Issue No. 67: Memo to New Administration: Heed KFF Report That Says Drugs Not ‘Primary Culprits’ in Health Costs

Joe Biden promised during the campaign to “protect and build on the Affordable Care Act,” signed into law 11 years ago. He said he would expand access and make health care less expensive and, using the rhetoric that politicians of both parties seem unable to resist, vowed to “stand up to abuse of power by prescription drug corporations.”

Before proposing the details of an improved Obamacare, the President-Elect and his advisors would be well advised to read a short and powerful Axios piece by Drew Altman, the president and CEO of the Kaiser Family Foundation (KFF). The headline on the Sept. 30 article: “Drugs aren't the reason the U.S. spends so much on health care.”

Altman wrote, “Voters care a lot about drug prices, but they’re not the main reason the U.S. spends so much on health care. The big picture: The U.S. spends twice as much per person as other wealthy nations,..and hospitals and outpatient care are the primary culprits.”
U.S. Inpatient and Outpatient Spending 144% Higher Per Person
The piece was derived from data published the week before by the KFF-Peterson Health System Tracker, an invaluable resource. The Tracker looked at U.S. spending per capita compared with average spending in nine comparable countries: Austria, Belgium, Canada, France, Germany, Netherlands, Sweden, Switzerland, and the U.K.

The comparison found that U.S. per-capita spending on “prescription drugs and other medical goods (including over-the-counter and clinically-delivered pharmaceuticals as well as durable and non-durable medical equipment)” was $1,397 in 2018; in the comparable countries, spending was $884. So spending in the U.S. was 58% higher – not a small disparity, though recognize that more than one-third of that difference (21 percentage points) is explained by the considerably higher GDP per capita in the U.S. compared with the other nine nations.
 
Now, compare the gap in drug and device spending with the gap in the category KFF-Peterson calls “inpatient and outpatient care.” It includes “payments to hospitals, clinics, and physicians for services and fees such as primary care or specialist visits, surgical care, and facility and professional fees.” Inpatient and outpatient spending was $6,624 in the U.S. compared with $2,718 in comparable countries, making the U.S. figure 144% higher, again compared with 54% for drugs and devices.

Overall, U.S. per-capita spending on health care is nearly twice that in comparable countries. But, as Altman writes, “The overwhelming majority of the difference — 76% of it — came from spending on inpatient and outpatient care — not drugs, which get more attention but represent just 10% of the difference.”
 
Here are the KFF-Peterson data in the form of a table:

Where Are Costs Rising the Fastest? Not Pharmaceuticals

Looking at the table, if you were setting out to make health care costs more affordable in America, where would you start? An article in Modern Healthcare last year concluded: “Hospital prices are the main driver of U.S. healthcare spending inflation, and that trend should direct any policy changes going forward.”

The Centers for Disease Control reported that hospitals represented 38.6% of all U.S. health spending in 2017, up from 36.1% in 2007, and that pharmaceuticals represented 11.3%, down from 12.3% ten years earlier. Among the five major categories of health spending, hospitals were the only one where the proportion rose.

Similarly, recent KFF-Peterson report looked at where health prices have been rising the most over the past decade. Overall, the increase in the U.S. from 2008 to 2018 was 3.6%, according to the report. Driving higher costs has been inpatient-outpatient spending with a 3.9% hike and administrative spending at 5.4%. The increase in prescription drugs and medical goods costs was just 2.7%.

Pharmaceutical cost increases have modulated in recent years, with the prices of prescriptions flat overall. The best source of current information is data published by the pharmaceutical benefit managers (PBMs) that serve insured Americans. Caremark, the largest PBM with 30% of the U.S. market, reported that total drug costs rose 1.4% between 2018 and 2019, entirely because of more utilization of medicines; the average prescription filled by its member actually cost 0.1% less. For Express Scripts, with 23% of the market, total drug costs rose 2.3%, again mainly because its members were using more medicines; the average prescription price rose just 0.9%.

As the KFF-Peterson report states:
 
Political discourse on health spending often focuses on prescription drug prices and administrative costs as being the primary drivers of high health spending in the U.S. compared to other nations. Current policy proposals aim to address prescription drug pricing.

Drug prices are, indeed, higher in the U.S. than in other high-income countries, but as this analysis shows, reducing drug spending alone would have a comparatively smaller effect on the gap between health costs in the U.S. and comparable countries. The biggest contributor to the difference in costs between the U.S. and peer nations is spending on inpatient and outpatient care.

The average cost of a hospital stay in the U.S. 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.

Putting Pressure on Hospitals to Reduce Costs Is ‘Politically Risky’

It's no secret that policy makers are obsessed with drug prices and pay little, if any, attention to inpatient or outpatient costs. A good question is why.

One reason is the design of health insurance policies, which require Americans to reach deep into their own pockets for co-pays and co-insurance. The out-of-pocket portion is 14.1% of total pharmaceutical spending but only 2. 9% of hospital costs and 8.4% of physician and clinical services costs. For Medicare beneficiaries, the gap is even greater. A Kaiser Family Foundation analysis last year found that Medicare patients spent an average of 2% of the cost of in-patient hospital services out of their own pockets, compared with an average of 21% of the cost of prescription drugs.

