Expenditures for prescription drugs: Too much or not enough?

AT A GLANCE

With insurance, consumers generally do not have a financial incentive to reduce or contain prescription drug use. Drug spending can be controlled by:

* Understanding the sources of drug cost

* Improving use of drug formularies

* Using clinical pharmacists to improve

Prescription drug expenditures in the United States have been the fastest growing component of Healthcare spending over the past several years. Although the actual rate of increase varies from year to year, and differs based on the source data, the mean annual increase in recent years has been around 15 percent, according to the CMS 2002 Data Compendium (www.cms.hhs.gov/ researchers/pubs/datacompendium). CMS found that spending on prescription drugs between 1990 and 2000 increased by more than 200 percent, and it projects that spending for prescription drugs will increase well into the future. However, the rate of increase is expected to level off at about 10 percent per year.

Notably, despite the remarkable growth in prescription drug spending, drugs remain a relatively small component of overall U.S. healthcare expenditures. In 2000, the $121.8 billion spent on retail prescription drugs accounted for just 9.4 percent of the total $1.3 trillion in healthcare expenditures, according to CMS data. By 2010, retail prescription drug sales are expected to peak at 14 percent of national expenditures.

The rising prescription drug expenditures have attracted considerable political and media attention in recent years. The discussion is fueled by reports of the high "prices" that patients and insurers pay for drugs, especially compared with Canada and Mexico. Many people naturally conclude that pharmaceutical companies are gouging the U.S. public and that actions are needed to reduce drug costs. However, an objective analysis of the situation demonstrates that the issue is much more complicated.

Do We Spend Too Much on Prescription Drugs?

By almost any measure, pharmaceuticals are a good value compared with other healthcare interventions. Medications cure and prevent diseases and disabilities, save lives, and improve quality of life. Medications also can reduce the need for surgery, hospitalizations, and other costly healthcare services. Evidence indicates that the more we spend on medications, the more we save in total healthcare expenditures. For example, a recent study from the University of Illinois at Chicago demonstrated this relationship for patients on cardiovascular medications.a

Americans derive huge benefit from the financial resources spent on prescription drugs, but an important question is at what point does increased spending result in only minimal gains in health? This question has yet to be answered. To do so, the factors that drive prescription drug spending need to be analyzed.

Drivers for Prescription Drug Spending

The factors that drive prescription drug spending are not only numerous but very diverse. In fact, several layers of factors are behind any one driver of spending. However, two categories of factors are generally considered most important: price inflation and utilization.

Price inflation. Traditional price inflation (the change in price of a commodity from one year to the next) commonly receives the brunt of criticism about drug spending, but actually accounts for only about 24 percent of the annual increase in drug spending. According to a Kaiser Family Foundation report, switching to more expensive (new) drugs accounts for 28 percent, and increased utilization accounts for 48 percent of the annual increase in drug spending.b

One must understand that the prescription drug industry is essentially a monopoly. Extended patent protection is given to pharmaceutical companies to encourage and compensate for the intensive and expensive research involved in drug discovery. Essentially, patent protection allows companies to charge monopoly prices for their new products. The price is even more inflated by the fact that drug insurance covers a significant portion of the costs for those fortunate enough to be covered. Once patent protection expires and generic competition enters the market, drug prices generally decrease substantially.

Utilization. The more significant cause of rising drug spending is increased utilization. Again, this is a multifaceted issue. Factors affecting utilization include the lack of financial incentive to encourage consumers to contain utilization, the increased use of prescriptions (on a per capita basis) due to the aging of the population and severity of disease, new indications for drugs, and heavy marketing of prescription medications.

Because insurance companies usually pay for drugs, consumers typically have very little financial incentive to contain their utilization. Although managed care organizations have attempted to link out-of-pocket costs to consumer utilization by creating multitiered copay and deductible schemes, these models have proven only somewhat effective, partly because physicians decide for the consumer what drug will be prescribed. With no other commodity does this unique phenomenon occur. Imagine going out to dinner, having someone else order the entree for you, and having yet another person pick up the tab at the end of meal. You can see how expenses might be inflated.

The Kaiser Family Foundation report notes that in 2000, there were 2,979.9 million prescriptions dispensed in the United States, an average of 10.8 per capita. Most influential to large and increasing utilization of prescription drugs, and to drug spending, is the aging of the U.S. population. The annual use of prescription medications increases exponentially with age, resulting from an increase in both the number of people taking medications and the number of prescriptions per capita. As our population lives longer, the number and severity of diseases increase, further raising the quantity of medications consumed.

