© 2001 The People-To-People Health Foundation, Inc.

Health Affairs

September, 2001 - October, 2001

LENGTH: 2987 words

TITLE: The Impact Of Pipeline Drugs On Drug Spending Growth ; New drugs in the
pipeline while beneficial could raise national estimates of drug spending $19 billion by
2004.

AUTHOR: C. Daniel Mullins, Junling Wang, Francis B. Palumbo, and Bruce Stuart

TEXT:
Among all components of escalating health care expenditures, spending on prescription
drugs is among those growing the fastest. The drug spending growth rate in 1995 1999
was more than twice that of overall health care spending. During that five-year period the
annual growth in drug spending increased 10 17 percent, while annual national health
expenditures increased 4 6 percent.1 Most of the prevailing literature has focused on
price increases as a major component of drug spending increases. Clearly, as prices
increase each year, drug spending surges upward correspondingly. However, two other
components that greatly affect drug spending are product shift and utilization. Product
shift occurs when newly approved drugs replace older therapies. As these new drugs enter
the market, they often bear higher price tags than do the older drugs they replace and may
also expand the market.

Pipeline drugs are entities that are undergoing testing but have not yet received approval
from the U.S. Food and Drug Administration (FDA). In 1999, 643 drugs were undergoing
Phase II/III or Phase III clinical trials in the United States or awaiting drug approval for
treatment of human diseases and disorders.2 Although drugs in Phase II/III testing have a
reasonable probability of gaining FDA approval within the next two to five years, one
should keep in mind that only one of every 3.5 drugs entering Phase II is ultimately
approved by the FDA.3

As product shift occurs with increased prescribing of newer pharmaceutical agents to

replace older drugs, the average price of prescriptions goes up, use of newer drugs
increases, and drug spending rises. The average price per prescription may rise, as was
the case with Cox-2 inhibitors (such as Celebrex and Vioxx) replacing generic versions of
older nonsteroidal anti-inflammatory drugs (NSAIDs). These new therapies may have
major benefits, such as reduced side effects or greater clinical effectiveness. However,
they are often more expensive than the therapies they replace. In addition, the benefits of
the newer therapies may lead to greater utilization. These newer products serve new
markets and meet the demands of older markets. For example, when Lipitor, a
cholesterol- lowering drug, was introduced in the late 1990s, its sales skyrocketed to
more than 1.5 million prescriptions in the thirteen months following its introduction.
People who were already being treated with other cholesterol-lowering drugs generated
some of these sales, but many sales were to new patients.

Components Of Drug Spending Increases

Drug spending increases can be broken down into three components: price, utilization,
and product shift. Each plays a pivotal role in determining the growth of future drug
spending. By examining where those components have charted historically, one can
predict the relative importance of each on future spending.

There are numerous studies that examine the relative contributions of changes in price
and utilization; we chose three representative studies that provided valuable projections
of future drug expenditures. In each of these studies, the research groups laid the
groundwork to justify the principle that historical precedent can serve as an indicator
forfuture spending. There was considerable variation in how the studies measured the
relative impact of price and utilization increases. For example, Robert Dubois and
colleagues analyzed seven diseases and their corresponding drug classes and found that
the relative ratios of increased volume to increased price ranged from a low of 2.5:1 to
more than 10:1. Based on these results, they argued that volume would be the major
component of spending change for most of the diseases they examined.4

Contrasting results emerged from a 1999 study conducted by Barents Group for the
National Institute for Health Care Management Research and Educational Foundation.
This study found that higher drug prices accounted for 64 percent of the total increase in
drug spending from 1993 to 1998; utilization accounted for 36 percent.5 These
researchers also found that the relative contributions of price and utilization varied
greatly across therapeutic categories.

