Six percentage points. That is the gap between the proportion of GDP the U.S. spends on health care and what other rich countries spend, according to a thorough study published last year in JAMA by three researchers affiliated with the Harvard T.H. Chan School of Public Health. What’s the source of the disparity?
Based on what you hear from media and politicians, a reasonable conclusion would be prescription pharmaceuticals. Even the Trump Administration, despite its professed preference for free-market competition over to nationalized medicine, wants to limit U.S. drug prices to an index of the pricesthat foreign governments set.
In fact, however, the Six Percent Gap has almost nothing to do with medicines. According to statistics from the OECD, the organization of developed nations, the U.S. spends 2.1% of GDP on pharmaceuticals; the average of the 10 other countries studied by the Harvard researchers is 1.5%. So that’s just six-tenths of a percentage point. A big chunk of the rest of the gap can be found in hospitals. The U.S. spends 5.8% of GDP on hospital care; the average of the 10 rich countries is 4%. That’s 1.8 percentage points. The rest of gap is filled with outpatient, physician, long-term care, and other costs.
Three Studies on Unhinged Hospital Costs
Not only are hospitals the main source of the disparity between health care spending in the U.S. and everywhere else, but also hospital costs, unlike pharmaceutical costs, appear to be coming unhinged. Consider:
These recent revelations once again raise a question that politicians and the media would rather ignore: Why is the spotlight on the cost of medicines when the cost of hospital care is far greater and, by some measures, out of control?
Some Facts About Hospital Spending
For the year 2017, the latest available statistics from the Centers for Medicare and Medicaid (CMS), hospital expenditures in the United States totaled $1.143 trillion. That’s about $3,500 per American. By comparison, prescription drug spending in 2017 was $333 billion, or about $1,000 per person. More facts about the scale of hospital costs:
Hospitals Change, But Efficiency Lags
The nature of hospitals is changing, and, while you would think that the change will lead to more efficiencies and lower costs, the opposite is happening. More and more, hospitals are becoming centers of out-patient, short-term care. For example, the total number of hospital admissions in the U.S. dropped from 38.9 million in 1980 to 35.1 million in 2015 (the latest statistics from theCenters for Disease Control) even though the U.S. population rose over this period by more than 100 million. The average length of a hospital stay during these 45 years fell from 10 days to six days, and the number of beds has dropped by half since 1975. Between 2000 and 2015 alone, the rate of hospital stays for those over age 65 dropped by 25%. Roughly half of appendectomy patients are going home the day of the operation; in the 1960s, the surgery required a stay of nearly a week.
Americans do not need intense, longer-term hospital services as much as they did in the past, and a major reason is that medicines are keeping them healthy enough to avoid surgeries and long stays. Just one examples: From 2001 to 2014, the rate of atherosclerotic cardiovascular disease (ASCVD) inpatient stays among adults decreased 41.5%. (ASCVD is defined here as coronary artery disease, acute myocardial infarction, or ischemic stroke.) This period coincides with the development of important medicines to reduce cholesterol and high blood pressure and to combat other precursors of ASCVD.
Hospitals, however, remain inefficient places for administering health care. Astudy by CMS found that over the period 1990-2013, the average annual growth rate of multi-factor productivity was only 0.1% to 0.6% (depending on methodology). “Multi-factor productivity” (MFP) is the change in outputs that results from a change in labor and capital inputs. Along with population increases, it is the main factor in GDP growth. For private non-farm businesses in the U.S., the rate was 1.1%.
Even as hospital beds and stays have fallen, hospital employment has risen – from 4,662,000 in April 2009 to 5,229,000 ten years later – an increase of 12%, according to the Bureau of Labor Statistics. As The Economist magazine reported Aug. 12 issue: “America spends vastly more on administration [than Europe]: 8% of health spending versus 2.5% in Britain. As of 2013, Duke University hospital had 400 more billing clerks (1,300) than hospital beds (900).”
While hospital stays are decreasing, the cost of procedures done in the hospital is rising. Between 2005 and 2014, the average cost per hospital stay, adjusted for inflation rose a total of 12.7%, according to a 2017 H-CUP report. “The cost of a maternal (childbirth) hospital stay rose 12.8% (again, adjusted for inflation); neonatal stay, 19.2%; surgical, 16.4%; injury, 17.1%.”
