Affording the advances in biomedicine

Recently the excessive growth in healthcare costs has slowed.  The respite will likely be temporary.  Forecasts by the Centers for Medicare and Medicaid Services see healthcare costs once again soaring to 6 percent per year between 2015 and 2023 or 1.1 percent faster than their expectations for the overall economy.

The problem of out of control healthcare costs must be addressed.  The urgency is even greater if we want to receive the full benefits from emerging innovations – such as the promise offered by biomedicines.  Recent advances in biomedicines offer patients innovative therapies, and biomedicines are a key tool in the emerging field of personalized medicine.

{mosads}Creating new drugs, whether based on chemical entities or biologics, are expensive however.  These costs, when coupled with the current cost expectations, raises questions regarding whether we can afford the coming revolution in biomedicine.

It is a mistake, however, to focus attention on the specific payments made for any one type of medical therapy.  Biomedicines, and other pharmaceutical drugs, are one option for doctors and patients – sometimes used in lieu of alternative therapies including surgeries and hospitalizations; other times used in coordination.

Healthcare expenditures, just like patients’ treatment plans, should be viewed systemically.  Spending more money on one therapy that improves patient outcomes and drives down overall health expenditures is a sign of efficiency, not a problem that needs to be addressed.  And, the evidence shows that pharmaceutical drugs create better patient outcomes while reducing overall healthcare expenditures.

Skyrocketing healthcare expenditures are not due to spending on pharmaceutical drugs – total pharmaceutical spending is less than 10 percent of total healthcare expenditures.  And, according to the Centers for Medicare & Medicaid Services, National Health Expenditure Projections, pharmaceutical spending will remain at, or below, its current share of total healthcare spending through 2022.

Instead, the problem of skyrocketing health care costs is due to our third-party payer system.  This system creates a complex web of payers, doctors, regulators, licensing boards, lawyers, and patients who are all, either directly or indirectly, involved in a patient’s healthcare decisions.

The third-party payer system creates a wedge between the doctor and patient, straining the relationship.  The isolation of patients from their doctors creates many adverse incentives including a bias toward rising healthcare inflation.

Consider that patients bear a small fraction of the costs from any additional health care service.  In 1960, the private sector funded over three quarters of the nation’s health care expenditures.  And, patients paid nearly one-half of the total national health care expenditures through out of pocket expenditures.

Today, the private sector pays for less than one-half of the $2.6 trillion in health care spending (17.8 percent of Gross Domestic Product); and, only a bit more than $1 out of every $10 is funded by patients through out of pocket expenditures.  Therefore, patients have little incentive to monitor their health care expenditures or those of providers.

Doctors and other medical providers also have no incentive to monitor costs or utilization of services.  The reason: lawsuits.  The risk of litigation incentivizes doctors to run extra tests (e.g. practice defensive medicine) to help minimize their risks of being sued.  According to the American Medical Association, defensive medicine in response to rising tort liability costs adds hundreds of billions of dollars in additional costs.  PricewaterhouseCoopers estimates the cost at $210 billion a year.

The lack of cost sensitivity also provides no incentive to effectively address waste, fraud, and abuse in the health care system, which has been estimated at over $700 billion a year!

In short, the problem of rapidly rising medical prices is caused by adverse incentives.  Neither patients nor doctors are incented to control the cost of medical care; and in fact, both patients and doctors are incented to let prices rise and increase utilization.

More broadly, the health care system in the U.S. is exceptionally wasteful, unproductive, and inefficient due to impediments such as ineffective insurance markets, tort liabilities that incent defensive medicine, and licensing rules that eliminate competition.

Instead of focusing attention on the affordability of biomedicines, effective health care reform should focus on the factors that are excessively growing overall health care spending.  Such reforms must eliminate the impediments that are diminishing the incentives for innovation and productivity growth, and create policies that empower patients to control their own health care decisions.

Empowering patients, along with their doctors and other medical professionals, to manage their own health care is the surest path to controlling health care costs.  It will also help patients enjoy the benefits from medical innovations, such as the promise offered by biomedicines.

Winegarden, Ph.D, is a senior fellow at the Pacific Research Institute and a partner in the consulting firm Capitol Economic Advisors.