The work of the pharmacy benefit management (PBM) company Express Scripts
demonstrated that the use of common drugs (defined as drugs other than those introduced
since 1996) grew by 6.2 percent and accounted for 38.8 percent of their total 1998 1999
cost increase.6 The increases in the average wholesale price (AWP) ingredient costs per
prescription for common drugs were responsible for half of the company s overall
prescription drug spending between 1998 and 1999. Express Scripts estimated that the
rate of inflation accounted for almost one-third of the overall 17.4 percent increasing
trend in per member per year AWP cost.

Overall, the available literature provides scarce quantitative projections of the potential
impact of pipeline drugs on future spending. American Druggist s top 100 (from 1995 to
1998) charts new drugs as consisting of close to half of the market share. As a category,
new drugs may be thought of as those drugs that were referred to as pipeline drugs
several years ago. The Barents Group and Express Scripts studies take this perspective.
The study by Dubois and colleagues provides insight into high-profile new drugs. The
studies results, however, are difficult to quantify in a uniform fashion given that (1) the
timeline upon which a pipeline drug was defined varied, and (2) the scope of the pipeline
drugs markets varied according to the definition of the drug/disease categories. Barents
Group defined new drugs as those that were launched in 1992 or later.7 Express Scripts
1999 report estimated the impact of the introduction of new drugs by looking at the drugs
introduced after 1996.8 Since neither of these studies adequately addressed the impact of
pipeline drugs on drug spending growth, our research fills a gap in the existing literature.

Our study has two objectives. The first is to disaggregate historical drug spending
increases into three components: price increase, utilization increase, and product shift.
The second objective is to demonstrate the potential impact of pipeline drugs on annual
drug spending increases, factoring in what has been observed historically for newer
drugs.

Using projections from the Health Care Financing Administration (HCFA, now the
Centers for Medicare and Medicaid Services, or CMS) as a reliable baseline measure, this
paper presents upper and lower bounds of their estimates surrounding future drug
spending based on plausible scenarios of the influence of pipeline drugs. While CMS
estimates do not specifically address pipeline drugs, they do provide a growth range of
national health spending that combined historical data and projections based upon those
data. These estimates predict drug spending increases of 17.4 percent from 2000 to
2001,with the annual rate of increase declining to 12.1 percent in 2004.9 We examine
how the insertion of pipeline drug trends can potentially adjust these trends. For example,
if pipeline drugs show a stronger influence than assumed in the baseline model, then the
CMS numbers would underestimate the probable future trend in drug spending.
Conversely, if the impact of pipeline drugs becomes weaker and there is increased use of
generic drugs, then the CMS estimates may overstate future trends. The CMS s numbers
reflect historical data as predictors of future growth and therefore are subject to
uncertainty. Furthermore, there are higher and lower estimates from other studies that fall
above and below the CMS scale. Such variation arises because of differences in the
market basket of drugs that are examined, the data sources, and the underlying
assumptions surrounding the projections.

Historical Contributions Of Price, Product, And Utilization

Our study examined those drugs reported by American Druggist as being in the top 100,
based on prescription volume, in 1995 1998.10 The underlying assumption is that these
drugs can be used to describe the pharmaceutical marketplace. They represent
approximately 40 percent of drugs dispensed in community pharmacies, based on
prescription volume. Since the top 100 drugs changed from year to year, a total of 131
drugs were included in the top 100 list over the four-year period. These data were
matched with drug price information from an AWP database. Although the AWP does not
reflect the actual price paid by retailers and consumers, it may serve as a reasonable
proxy for calculating the percentage change in spending as long as the relative variance
from price is constant over the study period. However, there are scarce data documenting
the typical rebate and markup percentages, so it is difficult to determine whether they
changed in the late 1990s.

The price associated with the most common dosage form, strength, and package size was
used for each drug. If two or more generically equivalent versions of the same drugs on
the top 100 list were produced by different manufacturers, all were included in our
analysis. Price information was available for 129 of the 131 drugs. The other two drugs
were thus excluded. We multiplied the number of prescriptions by the corresponding
prices to produce a proxy for drug spending.

