Issue No. 27: Making Sense of Health Spending

The health-care spending data being released lately can make your head swim. Let’s try to make some sense of it – and then turn to a refreshing new report from the President’s Council of Economic Advisers.

In Newsletter No. 24, we reported on National Health Expenditure [NHE] figures for 2016, according to actuaries of the Centers for Medicare and Medicaid Services. Overall health costs rose 4.3%, the smallest increase since 2013, and pharmaceutical costs rose only 1.3%.
 
Then, in Newsletter No. 26, we reported on data gleaned by Express Scripts, the largest pharmaceutical benefit manager (PBM), which found that in 2017, drug spending for its private clients rose only 1.5% -- the smallest increase since the company became gathering records in 1993. The rise was consistent with data previously reported by another large PBM, Prime Therapeutics, which found that in the first half of 2017, spending increased at 0.8% compared with the same period the year before.
 
We also noted in that newsletter that the Health Care Cost Institute (HCCI) reported an increase in total health expenditures for 2016 of 4.6%, about the same as the CMS report. But HCCI found that pharmaceutical spending was up 5.1%, compared with 1.3%, according to CMS. The difference could mainly be explained by the fact that CMS was looking at costs net of discounts and rebates while HCCI looked at gross costs.
 
A New Report Projects Spending Through 2026
 
With us so far?
 
Now, we have a new report on National Health Expenditures (NHE) from CMS, issued on Feb. 14, and summarized in a Health Affairs article by Gigi Cuckler and seven other officials of CMS.
 
This report consists not of hard data but of forecasts through 2026. For 2017, CMS believes that the increase in NHE was 4.6%, just a few ticks above the 4.3% in 2016. Also for 2017, CMS estimates that pharmaceutical expenditures (net of rebates, etc) will increase by 2.9% -- higher than what the PBMs indicated but still a small increase and well below overall NHE.
 
But in 2018 and the years after, CMS expects major increases in pharmaceutical spending – 6.6% in 2018 and about the same annually through 2026. These are only guesses, but they are disturbing on their face and require some explanation.
 
First, prescription-drug expenses are forecast to rise 6.3% annually, on average, from 2017 to 2026; overall, NHE is projected to rise 5.4% -- less than a percentage point difference. Second, forecasting drug costs is a difficult proposition. CMS proved that a year ago when it predicted that drug spending in 2016 (which had ended a month before) would rise 5%. Spending actually rose just 1.3%.
 
Consider the factors that boost drug spending. Begin with prices of the vast majority of medicines, both generics and branded drugs. The trend for these medicines is flat to down, as the PBM data show clearly. Next, look at utilization. Americans are using more medicines every year. That’s a good thing since taking prescription drugs prevents patients from getting sicker and moving into the more costly parts of the health-care system: physician visits and hospitals. Next, examine which branded drugs are losing their patent protection. Medicines are unique in health care because their prices go down over time as more competitors enter the market and benefits continue in perpetuity, but, as it happens, the dollar-value of branded drugs whose patents expire in 2018 will be lower than in years past; hence, that estimated 6.6% increase in costs.
 
Now the story grows more complicated. To a great extent, the CMS projections of higher drug-cost growth is the result of forecasts that new drugs – especially more costly and more powerful specialty drugs, such as cancer immunotherapy treatments – will enter the market. In other words, increased spending reflects not so much drug-price inflation as innovation, so apples are not being compared to other apples.
 
One way to reduce drug spending growth would be to pass a law banning pharmaceutical research. No new immunotherapy drugs to fight cancer would mean no increase in costs from innovative drugs entering the market.
 
In fact, we are living in a golden age of medicines. Already this year, the Food & Drug Administration has approved Erleada, to treat prostate cancer; Symdeko, for cystic fibrosis; Biktarvy, to treat HIV infections; and Lutathera, for cancerous tumors of the pancreas or the gastrointenstinal tract. When a new drug comes on the market to treat a disease that has been effectively treated before, then, by definition, drug costs will rise. But lives will be prolonged or saved. Without weighing the benefits, citing costs is meaningless.
 
Some Perspective on All Those Numbers
 
Despite the deficiencies of huge, aggregate numbers, the NHE projections do allow us to put health-care costs into perspective. For example….
 

• The cost of hospital care for 2018 is estimated at $1.2 billion; the cost of physician and clinical services, $734 million; the cost of prescription drugs, $360 billion.
• Between 2017 and 2022, the mere increase in hospital spending will be greater than the entire amount spent on prescription drugs last year.
• Despite the big numbers being bandied about, CMS projects that per-capita drug expenses that Americans pay out of their own pockets will rise from $137 year in 2017 to $166 in 2022 to $207 in 2026. That’s an increase of less than $10 annually.

