Issue No. 17: Debunking the Mythology of Drug Costs

On a morning in late June, Chris Cuomo was hectoring Sen. Dick Durbin (D-Ill) on CNN’s “New Day” for not doing enough to rein in drug costs. “Senator,” said the TV host, “drug prices are statistically the biggest reason that prices go up.” 

Cuomo added, “Look, it's sticking out there as this big, ugly number. It's like 70%. You'll see estimates, that that's how much drug prices are going to go up. [You’re] fighting on all of these other fronts but ignoring the biggest number.” Cuomo concluded, plaintively, “It’s hard to get the people behind you when you don't go after the biggest, you know, the biggest factor in the room.”

Chris Cuomo’s ignorance of the facts about health-care spending is appalling, and he’s hardly alone. Politicians and media figures have been criticizing drug costs for years without showing evidence that they understand the data. The mythology is that powerful.

Just for starters, the “biggest factor in the room” is not prescription drugs but hospital care, which, according to the Centers for Disease Control accounts for three times as much spending. In fact, drugs don’t even rank second. That honor goes to a category termed “physician and clinical services,” with spending double that of drugs. 

As for rising costs: pharmaceuticals rank far down the list. For the year 2016, according to the Center for Sustainable Health Spending of the Altarum Institute, here are the increases:

In other words, spending on drugs rose just five-tenths of a percentage point faster than GDP while hospital spending rose nearly two points faster.

“Pharmaceuticals accounted for only 11% of the rise in health care costs in 2016,” according to Michael Mandel, chief economic strategist at the Progressive Policy Institute and former chief economist at Business Week. 

And Cuomo says that drugs are “the biggest reason that prices go up”? Hardly.

Not only are drug costs a minor part of the overall health-cost picture, but also the growth of spending on prescription medicines has been slowing.

A recent report from the QintilesIMS Institute projects that “moderating price increases for branded products, and the larger impact of patent expires, will drive net growth in total U.S. [drug] spending of 2-5 percent through 2021.” That 2% to 5% is a far cry from Chris Cuomo’s 70%. 

How to Explain the Paradox

So how do we explain the paradox? Drug costs aren’t out of control, yet so many people seem to think they are.

For the answer, we have to distinguish among types of drugs and gain a better understanding of how health insurance works….

For the vast majority of prescriptions that Americans fill, prices are not rising. In fact, they are falling. Look at the 2016 Drug Trend Report, issued by Express Scripts, the largest of the pharmaceutical benefit managers with 83 million members. 

Express Scripts divides prescription medicines into two categories – traditional and specialty. For traditional drugs – for instance, statins for lowering cholesterol, amphetamines for attention disorders, diabetes medicines like Lantus and Januvia – average unit costs actually declined, down 2.3% from 2015 to 2016. For specialty drugs – anti-inflammatory medicines like Humira and Enbrel, cancer drugs, and new medicines like Harvoni, that cure Hepatitis C – average unit costs rose at a much faster rate: 6.2% These specialty drugs are also being used more by patients, and total spending on them increased 13.3%, compared with a spending decline of 1% for traditional drugs, including increased use. (The fact that more people are using these drugs is, by the way, a good thing: It means that lives are being saved and lengthened. Before Harvoni, for instance, there was no effective cure for Hepatitis C, a disease that often led to liver cancer or a transplant or death.)

The spending experience of Express Scripts is reflected in the data of the other large PBMs.

As for patients themselves, the QuintilesIMS study found that only 2.3% of all prescriptions required payments by patients of more than $50, and the average amount paid for any prescription in 2016 was just $8.47, down from $9.66 in 2013. 

As Carolyn Johnson wrote May 5 in the Washington Post:

There’s widespread outrage about soaring drug prices, but a new report shows that people are, on average, actually paying less for their medications than they did a few years ago.

Johnson also pointed to a Peterson-Kaiser Health System Tracker report last year, which “found a slight decline in personal spending on prescriptions” between 2013 and 2014 (the latest year in the study). In fact, overall out-of-pocket payments by enrollees in health plans rose only from $142 to $144 over a decade.

Out-of-Pocket: 15% for Drugs, But Just 3% for Hospitals

But these numbers must be read in context. On average, out-of-pocket spending as a proportion of total drug costs is very high compared to other parts of the health-care system: 15%, compared with just 3% for hospital costs, according to the Centers for Disease Control.

Those are average figures. Out-of-pocket costs, in real life, are far more of a burden for Americans who need specialty, as opposed to traditional, medicines. If that sounds crazy, blame the structure of insurance policies.

For Traditional Drugs, Competition Puts a Lid on Prices

A major reason overall costs have been held down is competition – especially because of greater use of generic drugs. A report by the U.S. Department of Health and Human Services last year noted that in 2014, prices fell for 65% of the generic drugs prescribed to Medicaid patients. Also last year, an IMS studyfound that the price of generic medicines dropped 79% on average within 12 months of entering the market for the period 2011-13 but only 44% for the period 2002-04. 