Although demographics have contributed most to increased utilization, another important factor is the change in the number and types of disease for which drugs are indicated. Drugs are continually being developed to treat diseases for which pharmacotherapy did not previously exist. Although many of these drugs are designed to treat rare or life-threatening diseases (thus signifying important advances in care), a significant proportion are the so-called "lifestyle" drugs, such as Viagra(TM) and Botox(TM), which have been developed for indications that were not previously addressed with pharmacotherapy, such as erectile dysfunction, hair loss, and other lifestyle problems. These new indications and the drugs designed for them have become noteworthy contributors to overall rising drug spending.

Also contributing to increased spending is the movement toward direct-to-consumer advertising. A recent study by the National Institute of Health Care Management Foundation found that the number of prescriptions written for the top 50 most heavily direct-to-consumer advertised drugs increased at six times the rate of all other drugs.c

How to Control Drug Spending?

The question of controlling drug spending is based on the assumption that we are spending too much. As noted above, this assumption may not be entirely valid, particularly if drug expenditures are negatively related to overall healthcare costs, which also are inflated by the incentives that insurance creates. Nevertheless, inefficiencies exist in any system, including the prescription drug industry.

To control drug spending, we need to first understand the sources of drug cost. The Kaiser Family Foundation report notes that three components contribute to the cost of a prescription drug at the retail level: the pharmacy (23 percent), the wholesaler (3 percent), and the pharmaceutical manufacturer (74 percent). Both the proportion of the total retail cost and the percentage that represents profit are heavily weighted toward the manufacturer. For example, the average net profit of a pharmaceutical wholesaler is 1.6 percent, of an independent pharmacy is 3.1 percent, and of the pharmaceutical manufacturer is 23.6 percent. In fact, according to the Kaiser Family Foundation report, the 74 percent of the cost of a prescription drug that is attributable to the manufacturer can be broken down into the following categories: manufacturing costs, 24.9 percent; sales and advertising, 34.4 percent; research and development, 13.7 percent; other, 5 percent; and before-tax profit, 23.6 percent.

Efforts by managed care organizations, state Medicaid programs, and the federal government (most recently in the form of the Bush administration's proposed Medicare drug coverage) almost always focus on reducing the retail price of a prescription at the pharmacy level, as do the so-called "discount drug cards." These approaches are shortsighted because the savings created comes primarily from reducing the profit of the pharmacy (3.1 percent of 23 percent of the total). The potential savings from this type of approach is limited (like squeezing blood from a turnip). Clearly the approach with more potential would be to target the element that contributes to the majority of the prescription cost: the manufacturer. However, the economic and political pressure wielded by pharmaceutical companies has effectively mitigated such efforts. The only real success story in this arena has been the Department of Veterans Affairs, which for a long time has effectively controlled drug costs by negotiating discounted prices and maintaining a strict drug formulary. In addition, although controlling prices charged by the industry may seem compelling, the profits made by the industry are the incentive that drives innovation. Although the strength of the relationship between profit and research is not known, the net effect of price controls would be to curtail pharmaceutical companies' efforts to develop new drugs.

One possible solution is the better use of drug formularies, which work by influencing utilization, not by reducing prices. Drug formularies have been used successfully by hospitals and more recently by managed care organizations. A related solution is to use the specialized knowledge of "clinical pharmacists" to assist physicians in drug decision-making, or in the retail setting, the use of "cognitive pharmacy services" to avoid drug-related problems and ensure patient compliance. Clinical pharmacists work to ensure optimal drug therapy in terms of both clinical outcomes and financial efficiency. They do this by working with patients and physicians to prevent and solve drug-related problems.d Studies have demonstrated that for every dollar invested in clinical pharmacists (through payment of salary), more than four dollars can be saved in drug and other Healthcare expenses.e Many state Medicaid programs, insurance companies, and managed care organizations are experiencing economic benefits by paying pharmacists to review medication profiles, along with patient health data, and intervene with physicians when necessary to ensure appropriate use of prescription drugs. Examples of these types of services are well-documented and are often focused on high-cost patient populations, such as those with asthma, hypercholesterolemia, or diabetes.f

What's Next?

Prescription drug spending has risen rapidly over recent years and, as a result, has gained much attention. However, it is unclear whether the current spending levels are really too high. In fact, some would argue that we should spend even more on drugs because we continue to gain through improved health, financial savings in other sectors of the Healthcare industry, and improved productivity of workers. The increase in prescription drug spending primarily results from increased utilization, which is directly associated with the aging of the U.S. population and the change in the severity and types of diseases being treated.

Efforts to reduce spending often do not target the primary contributor to the prescription prices, the pharmaceutical manufacturer, and attempting to do that has its own set of challenges and questions. A promising strategy is to focus on appropriate utilization. In the end, it seems that our best efforts likely will only slow the increase in drug spending. Nevertheless, Healthcare executives should support efforts to control drug spending in their own organizations. Programs that alter prescribing behavior, such as tighter drug formularies and increased utilization of clinical pharmacists, are most likely to make the most out of the dollars being spent.