 
Where the Money Is: Hospitals
 
Hospitals are where the money is. Hospital spending is more than three times drug spending, but unlike medicines – whose use increases every year, mainly through innovation – hospitals are on the decline. A special section in the Wall Street Journal on Feb. 26 points out, “Traditional hospital care is too costly and inefficient for many medical issues.” The number of community hospitals has fallen from nearly 6,000 in 1980 to fewer than 5,000 today despite an increase of 100 million in the U.S. population. Hospital stays have been dropping since 2007.
 
A provocative article in the New England Journal of Medicine’s Catalyst in December was headlined, “Do Hospitals Still Make Sense?” It notes that inefficiency is built into the system:
 
In the not-too-distant future, health delivery systems will, and should be, paid for keeping people healthy and out of the hospital rather than for procedures and admissions. The economic framework of health care will be turned upside down, with profit being directed toward maintaining the health of populations rather than toward just thwarting illness.
 
It is unlikely, however, that this glorious day will arrive through the leadership of existing mega-hospitals. As the authors – Jennifer Wiler, Nir Harish, and Richard Zane – write,
 
It is challenging, if not impossible, for most large hospitals, with their high fixed costs, to morph into nimble, low-cost businesses. The delivery models that will succeed are those that do not simply extend the reach of the hospital but begin to entirely replace the hospital as we know it.
 
This is the real cost challenge: disrupting the incumbent system that accounts for one-third of NHE. The impact will be far greater than playing around at the edges, focusing, as so many politicians do, on the category that accounts for one-tenth of NHE – which also happens to be the category where huge innovation is occurring.
 
The CEA’s Refreshing Report
 
The Council of Economic Advisers recently weighed in on the issue of drug pricing, with a 29-page report. One of the CEA’s three members is Tomas Philipson, a leading health economist from the University of Chicago, and, while the report is not perfect, it reveals Philipson’s depth of knowledge and free-market orientation.
 
This report is valuable not so much for its recommendations (though many are excellent) but for its approach to a complex issue. It is refreshing to read a sentence like this in a government report: “It is misleading…to consider only the prices of these new drugs without evaluating the well-being of patients before the drug became available.”
 
The report uses the example of a patient diagnosed with HIV in the early 1990s. “Before new breakthrough therapies for HIV emerged, the price of a longer life was prohibitively high because a longer life could not be bought at any price anywhere in the world.” In fact, the price could be called infinite. But once HIV drugs were developed and marketed in 1996, “the price of a longer and healthier life for HIV-positive individuals decreased dramatically: it reached the equivalent of the price of the new, patented drugs.”
 
Competition then drove down the price further. The report concludes, “The example of innovative HIV drugs makes the essential point that even though the price of the drug was considerable and drug spending rose, the effective price of better health declined.”
 
How to lower the effective price of health care further? By “preserving incentives to innovate.”
 
The report notes that “the fixed costs of developing and bringing a drug to market are typically large…[and] the incentive to innovate is driven by whether expected profits exceed those high fixed R&D costs,” which are about $2.6 billion per new prescription drug approval “inclusive of failures and capital costs,” according to the Tufts Center for the Study of Drug Development. And “government policies have a major influence on the size of these fixed costs.”
 
The report notes that the FDA has put in place programs to speed up the entry of therapeutic drugs, but “there is still room for improvement – the average time of development and entry of new drugs of more than a decade is too long.”
 
The report also zeroes in on “biosimilars,” which, according to the FDA, are “highly similar to and [have] no clinicially meaningful differences from” existing branded biological products. Those biological products are large-molecule drugs that treat difficult illnesses such as cancer and auto-immune disease. Says the CEA report:
 
Lack of competition for biologics, including those with expired patents and data exclusivity periods, is one potential reason prices remain high. Eighteen of the top 30 selling biologics were first licensed in 2004 or earlier, suggesting that prices have remained high despite relevant patent expirations.
 
CEA says that one problem is that the FDA has not finalized guidelines for demonstrating biosimilar interchangeability yet. “Speeding up the issuance of final guidelines could add certainty and attract additional biosimilar applicants.” In addition, economics incentives such as buy and bill will continue to promote use of more expensive originator biologics compared to biosimilars.
 
High Prices ‘Result From Government Policies’
 
The report concludes that “many artificially high prices result from government policies,” and the CEA recommends not just changes to drug approvals but changes to Medicaid and Medicare – for example, giving Part D beneficiaries access to negotiated discounts at the pharmacy counter.
 
The report also advocates reducing Part B reimbursement for hospitals under the 340B drug rebate program, which has been distorted beyond its original purposes. The CEA proposes that some savings go to the Treasury and other savings to hospitals based on their uncompensated care. (The report devotes extensive coverage to 340B, which cries out for reform, as we noted in ourNewsletter No. 14.)

We will have more on 340B in an upcoming letter.