These data were used to estimate the historical components of drug spending increases,
which include the pure price inflation effect, the utilization effect, and a product shift
effect. The drug price increase was estimated based on those drugs that remained on the
top 100 list for two consecutive years. The utilization increase is based on the utilization
growth rate of all drugs. Removing the contributions of these two factors, one can obtain
the value of the third component: increases in the average cost per prescription as a result
of switching from older drugs to newer drugs.11

American Druggist reports complete data on the total number of prescriptions for all
drugs, so we could calculate the utilization increase based on all drugs, not just the
sample of those drugs in the top 100 in a given year.12 Thus, our estimate of utilization
increases is the percentage increase in the total number of prescriptions from one year to
the next. Calculations for projected expenditures and price inflation were more complex
because we had to model our estimates based on the top 100 sample. To acquire accurate
estimates, we used two distinct methods. The first involved a fixed basket of drugs and
measured the utilization-weighted mean of annual percentage increases in the prices and
expenditures for the top 100 sample. The numbers of prescriptions were used as weights.
This method focused exclusively on those drugs that remained in the top 100 list for two
consecutive years. Because this method uses a fixed basket of drugs, it is fine for
calculating pure price inflation but may be problematic for calculating spending
increases.13 Therefore, we used an alternative method, one that reflects the change in
spending from an old basket of drugs to a new basket. This second method consisted of
calculating the annual percentage increase in total spending for all drugs on the top 100
list from one year to the next, allowing the basket to change. Thus, the spending increase
includes all three components: pure price inflation, increase in utilization, and product
shift.

Based on this methodology, slightly less that one-third of the drug spending increase
between 1995 and 1998 was due to price gains on existing drugs, approximately one-third
was due to increases in the use of existing drugs, and slightly more than one-third was
due to product shift. Thus, while the three contributing factors have similar impacts, the
increased use of newer drugs is the most important by a small margin.

We also estimated the relative contribution of newer drugs to the overall drug spending
increase, to appraise the possible contribution of pipeline drugs. Based on our data, the
historical spending increase was 15 percent for all drugs, 25 percent for newer drugs, and
7 percent for older drugs. Our findings indicate that although newer drugs, as a proxy for
pipeline drugs, constituted 45 percent of the top 100 drugs during our study period, they
contributed 75.3 percent of the overall drug spending increase. This contribution reflects
not only the product shift from older to newer drugs, but also the corresponding increases
in prices and use of these drugs. The remaining 25 percent is attributable to price and
utilization increases of drugs that are more than five years old. Furthermore, the relative
contribution of pipeline drugs appears to have increased over time.

Implications For Future Spending Trends

To determine how the impact of pipeline drugs could influence future drug spending
trends, we modeled several variations around the CMS projections, using our own
research on the relative contributions of pipeline and other drugs. These projections are
intended not to replace the CMS estimates but rather to provide a plausible range around
those estimates.14 For brevity, we provide only upper- and lower-bound projections
around the CMS estimates and acknowledge that the procedures to obtain the upper and
lower bounds use different methods.15 We also have taken into consideration that the
CMS did not address pipeline drugs.

To generate these estimates, we hypothesized that the relative contribution of pipeline

drugs on overall spending increases from our own research, estimated at 75 percent,
could be applied to the CMS s annual spending estimates. We then explored several
alternative scenarios, holding constant the portion of the CMS estimates attributable to
nonpipeline drugs, while allowing the pipeline component to change. In estimating the
lower bound we considered changes in the number of new drug approvals and the relative
contributions of pipeline and other drugs to overall spending based on our research. The
compounded annual growth rate of new drug approvals decreased 7.5 percent over 1996
2000. Assuming that this decline reduces the contribution of pipeline drugs to future
spending by the same percentage, we calculated revised estimates of the annual change in
drug spending. In the lower-bound scenario the pipeline drug component isdecreased by
7.5 percent from the CMS estimate each year, while that of nonpipeline drugs remains
consistent with the baseline case (Exhibit 1).16

For the upper-bound analysis, we presupposed that the percentage increase in spending
for pipeline drugs for 2000 2004 would increase at the same level as for 1995 1998.
Continuing to assume that the changes in nonpipeline drugs would follow the baseline
trend from CMS projection and our estimates of the share of pipeline and other drugs, we
calculated the estimate for the upper bound.