Government More Problem Than Solution
What is the problem? An excellent report in December titled, “Reforming America’s Healthcare System Through Choice and Competition,” by the departments of HHS, Treasury and Labor, points to government itself as responsible for much of the problem, citing “misallocation of resources and widespread inefficiency in the healthcare system, particularly in public programs.” Says the report:
Since the government share of healthcare spending is so large, government rules impose inefficiencies on private firms dependent on public funding, even if they also serve privately funded patients. Simply put, government has played a large role in limiting the value Americans obtain for their healthcare spending. The United States is spending a large and increasing share of its national income on healthcare, and much of this spending does not lead to citizens living longer, healthier lives.
The HHS-Treasury-DoL report also pointed out that both hospitals and physician services have become more and more concentrated, with fewer players in big markets. The proportion of primary-care physicians working in a hospital or health care system rose between 2010 and 2016 from 28% to 44. Zack Cooper, a co-author of the study published in Health Affairs and an associate professor of health policy at Yale University, was quoted in Modern Healthcare as saying:
What is most worrying to me is that there has been fairly profound consolidation among hospitals and when they gain market power they have the ability to raise prices. They have the ability to gain more favorable contractual terms, which allows them to raise prices and resist the new, more sensible payment reforms.
A study published in Health Affairs in 2014 found “that an increase in the market share of hospitals with the tightest vertically integrated relationship with physicians--ownership of physician practices--was associated with higher hospital prices and spending.”
For the 10 years ending in February 2018, a study found, an average of 14 community oncology practices a month have been closed, acquired, or merged into hospitals. And a study last year found that between 2004 and 2014, the proportion of chemotherapy infusions conducted in hospitals for commercially insured patients rose from 6% to 43% -- and the cost of such treatment in a hospital as opposed to a doctor’s office for a day was more than twice as high on average.
Example of What’s Wrong: 340B
Government policy is encouraging concentration. Consider the 340B program, established more than a quarter-century ago as a way to help poor hospital patients. In order to participate in Medicaid, drug manufacturers have to provide outpatient medicines at prices discounted by 20% to 50% to hospitals that serve a disproportionate share of low-income Americans. The hospitals are then allowed to claim full reimbursement at undiscounted rates and are supposed to use this excess for charitable care.
But, as we pointed out in Issue No. 30 of this newsletter, the program is not working as promised. It has become just another subsidy to support inefficient hospitals, and it is encouraging these hospitals to swallow up other health practices, which then get to take advantage of 340B. Meanwhile, the vagueness of the law allows hospitals to ignore the obligation to help poor patients and for hospitals that serve non-poor patients to get benefits as well.
In a paper in 2014, Rena Conti of the University of Chicago and Peter Bach of Memorial Sloan-Kettering pointed out how 340B has set in motion factors that raise overall health costs:
The 340B program creates a widening disparity between noneligible and eligible hospitals and affiliated oncology practices in the profits they are able to obtain from the care of well-insured patients with cancer. This disparity is likely underlying trends toward consolidation and affiliations between community-based oncology practices and 340B-eligible hospitals.
This disparity may also lead to shifting of care out of community-based oncology practices and into hospital-based infusion suites. These trends will tend to increase total spending. Cancer care delivered in a hospital-based outpatient infusion suite is typically more expensive than that delivered in a physician’s community-based office.
Weak Attempts to Address Costs
So far, government attempts to address the hospital-cost issue have been weak. In an attempt to increase competition, HHS is now requiring hospitals to disclose their prices. But the information that hospitals are providing is largely indecipherable. Take a look at this “Chargemaster” Excel spreadsheet provided by a hospital chosen at random, Methodist LeBonheur Healthcare of Memphis. What do you suppose “FNA BX W/CT GDN 1ST LES” means? It costs $1,604. In addition, these prices are meaningless to the 91% of Americans with health insurance. They want to know what they have to pay.
If, however, you want to get an idea of the total cost – to insurers and individuals – of major procedures, there are resources. The average cost of a hospital stay for pneumonia, for example, is $10,000; for the fracture of a lower limb, $17,000; for a heart valve disorder, $42,000. A liver transplant averages $813,000; kidney transplant, $415,000. An MRI averages $1,119 in the U.S. and $503 in Switzerland; an appendix removal is $15,930 in the U.S. and $2,003 in Spain; and a C-Section is $16,106 in the U.S. and $7,901 in Australia.
