for the years 2023-2025.  

To Adjust or Not to Adjust 

Over the last few years, health care cost growth target states had to make difficult decisions about whether and how the dramatic increase in inflation should impact existing cost growth target values and/or the process and methodology for setting new cost growth target values.  

The principal rationale for accounting for inflation spikes when setting or adjusting a cost growth target is to acknowledge the impact of inflation on provider input costs, and remove payer and provider accountability for price increases in response to a macroeconomic event. This recognition might help maintain the credibility of the cost growth target, increasing the likelihood that payers and providers will consider the target in future decisions that impact health care spending.  

Yet, adjusting the target value could sanction increased spending growth at a time when consumers most need protection as inflation also outpaced increases in wages. In addition, adjusting an existing target value could set a precedent that targets can be modified on an ad hoc basis, making the cost growth target less predictable and, for that reason, potentially less effective. 

Faced with these considerations, most states with health care cost growth targets have thus far opted not to adjust their target values in response to high inflation. However, two states did make adjustments: Rhode Island and Connecticut.  

Rhode Island’s Approach 

For the first several years of Rhode Island’s cost growth target program (2019-2022), the target value was set at 3.2%, in line with the state’s PGSP. Rhode Island had to set new target values for 2023-2027 during the summer of 2022, when general inflation was reaching its peak.  

Rhode Island decided to make several changes to its approach. First, the state moved to factor in income growth when calculating target values, deciding on a 75%/25% blend of PGSP and forecasted median household income growth. However, due to the unusually high general inflation between 2021-2023 and the lag in inflation’s impact on health care spending, Rhode Island replaced the long-term PCE component of PGSP with:  

  • actual 2021 PCE for calculation of the 2023 target,  
  • forecasted 2022 inflation for calculation of the 2024 target, and  
  • forecasted 2023 inflation for calculation of the 2025 target. 

This approach produced target values for 2023, 2024, and 2025 of 6.0%, 5.1%, and 3.6%, respectively, before dropping to 3.3% in 2026 and 2027 when the methodology returns to using the long-term PCE forecast.  

Connecticut’s Approach 

Connecticut’s initial cost growth target values were set for 2021-2025. The methodology employed in Connecticut involved a 20%/80% blend of PGSP and forecasted median household income growth, producing a base target value of 2.9%. 

Due to the spike in general inflation peaking in 2022 (and the observed approximately two-year lag in general inflation affecting health care spending), Connecticut made the decision in early 2024 to adjust its existing 2024 cost growth target value. The adjustment replaced the long-term PCE component of PGSP with actual PCE inflation observed for 2022, similar to the approach taken in Rhode Island. However, Connecticut also updated the forecasted median household income growth value used in its calculation to reflect the latest projection for 2023-2024. Together, these changes resulted in an adjusted 2024 cost growth target value of 4%.  

Looking Ahead 

While the inflation spike has since moderated, cost growth target states may have to contend yet again with unanticipated macroeconomic changes in future years. The political and methodological considerations weighed by all of the cost growth target states, and the different decisions they have made, may prove instructive when states evaluate whether and how to account for inflation rate changes in the future.