There’s a prevailing narrative that drug spending is a relatively minor 10% of overall healthcare spending in the US.  Like most narratives, this isn’t completely wrong, but it ignores a relatively big portion of spending on drugs: those drugs that are administered in a hospital or clinic and get billed under a patient’s medical benefit plan, rather than the drug benefit portion of their insurance.  Taking those hospital administered drugs, and other such direct distribution channels into account, the biopharma share of healthcare spending jumps to an estimated 16.7% of personal healthcare spending (14.2% if you include government and insurance overhead in total spending).

We’ll come back to that estimate in a bit, but first it is worth discussing where the 10% number comes from and how it became so fixed in people’s minds.  The where is easy: CMS (Centers for Medicare & Medicaid Services) collates and reports on national healthcare spending and has data on prescription drugs going back to 1960. It’s interesting to see that in 1960, prescription drugs were right around 10% (9.8%) of the healthcare pie.  But from that year on they started on a pretty steady downward trend, and were under 5% by the early 80’s, when they started climbing again.  By 2000 they were back to 9% and have stayed in the 9-10% range ever since.

Hospital Spending

This seeming stability gives the impression that spending increases on pharmaceuticals have just matched overall healthcare inflation this millennium, but if we include the non-retail portion we can see this is not necessarily the case.  Unfortunately, non-retail spending is not well documented.  The best treatment of this comes from an Altarum Institute study based on unpublished IMS data on wholesale spending from 2008-2013.  They found a remarkably consistent relationship between retail and non-retail wholesale spending, with non-retail channels coming in right around 28% of total drug spending over this six-year period.

From this data they try to extrapolate from wholesale prices, and make the assumption that markup from wholesale in each channel is the same. They acknowledge that this may not be realistic, and create a low estimate, where retail markup is 10% more than non-retail, and a high estimate where it is the reverse.  However, pricing in this area is very opaque (an issue for a future column), and these adjustments may not go far enough. Studies we do have are suggestive that hospital markup is much higher than in other settings, which would lead to a significant underestimation of the non-retail share of drug spending. 

More importantly, they use the fact that the share between the two channels was steady during the period they looked at, and assume it will remain relatively steady going forward.  This assumption is likely not warranted, as the period from 2008-2013 was unique in recent history as a period of essentially no growth in total pharma spending with a CAGR of 1.9% vs. a 10.6% CAGR since 2013, a trend that CMS predicts will continue through the decade and into the next. 

Specialty Drugs

To better understand this we need to delve a little bit into the so-called “specialty drugs” a topic that has been well covered, but not always well understood.  Generally speaking, specialty drugs must have one or more of the following characteristics; expensive, difficult to administer, require special handling, a specialist to administer, or a biologic origin.  For purposes of this discussion that first one, expensive, is the most important. 

The non-retail market will likely grow faster than the already fast pace of retail growth predicted over the next decade

Specialty drugs can be part of either the retail or non-retail channel, but they make up a much higher share of the non-retail market (58% vs. 33% according to IMS).  Recently, the incredible growth in the hepatitis C market has put much of that specialty growth firmly in the retail side of the business, but this is not likely to repeat going forward with immuno-oncology, blood disorders, rare diseases, and farther in the future CRISPR therapies all making a big impact under the medical benefit, which suggests that the non-retail market will likely grow faster than the already fast pace of retail growth predicted by CMS over the next decade.

So What?

All of this raises the obvious question: So what? Drug spending is more than we thought, but it is still a small fraction of overall healthcare spending. And pharmaceuticals can lower healthcare spending in other parts of the system. So why does this overall narrative matter? 

The cocktail is brewing for a volatile discourse that the biopharma managers can ignore only at their peril

First, it matters because biopharma is approaching physician and clinical services share of around 20%. 

Second, a handful of the drugs, mostly in the lesser understood 6%, account for over one-half of the healthcare inflation.

Third, this handful of drugs is much easier to target for any cost-containment efforts than the countless clinicians. 

Above all, the recent script has turned pointedly against the biopharma industry, and globally so. Add the Trump unpredictability, and the cocktail is brewing for a volatile discourse that the biopharma managers can ignore only at their peril. Key to this disparity will be in looking closely at the specialty drugs and differentiation in clinical benefit to patients, cumulative costs over their duration of use, potential for savings to the system from co-morbidities, and price increases over time, to assess their true benefit.

This column originally appeared on Scrip Biopharma Intelligence, May 24th, 2017