Why aren’t these figures more daunting to individuals and politicians? A big reason is the structure of insurance policies, both government and private. While hospital spending is more than three times pharmaceutical spending overall in the United States, individual Americans pay out of their own pockets$47 billion a year for pharmaceuticals compared with $34 billion for hospital services – or 38% more.
Let’s put the issue as simply as possible. In one sector of health care – hospitals – costs are rising at more than 4% annually, mainly because prices are rising. In another sector of health care – pharmaceuticals – costs are flat, and prices are flat. Hospitals represent about one-third of total health care costs; prescription pharmaceuticals, about one-tenth. If the aim is to constrain costs, where would any sensible public policy effort concentrate?
Three months ago, Alex Azar, the HHS Secretary, explained, in his typically blunt fashion, why the Trump Administration wanted to end the “hidden system of kickbacks to middlemen.” Azar was referring to payments extracted from drug manufacturers by powerful pharmacy benefit managers (or PBMs), companies that determine the medicines that patients can access under their insurance plans.
Azar left little doubt why change was necessary. “Every day,” he said, “Americans, particularly our seniors, pay more than they need to for their prescription drugs.” By ending “this era of backdoor deals,” he continued, President Trump will “deliver savings directly to patients when they walk into the pharmacy.”
In short, the President wants to lift the burden of drug costs for patients. He is not out to cut federal spending or transfer wealth from one industry to another. He wants people who are sick to save some money and improve their health. That has been the Administration’s intention from the start, and it has achieved notable – though often unnoticed -- success.
The Food & Drug Administration took the first big step by easing approval of generic medicines to increase competition and drive down prices. The Bureau of Labor Statistics reports that the pharmaceutical price index is down 0.4% for the year ending March 31, compared with a 1.9% increase in U.S. prices overall. Converting drug rebates to consumer discounts is the Administration’s second big step. We explored the measure at length in No. 43 of this newsletter, but, the rebate proposal is so important that developments in the past two weeks prompted this update.
CBO Issues Report on Budget Impact
On Feb. 6, the Department of Health and Human Services published a proposed rule in the Federal Register that seeks to replace rebates to PBMs, insurers and health plans with discounts to patients at the point of purchase, perhaps as soon as next year. The rule, which would end a safe harbor for rebates that would otherwise have violated the 1972 federal Anti-Kickback Statute, applies only to Part D of Medicare and to managed care organizations (MCOs) that participate in Medicaid, but the anticipated change is alreadyaffecting some commercial insurance plans.
The Congressional Budget Office (CBO) last week issued a seven-page report on the possible effect of the rule on the federal budget. CBO estimated that spending for Medicare and Medicaid would rise by a total of $177 billion between 2020 and 2029. That looks like a large number, but put it in perspective. Total Medicare and Medicaid spending over the 10-year period is projected at $17.1 trillion, so the increase would be about 1%, or about $50 per year for every American. More important, the CBO report was based on necessarily shaky assumptions. Change the assumptions, and you get much different results – including, as one respected research firm found, governmentsavings.
What is not disputed is that Medicare beneficiaries will be winners – which was, after all, the very purpose of the change. Not only will consumers pay less at the pharmacy but they will be more likely to fill their prescriptions and “better adhere to their prescribed drug regimens if their costs were lower, as they would be under the proposed rule.”
More Medicine Utilization Means More Savings
on Hospital and Physician Care
Greater utilization is a cost to the government that CBO estimates at about $10 billion. But, says the CBO, “the increase in the number of beneficiaries following their drug regimens would also reduce spending for services covered under Parts A and B of Medicare, such as hospital and physician care, by an estimated $20 billion over that period.”
As obvious as this statement may be, it is a remarkable one for a government budget agency to make: Spending more on drugs means spending less on health care overall because drugs make people well, so they don’t have to use hospitals and doctors as much. The CBO even published a monograph on this subject in 2012 titled, “Offsetting Effects of Prescription Drug Use on Medicare’s Spending for Medical Services.”
For example, Hepatitis C (HPC) kills more Americans than any other infectious disease. Before the advent in 2014 of the first drug that cures HPC, a significant proportion of patients with the disease ended up saving their lives only through a liver transplant, at an average cost of $813,000. That expense – not to mention pain and suffering caused by the disease itself – can be avoided now with a three-month course of a medicine at a total cost to all payers of less than one-tenth the price of a transplant.
