Debunking The 10 Percent Myth

Later today the Secretary of Health and Human Services is convening a meeting on what to do about high drug prices in the US.

The topic has been in the news. Generic drug companies such as Turing and Valeant have raised prices on drugs that are decades old. Branded drug companies such as Alexion have decided it’s appropriate to charge $440,000 per year for their drug for the rare condition paroxysmal nocturnal hemoglobinuria.

Rest assured, the executives from the pharmaceutical industry will make several points in their defense, among which will be the well worn assertion that drug spending accounts for only 10 percent of all healthcare spending. They will say that this statistic has been stable for decades and is projected to stay right where it is. Why, they will ask, are drugs being singled out?

Of course drug spending has not been singled out. The Affordable Care Act took on nearly every pocket of healthcare spending, but barely touched drugs, and more recent federal budget changes re-jiggered how US doctors and hospitals will be paid by Medicare. That reality aside, the 10 percent talking point just keeps popping up.

I think it might be time to retire it. After all, this ‘fact’ is not even accurate as drugs used in hospitals and given to patients in doctors’ offices are not included in the estimate. The IMS Institute for Health Informatics estimates that drugs account for 22% of healthcare spending, Altarum Institute pegs the number at 14%. MEDPAC reports that drugs amount to 19% of Medicare spending. Whether it’s ten percent, fourteen percent, or twenty-two percent, we’re talking huge numbers. Fourteen percent of healthcare spending is around $400 Billion, more than $1,000 per person per year.

But rather than quibbling over percentages, note how much we spend on drugs compared to other spending on health improvement. The States will spend $500 million dollars this year to try to get people either to stop smoking, or not start smoking in the first place. Smoking is the primary cause of lung cancer and the number one cause of preventable death and disability in the US.  We will spend 50% more this year, around $730 million dollars, on the drug Tarceva, which is primarily used to treat one rare form of lung cancer.

Then there’s the fact that the talking point contradicts another argument the pharmaceutical industry regularly makes. Drugs are worth their high pricetags because they lead to reductions in other types of healthcare spending. Novartis’ new heart failure drug is supposed to prevent hospitalization for heart failure. Gilead’s drugs for Hepatitis C are supposed to prevent the need for some people to get liver transplantation. Someday, we hear, there will be an Alzheimer’s drug that will precipitously lower the amount we spend on expensive nursing home care. Let’s hope that last forecast turns out to be correct.

But here’s the paradox: If these promises come true, then the share of money spent on drugs should rise as spending on other services fall. So drugs should have a larger share of the pie, not the same 10% slice we are being promised.

But the biggest problem with the 10 percent talking point is the implication that drug spending just sorts itself out and magically ends up just where it should be. In other words, policymakers should stay far away, lest they upset this mysterious equilibrium. It is sort of true that if you average across the past twenty years, the inflation rate on drug spending (which is higher than ideal) has kept roughly in line with the inflation rate on other types of healthcare spending (also higher than ideal).  But this prior balance is not due to any market forces. Rather, it is a product of happenstance. A frustratingly slow innovation cycle that produced few new drugs, a tradition of affixing reasonable prices to those drugs that are approved, and a steady and durable wave of large market drugs becoming cheap generics.

All the elements of this equilibrium have shifted in the past few years, and the inflation rate on drug spending has exceeded that for any other healthcare spending category each of the past two years. We have many new drugs coming on the market, not just a few, with FDA approval rates for new drug applications up from 50% eight years ago to 90% today. Prices are at never before seen levels, like Gilead’s $84,000 one-time treatment for Hepatitis C infection, or Vertex’ $300,000 per year treatments for Cystic Fibrosis. Compare these to the price of the poster child for high priced drugs from the 1990’s, Genentech’s Activase, a clot buster that generated what now seem quaint headlines for its price. It cost just over $2,000.

Generic offsets are rarer, and the potential savings for generic version of biologics called biosimilars will be smaller. This is true both because the FDA exclusivity period is far longer for biologics than for drugs, and because all predictions are that the size of the discounts will be small. Price hikes on old generics are another reason cost saving offsets are getting harder to find.

For all of these reasons, I think it is time that the pharmaceutical industry retires its 10 percent talking point. We finally have an innovation cycle that is producing important breakthroughs nearly daily. Now we need an innovative pricing system that ensures that patients receive the benefits of those breakthroughs.

Peter B. Bach directs the Center for Health Policy and Outcomes at Memorial Sloan Kettering Cancer Center in New York.

Morning Consult