Healthcare has no shortage of frightening statistics, but a recent review of U.S. spending on medicine last year by the pharmacy benefit manager Express Scripts (NASDAQ:ESRX) contained a particularly scary revelation: Last year, Americans shelled out 13.1% more for medicine than they did in 2013. That surge in spending could put our healthcare system on a perilous path, especially given that healthcare utilization is climbing on the tailwind from aging baby boomers and healthcare reform.
Better drugs equals pricier medicine
Thanks to innovative new therapies, people are living longer, but they're doing so at a steep cost.
A decade ago, medicines were primarily small molecule drugs that were easy to manufacture and duplicate. As a result, these drugs were less costly to prescribe and were more quickly challenged by generic alternatives once their patent protection ended.
Today, medicines are increasingly complex biologics. These biologic drugs are medicines that are developed inside living systems such as plant or animal cells. Most biologics are complicated molecules or combination molecules that aren't easily replicated. The complexity of biologics often translates into increased efficacy over prior generation drugs, but it also makes them much more expensive to develop and manufacture. It also makes it incredibly difficult for generic drugmakers to duplicate them once their patents expire.
The ongoing shift toward these increasingly complex -- and correspondingly more expensive medicines -- has resulted in them accounting for an increasingly larger share of our healthcare dollars.
According to Express Scripts, despite specialty drugs like biologics representing just 1% of all annual prescriptions, they accounted for a whopping 31.8% of drug spending last year.
Across the tens of millions of health insurance members covered by Express Scripts pharmacy plans, spending on the average member climbed to $668.75 per year for traditional drugs and $311.11 for specialty medicines.
As you can see in the following table, annual spending per member increased by 6.4% year over year for traditional drugs and by 30.9% for specialty drugs. In both instances, higher drug prices were overwhelmingly behind the increases.
If left unchecked, drug spending growth of this magnitude could be unsustainable. In 2013, IMS Health reported that U.S. spending on medicine clocked in at about $329 billion.
If spending increases by 13.1% per year over the next 20 years, the amount spent annually on prescription medicine would surpass $3.8 trillion (yes, with a "t").
Taking matters into hand
Such a surge in drug spending would undeniably put patients at risk. Medical costs are the biggest reason for personal bankruptcy, particularly among patients with diseases like HIV and cancer.
In an attempt to blunt the risk to the system posed by runaway drug costs, pharmacy benefit managers, or PBMs, like Express Scripts and CVS Health (NYSE:CVS) -- the two largest PBMs -- are rethinking how they pay for drugs.
In December, Express Scripts negotiated a steep discount to AbbVie's (NYSE:ABBV) new hepatitis C drug Viekira Pak by offering exclusivity. In January, CVS Health similarly orchestrated a discount for Gilead Sciences' (NASDAQ:GILD) competing hepatitis C drugs, also in exchange for exclusivity. Express Scripts estimates that its deal with AbbVie will save its clients $1 billion annually.
In addition to more aggressive price contracts with drugmakers, healthcare payers are also developing programs that can increase patient adherence to medicine to lower the risk of costly future healthcare events, as well as programs to increase the use of generic alternatives.
PBM programs that increase the use of lower cost generics could prove to be critical. Despite biologics' difficult-to-copy nature, technology advances are helping generic drugmakers develop biosimilars. While not exact copies, these biosimilars deliver similar efficacy to their brand name counterparts. So far, biosimilars have been a bigger story in Europe than in the U.S.; however, the FDA approved its first biosimilar this month when it gave Novartis' Sandoz unit the go-ahead to begin marketing its biosimilar of the top-selling cancer drug Neupogen. That approval is likely to be the first of many over the coming years.
The financial stakes are high for patients and drugmakers. If prices are too low, it could force drug developers to focus only on diseases that offer the biggest payoff. That could derail advances in a range of orphan diseases. However, if prices for medicine continue to grow at this rate, it's unlikely that the system will be able to afford it. Clearly, a middle ground is not only necessary, but in the best interest of everyone. Finding that middle ground, however, may remain difficult.
Todd Campbell owns shares of Gilead Sciences. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. The Motley Fool recommends CVS Health, Express Scripts, and Gilead Sciences. The Motley Fool owns shares of Express Scripts and Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.