Very simply, lower out-of-pocket drug costs (as the new rebate rule will produce) will lead to more people taking the medicines they need, in turn making them healthier.
Milliman Finds Very Different Result
Still, despite this saving, the CBO finds that net $177 billion loss to the Treasury over five years. But CBO also admits in its report that other organizations have come up with different results.
The consulting firm Milliman engaged in a thorough study for HHS earlier this year that looked at seven possible scenarios, each distinguished by different behavioral changes. Milliman found that in four of the scenarios, the government actually saved money – as much as $100 billion in one case. In three scenarios, the net increase in government spending ranged from $18 billion to $139 billion. In another study, the Office of the Actuary of the Centers for Medicare and Medicaid Services (CMS) estimated that cost to the government will total $196 billion.
The CMS study, which was released in August 2018, projected that the out-of-pocket savings to consumers would total $93 billion and be offset by premium increases of $50 billion.
Those anticipated premium increases, as Wayne Weingarten of the Pacific Research Institute wrote in Forbes, are evidence “that the patients who require expensive medicines have been subsidizing the premiums for all other patients. Such a financial arrangement violates the fundamental premise of health insurance.” It does, but the arrangement, unfortunately, is at the heart of our upside-down system of reimbursement for medicine costs. Ending the current rebate system will help patients who are carrying the heaviest burden today because list prices for drugs, on which co-payments are based, will decline.
And put those potential Part D increases in context. For 2019, the average Part D premium is $32.50 a month, down from $33.59 in 2018. HHS forecasts that, after rebate reform, premiums will rise between $2.70 and $5.64 a month – well below the average out-of-pocket savings and a special boon to seniors who rely on more advanced medicines.
How Will Behavior Change?
More dubious was CMS’s forecast that pharmaceutical manufacturers would not turn all of the current rebate money into discounts. Instead, the manufacturers “would withhold about 15 percent…and would negotiate discounts approximately equal to the remaining 85 percent.” CBO concluded that this estimate was “reasonable and adopted it.”
But why is it reasonable? Using economic common sense, we would expect that the future net price (where rebates are replaced by discounts) should be approximately the same as the current net price (that is, under the rebate regime). The current net price is the result of hard bargaining between drug manufacturers and PBMs; it’s doubtful that the bargaining would be much different under an all-discount regime.
In fact, in one of its scenarios, Milliman makes the assumption that PBMs will respond to being deprived of rebates by tightening their formulary controls and even forcing manufacturers to make additional price concessions, “which could be even greater than the equivalent rebate arrangements today.”
CBO neglects to point out that this trend – the increased administrative burden and restricted access for patients and the increased cost-sharing – has been growing in recent years and can be expected to continue. The Milliman scenario that reflects this narrative, which the researchers call “Increased Formulary Controls and Increased Price Concessions” and which produces the $100 million in savings for the U.S. Treasury, may be the most plausible of all.
And let’s not forget one of the major aims of the reform: increasing transparency. Today, rebates are a closely secret, but imagine what will happen with reform. The largest concessions a manufacturer makes to a plan will suddenly become known to all the other plans, putting downward pressure on prices. This is another reason that post-rebate reform price concessions could be greater than they are today.
Making projections on the effect of ending rebates on government spending means guessing the behavior of some huge players: consumers, PBMs, insurers, pharmacies, and drug manufacturers. CBO and CMS do not have a great track record in this regard. When Medicare Part D was enacted, CBO projected that the average premium in 2013 would be about $60. In fact, it was $31.17.
Eyes on the Prize
The precise dollar effect of the reform may be a mystery, but the value to senior Americans is not. A year ago, HHS issued a blueprint called, “American Patients First.” Its aim was clear: “bringing down the high price of drugs and reducing out-of-pocket costs for the American consumer.”
Under the current, almost absurdly complex system for pricing drugs and reimbursing their costs, rebates play an outsized and pernicious role. They are opaque, they provide a perverse incentive to increase list prices, and they harm patients by boosting what they have to pay out of their pockets. Ending rebates addresses all of those deficiencies at what is at worst a low cost to the Treasury – and what may be no cost at all, or even a small profit.
The CBO study, in fact, can be seen as a form of indirection. It’s critical to keep our eyes on the prize. The goal is constraining costs to consumers and improving their health. This, undoubtedly, rebate reform will do.
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