Forecasting medical cost inflation rates: A model comparison approach

Due to healthcare costs rising faster than overall cost of living, decision makers (i.e., households, businesses, and governments) must cut back on healthcare utilization or spending elsewhere to be fiscally responsible. Accurate forecasts of future medical costs are critical for efficient planning, budgeting and operating decisions at all levels. This research compares the accuracy of the linear autoregressive moving average (ARMA) model and the nonlinear neural network model in producing forecasts of medical cost inflation rates. The analysis focuses on twelve monthly measures of medical costs including the overall medical care price index and eleven (disaggregated) subsectors of medical costs. In addition to standard symmetric measures of forecast accuracy, we utilize two asymmetric error measures designed to capture and penalize preferences for under‐ and overprediction in model selection. The findings indicate that the neural network model outperforms the univariate ARMA in both 1‐step and 12‐step ahead forecasts. A number of important practical implications are discussed, such as the use of accurate forecasts in contract negotiations, budgeting and planning.