A lot of attention and a bevy of proposals have focused on the rising cost of drugs, among all Americans, including older adults covered by Medicare.
But are these costs really rising as fast as people think? Or is the concern over drug spending due to something I call the prescription escalator?
The U.S. Bureau of Labor Statistics reported in September that the average spending by senior households for prescription and nonprescription drugs dropped in 2019 for the second straight year. In fact, households headed by Americans age 65 and older devoted only 1.5% of their total household outlays to out-of-pocket spending on drugs in 2019, the lowest level in at least 20 years.
Taking a broader look at Americans of all ages, average out-of-pocket drug spending in 2019 came to $486 per household, close to the amount spent in 2014. The long-term trend is that out-of-pocket drug spending is a falling share of household budgets.
If it’s not out-of-pocket spending, perhaps the cost of paying for essential medicines is putting an increasing burden on the economy. List prices are certainly rising. The IQVIA Institute calculates that spending for pharmaceuticals, taking list prices at face value, went up by $194 billion between 2014 and 2019. But after taking rebates and discounts into account, the report showed that net revenues to manufacturers rose by only $56 billion, or 19%, over the same stretch.
Indeed, the net revenues going to drug manufacturers rose more slowly than the 22% increase in gross domestic product. The implication is that the economic burden of drug spending has been declining. The increase in manufacturer net revenue accounts for only 7% of the rise in national health care expenditures from 2014 to 2019 — not zero for sure, but not the major factor. Moreover, the U.S. Bureau of Economic Analysis reports that pharmaceutical research and development rose by $26 billion, or 41%, from 2014 to 2019. That means almost half the rise in revenue went to higher R&D.
To explore what’s really troubling Americans about drug prices, my colleagues and I dug into the federal government’s Medical Expenditure Panel Survey (MEPS) data on prescription drug use. Starting in their mid-30s, Americans tend to fill 5% to 6% more prescriptions each year, including refills. For example, in 2018, individuals between the ages of 35 and 44 filled an average of 7.2 prescriptions, including refills, compared to an average of 12.2 prescriptions for those between the ages of 45 and 54 and 18.1 prescriptions for those between the ages of 55 and 64. This 150% increase in the number of prescriptions as people age corresponds to an equivalent rise in prescription drug spending.
The age-related rise in the number of prescriptions filled, which I call the prescription escalator, tends to boost individuals’ out of-pocket drug spending year after year, no matter what is happening to the price of drugs. In other words, the very usefulness of medicines to fight the ills of aging, combined with the copayment insurance model, translates into rising spending for individuals.
The prescription escalator dominates the individual experience of drug spending. Given that most insurance plans require a fixed copay, individual Americans see their drug bills steadily increase year after year, even if prescription prices stay flat. Indeed, it is arithmetically possible for drug spending by individuals to rise much faster than aggregate drug spending.
Picture a real-world escalator. It smoothly transports people from one level to the next without actually moving itself. The key is that the escalator steps go back down after depositing the passenger at the top or bottom, so that their “average” rise is zero. In the case of drugs, the drop in individual spending comes at death.
Meanwhile, total copays for inpatient stays and office-based visits rise at a much slower rate with age. For example, if we compare individuals aged 45 to 54 with their counterparts aged 65 to 74, the older group pays 84% more out-of-pocket for prescription drugs, mostly because of increased usage. But the corresponding increase in out-of-pocket expenses for office-based visits is only 18%.
To add to the perceived pain from the prescription escalator, a small percentage of Americans fall between the cracks of current insurance schemes, and end up with large pharmaceutical bills. In an analysis I published in March 2020, about 1% of Americans each year pay more than $2,000 in out-of-pocket drug costs. That’s not acceptable and needs to be fixed.
The prescription escalator means that spending increases are mainly being driven by higher drug use as individuals get older and sicker rather than rising list prices. Indeed, given the baroque and complicated system of rebates and discounts, there is little evidence that proposals to reduce list prices for drugs will translate directly into relief for either individuals or payers. Even in cases where insurers have tied cost sharing to a percentage of list prices, they are the ones setting that percentage and could easily raise it if list prices were reduced, so consumers would still be paying the same out-of-pocket expenses.
I believe that the most important step in addressing the real complaints of Americans is to put a tighter cap on out-of-pocket expenses from drug spending. For example, in July 2018, Sens. Elizabeth Warren (D-Mass.) and Ron Wyden (D-Ore.) introduced the Capping Prescription Costs Act of 2018, which set caps for prescription drug copays at $250 per month for individuals and $500 per month for families.
Equally important is legislation that would encourage point-of-sale rebates. These are rebates paid directly to consumers rather than to insurers or pharmacy benefit managers. From the perspective of economics, this approach has several virtues. First, it clarifies the true cost of prescription medications and allows consumers and physicians to make better cost-benefit trade-offs. Indeed, the cries of pain from Americans hit by high out-of-pocket spending would then directly correspond to net prices. Second, it reduces the incentive for companies to raise their list prices while offering bigger rebates to insurance companies and pharmacy benefit managers.
The drug price debate is a classic illustration of the gap between individual experience and aggregate data. It’s time to change policy to directly address the problems that are actually bothering middle-aged and older Americans.
Michael Mandel is the chief economic strategist for the Progressive Policy Institute.