On a dollar basis, out-of-pocket spending in 2018 (latest data) was 38% greater for prescription drugs than it was for hospitals even though hospitals account for more than three times the cost of drugs overall. See Tables 7, 8, and 16 of the National Health Expenditure (NHE) data from the Centers for Medicare and Medicaid Services here.

Insurance companies make more money from pharmaceutical insurance than for other kinds of health insurance. The actuarial value – that is, the percentage of total average costs for benefits that a plan will cover – is 72% for hospitals, 71% for professionals and other, and just 54% for drugs in silver ACA Exchange plans with combined medical and pharmacy deductibles.

While total out-of-pocket costs per capita is not particularly high for drugs – only about $12 per month, according to the NHE data – the sickest Americans can face large bills, ratcheting up anxiety and political pressure both on the part of those facing bills and those who worry they will.

A study last year by Michael Mandel of the Progressive Policy Institute pointed out that for Americans who perceive their own health as “excellent,” drugs represent just 13% of their total health care out-of-pocket spending, but for Americans who says their health is “poor,” drugs represent 43%. (See Figure 2, here.) The person in excellent health spends $45 a year out-of-pocket on drugs while the person in poor health spends more than $600. “As people become less healthy,” writes Mandel, “they see their out-of-pocket drug spending soar faster than other medical expenses or overall incomes. No wonder they are angry with drug companies!”

Seniors, especially, are saddled with huge bills if they need the most advanced medicines because Medicare has no cap on what they are required to pay out of pocket each year. As we pointed out in Issue No. 64 of this newsletter, a study in the journal Arthritis Care & Research found that Medicare beneficiaries not qualifying for low-income subsidies paid an out-of-pocket average of $484 for a one-month prescription of a Part D biologic agent to combat the disease. Largely as a result of the cost, only 61.2% of the 886 beneficiaries studied filled their prescription, leading to more sick people for expensive physician and hospital care.

A research piece last year by Juliette Cubanski, Tricia Neuman, and Anthony Damico of the Kaiser Family Foundation found that a total of 1,016,660 enrollees had out-of-pocket spending on drugs that exceeded the catastrophic threshold, with average annual costs of $3,214). Average out-of-pocket spending on the 10 highest-cost medications was more than $5,000; for one anti-inflammatory drug, the average exceeded $12,000.

Another reason that politicians fixate on drug costs is that they consider hospitals to be protected health care species – in large part because hospitals are among the two or three largest employers in many congressional districts. Hospitals employ 5.1 million Americans while pharmaceutical manufacturers employ just 300,000.

Putting pressure on hospitals to constrain costs, Altman writes, is “politically risky” – which may be an understatement.

Drug spending reduces hospital spending

The best discipline on hospital spending has come, ironically enough, from the development of new pharmaceuticals. Research has shown consistently that drugs keep people out of the hospital, reducing overall health spending. The Boston Consulting Group decades ago found that the number of annual surgeries for peptic ulcers dropped from 97,000 in 1977, when H2 antagonists were introduced, to 17,000 ten years later. In research published in 1995, Frank Lichtenberg of Columbia University concluded that “a $1 increase in pharmaceutical expenditure is associated with a $3.65 reduction in hospital care expenditure.”

A subsequent study by Lichtenberg, released as a National Bureau of Economic Research working paper in 2002, looked at the ability of newer medicines to cut hospital costs. Lichtenberg concluded:

In the Medicare population, a reduction in the age of drugs utilized reduces non-drug expenditure by all payers 8.3 times as much as it increases drug expenditure; it reduces Medicare non-drug expenditure 6.0 times as much as it increases drug expenditure. About two-thirds of the non-drug Medicare cost reduction is due to reduced hospital costs. The remaining third is approximately evenly divided between reduced Medicare home health care cost and reduced Medicare office-visit cost.

Drugs that lower cholesterol and treat high blood pressure have produced dramatic reductions in hospital stays around the world. A 2014 study, published in the European Heart Journal, looked at the effect of five years of treatment with statin drugs for 1,000 patients. Savings for the National Health Service totaled 710,000 British pounds, or about $1,000 per patient after accounting for the cost of drug and safety monitoring. The drugs reduced hospital stays for the 1,000 patients by 1,836 days. This accounting does not even quantify the value of the lives saved and enhanced.

For a more recent example of drugs reducing hospital spending, consider remdesivir, the first therapeutic approved by the FDA for COVID-19. A randomized double-blind trial, conducted by NIH’s National Institute of Allergy and Infectious Diseases, found that Remdesivir, which now goes by the brand name Veklury, reduced the median recovery time for patients in the hospital by a median of five days compared with the placebo group, according to a peer-reviewed article in the New England Journal of Medicine on Nov. 5.