• Since 88% of all drugs are generics and since insured patients have a zero co-pay for about one-third of those generics, the system seems to be working well for the most part. But it can work better. The new FDA Commissioner, Scott Gottlieb, wants to speed the approval process to allow more generics to reach the market quickly, thus increasing competition and lowering costs.

Said Dr. Gottlieb on CNBC on June 28:

We don't play a role in drug pricing, but we do affect drug competition in terms of getting new drugs on to the market, and create competition to older drugs, particularly with generic drugs.

Specialty drugs, however, are another story. When patients are prescribed one of these innovative medicines, they often have to pay a great deal out of their own pockets.

A System of Tiers

Insurers, through their PBMs, apply different benefits to different tiers. For example, they might pick up the entire tab for drugs in the generic tier and provide more support for preferred brand-name drugs in a slightly higher tier. As the tiers rise, patients usually share more of the burden in coinsurance or copayments.

Specialty drugs are on high tiers, so patients have to pay more for them, and the spread between low and high tiers is widening. As Adam J. Fein explains inDrug Channels: “In 2016, copayments on the fourth tier [were] 9.3x more expensive than those on the first tier, compared with 5.9x in 2004.” The result is that even if you have a good commercial insurance policy with your employer, you “would pay about $1,000 for a specialty prescription of about $3,500.” 

Yes, many of these policies limit out of pocket maximum-dollar payments, Fein points out, but, he writes, “one in five workers is in a plan with no out-of-pocket maximum for fourth-tier and specialty drugs.” And look at Medicare Part D, which, with its “doughnut hole,” has no limit on out-of-pocket spending after a patient reaches $8,017. 

Writes Fein in his June 1 letter:

These benefit designs essentially discriminate against the very few patients undergoing intensive therapies for such chronic, complex illnesses as cancer, rheumatoid arthritis, multiple sclerosis, and HIV.

What kind of insurance is this, anyway? Insured patients pay zero for generic statin drugs that they have been taking for years but face out-of-pocket payments of tens of thousands of dollars a year for a cancer drug after getting a shocking diagnosis out of the blue. 

Health Insurers Have It Exactly Backwards

No wonder politicians are hearing from constituents, and no wonder Chris Cuomo is confused. Health insurers have it exactly backwards, and average Americans are suffering as a result. Insurance is supposed to protect you from the unexpected, from crushing expenses that a household budget can’t manage. Instead, in the United States, health insurance is structured to pay a large proportion of small expenditures while often leaving patients to fend for themselves – or to get help from a charitable foundation – to pay for the big, devastating costs.

Despite these backward policies, some advocates want public policy to exacerbate the situation. Steven Brill, for example, wrote recently in the Washington Post that the Affordable Care Act should be changed to allow insurers to raise the ratio of rates between older and younger Americans from 3-1 to 5-1, to give older Americans greater government subsidies to pay for part of that increase, and to slap “controls on the price of prescription drugs” to pay for the subsidies. Price controls in the U.S. would have the same effect as in Europe and Canada: limiting the access of seniors to the most effective medicines.

Finding ways to reduce health-care costs is a great idea – but only if we look at the facts squarely and recognize where the problems really lie.

The Four Myths

Now, let’s review the myths:

Spending on medicines is out of control.
False. Spending is currently rising between 4% and 5% a year, a rate that is projected to moderate through 2021. Last year’s increase in drug expenditures was lower than the increase in hospital and physician costs..

Prescription drugs are “the biggest factor in the room.”
False. As of April, annual spending on prescription drugs was $355 billion, compared with $1,121 billion for hospitals and $706 billion for physicians and clinical expenses. 

Drug prices are crushing most Americans.
False. Most Americans are not being crushed, but all Americans recognized that they could be if they get sick. Average out-of-pocket cost of a prescription is less than $10 – and dropping. Some 88% of prescriptions are for generics. But insurance policies force patients to pay a big chunk of the cost of specialty drugs for such diseases as cancer.

Drug companies are at fault for Americans going broke paying for specialty drugs.
False. The problem is not the price of these drugs, but the way insurance policies are structured. Insurers pay a higher proportion of the cost of old-line generics than they pay for complex specialty medicines. This is the opposite of how insurance is supposed to work.

This is not to say that policy makers should sit on their hands. The best ways to modulate prices are to increase competition among drug manufacturers – as Dr. Gottlieb wants to do – and to pressure insurers to act as real insurers rather than pre-paid plans for already low-priced drugs. 

Finally, policy makers should focus on the big-ticket parts of the health-care system – in-patient and out-patient care – rather than on the part that has accounted for just 11% of the spending rise last year.