Issue

The rise in costs of prescription medicines affects all sectors of the health care industry, including private insurers, public programs, and patients. Spending on prescription drugs continues to be an important health care concern, particularly in light of rising pharmaceutical costs, the aging population, and increased use of costly specialty drugs.  In recent history, increases in prescription drug costs have outpaced other categories of health care spending, rising rapidly throughout the latter half of the 1990s and early 2000s (see Figure 1). [1] While the rate of growth in spending has slowed somewhat, it is projected to exceed the growth rates for hospital care and other professional services in 2010 and through 2019. [2]

Figure 1

Average Annual Percentage Increase in Selected National Health
Expenditures, 1996-2008

Source: Kaiser Family Foundation calculations using National Health Expenditures data
from Centers for Medicare and Medicaid Services.

Background

Advances in pharmaceuticals have transformed health care over the last several decades. Today, many health problems are prevented, cured, or managed effectively for years through the use of prescription drugs. In some cases, the use of prescription medicines keeps people from needing other expensive health care such as being hospitalized or having surgery. [3] In 2007, 90% of seniors and 58% of non-elderly adults rely on a prescription medicine on a regular basis. [4] Although still only a modest part of total health care spending in the U.S (10%), with so many people relying on prescriptions, the cost implications loom large for the American public, health insurers, and government payers.  Furthermore, the drug industry’s profit margins have raised considerable attention. Pharmaceutical manufacturing was the most profitable industry in the U.S. from 1995 to 2002, and in 2008 it ranked third with profits after taxes of about 19 percent. [5]

Several factors have contributed to this growth in spending on pharmaceuticals, including:

• Increased utilization and demand for prescription drugs - From 1999 to 2009, the number of prescriptions purchased in the United States increased 39%, [6] while the population only grew 9%. [7]
• Types of prescriptions written – Most of the top-selling prescriptions are newer, higher-priced brand name drugs that have replaced older, less-expensive drugs.
• Price increases - Retail prescription prices have increased on average 3.6% annually between 2000 and 2009, [8] much faster than the average inflation rate of 2.5%. [9]
• Research and Development – Manufacturers try to recoup the research and development, costs for drugs that make it to the market as well as those that do not enter the marketplace.  Only one in five drugs that make it to the clinical testing process receive FDA approval and are brought to market. [10]
• Advertising and Marketing - Pharmaceutical manufacturers make substantial investments on marketing to consumers and physicians, which may influence consumer demand and physician prescribing practices. [11] Furthermore, the most heavily advertised products tend to be newer, more expensive drugs. This results in overall increases in spending. 

The role of patent laws in drug pricing is also an important factor.  Patent protection provides manufacturers an exclusive right to sell new drug products for up to 20 years from the date of the patent filing. Once the patent expires, the drug may be manufactured in generic versions by any number of manufacturers, thus lowering the prices for the drug. Pharmaceutical companies have been accused of obtaining a new patent on a slightly different version of a drug about to go off patent to extend their favorable market situation, and these patent protections have garnered criticism by some groups for limiting access to competition and making some life-saving medications unaffordable for patients [12]

Rising prescription costs have led many to call for greater government involvement in regulating the pharmaceutical industry, particularly since prices for brand pharmaceutical products are considerably higher in the U.S. than in countries where governments take a more active role in negotiating prices and regulating profits.  Opponents however, argue that government involvement will not guarantee lower prices, may have unintended consequences for the rest of the market, and would negatively affect patients because regulatory actions would stifle industry incentives to invest in research and development of new therapies.

Insurance Coverage

Private Insurance:Most private health insurance plans cover prescription medicines; however, there is considerable variation in the drugs that are covered and the share of costs that the insured individual must bear.  Some have seen their cost-sharing for brand-name products increase substantially as employers and health plans have adopted wider use of tiered benefit packages that impose higher co-payments for certain more expensive drugs. [13] This is particularly concerning for low-income individuals, who may not be able to afford even minimal co-payments.

Medicare:After many years of debate and in response to longstanding concerns over the out-of-pocket cost burdens on the elderly and disabled, the Medicare Part D outpatient prescription drug benefit went into effect on January 1, 2006.  Enrollment is voluntary; however, unless beneficiaries have drug coverage from another source (e.g., an employer plan) that is at least as good as standard Part D coverage, they face a financial penalty.  Spending on the Part D program is estimated to reach $51 billion in 2010, financed by a combination of beneficiary premiums, general federal revenues, and state payments. [14] While subsidies are available for low-income seniors for the associated costs of Part D, other Medicare beneficiaries may still face significant out-of-pocket expenses for their prescription drugs.  A 2009 survey found that 12% of seniors said they chose to forgo prescription medications in the past year due to high costs. [15]

Medicaid:All state Medicaid programs provide coverage for prescription drugs, although there are differences in state policies with regard to copays, types of drugs that are covered, and the number of prescriptions that can be filled.  Similar to the private sector, prescription drug costs under Medicaid have also grown rapidly in recent years. However, to date, Medicaid programs have imposed minimal cost-sharing for its beneficiaries. As states struggle to meet expenses within their Medicaid programs, more have turned to or are considering policies to help control drug expenditures. [16]

Policy Options for Making Prescription Drugs More Affordable

While there are a number of policy options under consideration for addressing rising drug costs, the two that are currently receiving the most attention from policymakers involve the government's role in drug pricing for the Medicare program and importation from other countries.

Government's role in Medicare drug prices:A major issue currently under debate involves the appropriate role for government regarding drug prices for Medicare beneficiaries under the Part D drug benefit. The law specifically prohibits the government from participating in negotiations between the drug plan sponsors and drug manufacturers and pharmacies, establishing any specific list of drugs that will be covered (formulary), or imposing any price controls on drugs. Supporters of this market-based approach believe that the competition for enrollees will cause plans to negotiate with drug manufacturers and pharmacies to offer drugs at the lowest possible prices, while opponents state that the lack of federal regulation and negotiating power will lead to higher costs for Medicare and for Medicare beneficiaries, many of whom still face sizable out-of-pocket costs for prescription medications.

Importation:The significantly lower prices available for common brand name prescription drugs in Canada and other countries has led some individuals as well as state governments to import drugs from those countries. Prescription drug importation is illegal in most cases although PL 109-245 allows citizens to bring in a 90 day supply from Canada. A number of proposals on importation have been introduced in Congress, varying in scope, the countries from which drugs could be imported, safety standards, regulatory requirements, and fees that would be levied to help pay the costs of increased government regulation. Supporters believe that if importation were legal from other countries, including Canada and the Asian and European markets, there would be enough volume to significantly affect prices in the U.S. market. Opponents question the safety of imported drugs and caution that cost savings would be small if foreign governments were to restrict the supply of drugs leaving their borders or pharmaceutical manufacturers limited the supply of drugs sold to foreign nations that facilitate sales to U.S. purchasers. [17]

Discussion

Included below are a series of questions for discussion:

• What are the major causes for the increase in prescription drug spending?
• What have been the major changes in prescription drug spending for the Medicare and Medicaid programs since implementation of the Medicare Part D program?
• What are the arguments for and against the different proposals to constrain prescription drug costs?
• Are there measures that the government could take to encourage companies to conduct research and development and still control the costs of pharmaceuticals?  How is it done in other nations?
• How will the PPACA affect prescription drug costs and spending for patients and industry?

BACK TO TOP

Acknowledgements: This issue module was prepared by Eric Kimbuende, Usha Ranji, and Alina Salganicoff of the Kaiser Family Foundation.....

Updated: February 2010.....