The drug, according to the Department of Health and Human Services, has a cost of approximately $3,200 for a full five-day course. Compare that $3,200 to the savings from cutting a hospital stay by five days. According to a study released in November by FAIR Health, a non-profit, the cost of a COVID hospital stay of 11 to 15 days for a patient over 60 years old was $152,388 while the cost of a stay of 6 to 10 days was $89,973 – a difference of more than $60,000.

‘Protectionism on Behalf of Hospitals’

Government actions have actually raised hospital costs. In an article last year in the National Interest, Chris Pope, a Manhattan Institute fellow, wrote that the U.S. health care system is distinguished “by the protectionist nature of government intervention in the marketplace. And this above all means protectionism on behalf of hospitals.”

He continued: “Over decades, the structure of state regulations and federal subsidies has encouraged hospitals to inflate their costs by protecting them from competition. This has yielded enormous overcapacity and inefficiency.”

Hospital admissions in the U.S. dropped from 39 million in 1980 to 35 million in 2015 (incredibly enough, the latest data from the Centers for Disease Control and Prevention) even as the population rose by 100 million, and the average length of a hospital fell by 40%. In 1997, some 6.6% of insured Americans had at least one hospital stay, but by 2017 the proportion had dropped to 5.3%. But, meanwhile, hospital employment has been rising sharply. As The Economist magazine reported: “Duke University hospital had 400 more billing clerks (1,300) than hospital beds (900).”

The U.S. also over-invests in equipment, in part, as Pope argues, because political imperatives keep hospitals open that should be closed and, as a result, our system is far too decentralized. Hospitals just don’t behave like other markets. Consolidation, which in most industries is a way to increase efficiency and bring down costs, has actually raised the prices of hospital services, according to a study by the National Council on Compensation Insurance (NCCI). The July 2018 report concluded:

Reductions in hospital operating costs do not translate into price decreases. Research to date shows that hospital mergers increase the average price of hospital services by 6%-18%. For Medicare, hospital concentration increases costs by increasing the quantity of care rather than the price of care.

A report in December 2018 in December titled, “Reforming America’s Healthcare System Through Choice and Competition,” by the departments of HHS, Treasury and Labor, also pinned much of the blame for poor hospital productivity on government, 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.

Hospital Concentration Has Not Led to Lower Costs

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 number of physicians employed by hospitals or health care systems rose by 78% between 2012 and 2018 and is now about half of all doctors, according to a study last year by Avalere Health and the Physicians Advisory Institute. Zack Cooper, 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. Another study 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

The 340B Subsidy

Rather than reducing inefficiencies through better management, hospitals address them through government subsidies like the 340B program. As we noted in Issue No. 57 of our newsletter, the program was established in 1992 to stretch scarce resources for government grantees providing health services and to help large mission-driven public hospitals such as New York Health and Hospitals Corporation.

Under 340B, in order to participate in Medicaid, drug manufacturers have to provide outpatient medicines at steep discounts to certain hospitals that serve lower-income communities. The hospitals are then allowed to claim full reimbursement at undiscounted rates for private payers. The difference is intended to help support the institutions and centers that provided care to low-income patients.

But the program has changed drastically from the original concept. It has encouraged hospitals to swallow up independent health practices, which then get to take advantage of 340B program. Meanwhile, the law allows hospitals to avoid passing on the discount to poor or financially stressed patients, and the number of eligible types of hospitals has been expanded regardless of whether they serve any Medicaid or uninsured patients. 

A December 2019 study by the research firm Milliman, commissioned by Pharmaceutical Research and Manufacturers of America (PhRMA), found that, on average, reimbursements to hospitals under 340B were 294% of drugs’ acquisition costs. The average treatment studied by Milliman received a reimbursement of $4,673, of which $3,082 was retained by the hospital itself.

A separate study by the Berkeley Research Group, also commissioned by PhRMA and released in October, looked at outside pharmacies that contracted with hospitals under the 340B program – a practice that was unleashed with a government decision in 2010. Today, 27,000 contract pharmacies are in the program. The research found that 340B prescriptions carried profit margins of 72%, compared with 22% for non-340B prescriptions dispersed through independent pharmacies.

Conclusion

Certainly, there are ways to hold down drug costs while maintaining high levels of innovation, and we have examined them in this newsletter many times: redesigning health insurance capping monthly out-of-pocket outlays by insured Americans, putting a ceiling on the catastrophic phase of Medicare Part D, allowing rebates to flow to patients themselves, and designing regulations with an eye to bringing biosimilars (that is, generic-equivalent versions of biological products) to increase competition. All of those changes can be effected by the Biden Administration in the first 100 days.

Just as important, however, if it wants to expand coverage and at the same time constrain costs and assure all Americans of the best care, the new Administration should look at the health care system broadly – not in sub-sectors. Clearly, policies that encourage drug innovation reduce inpatient and outpatient costs. And, just as clearly, it makes little sense to focus attention on medicines that constitute one-seventh or one-eighth of total expenditures when hospitals are where the savings are.