Based on the CMS model, drug spending is projected to increase from $116.93 billion to
$196.91 billion between 2000 and 2004 (Exhibit 2). According to our lower-bound
analysis, it is projected to reach $191.56 billion in 2004. Our upper-bound scenario
projects national drug spending of $215.62 billion in 2004. Thus, there is approximately a
12 percent variance for the 2004 estimate using our upper- and lower-bound estimates.
The CMS projections predict different percentage increases each year, which translate
into an overall compounded drug spending increase of 13.92 percent annually over the
five-year period. The corresponding average compounded increase is 13.13 percent using
our lower-bound estimate and 16.53 percent using our upper-bound estimate.

Discussion And Policy Implications

We began this paper by citing the work of other researchers, who have produced widely
divergent estimates of future drug spending increases. The CMS projections for 2000
2004 have changed as new data have become available. In its 2000 projection, the CMS
had data only through 1997, and the agency s projection for 2000 2004 was in the range
of 10.2 11.4 percent. However, when data through 1999 were included, the projection for
the same period rose to 12.1 17.4 percent.17

Our assumption that the future impact of pipeline drugs can be predicted based on the
relative impact of recently released drugs may seem to be a heroic one. Indeed, it is
subject to variability in the same way that predicting future drug trends based on
historical spending patterns is speculative. The uncertainty surrounding the impact of
pipeline drugs on future spending underscores the reason why drug spending trends are
so sensitive to the under- lying assumptions of the predictive model.

Based on the analysis presented in this paper, the impact of pipeline drugs on total
expenditures could alter the CMS s projected drug spending growth rate by around one to
three percentage points. Although seemingly small on a percentage basis, these
alternative estimates translate into a $24 billion difference between our lower- and upper-
bound estimates for 2004. Therefore, consideration of pipeline drugs is imperative for
understanding and projecting future drug trends.

With so many drugs in the pipeline, there will undoubtedly be innovative drugs that will
assist patients who went untreated before. How our society will pay for these new
treatments is one of the most important health policy questions we face. In an era of finite
resources, the question is how to balance providing access to as many of these innovative,
life-saving drugs as possible without increasing premiums beyond health care purchasers
ability to pay. Rising demand for pharmaceuticals makes this balancing act a challenge.
Future studies on the value of pipeline drugs will aid enormously in this decision-making
process.

Funding for this project was provided by the Health Insurance Association of America
and the Blue Cross/Blue Shield Association.NOTES

REFERENCE:
[n1.] Centers for Medicare and Medicaid Services, National Health Care Expenditures
Projections Tables, March 2001, www.hcfa.gov/stats/NHE-Proj/proj2000/tables>> (30
March 2001); and CMS, National Health Care Expenditures Projections Tables, January
2000, www.hcfa.gov/ stats/NHE-Proj/proj1998/tables>> (30 March 2001).

[n2.] Products in the Pipeline, What s in the Pipeline (A supplement to MedAdNews, July
1999): 17 148. In Phase II clinical trials, the study drug or treatment is given to a larger
group of people (100 300) to see if it is effective and to further evaluate its safety. In
Phase III studies, the study drug or treatment is given to large groups of people (1,000
3,000) to confirm its effectiveness, monitor side effects, compare it to commonly used
treatments, and collect information that will allow the drug or treatment to be used safely.
National Institutes of Health, clinical trials.gov>> (9 July 2001).

[n3.] M. Montagne, Drug Use and the Pharmaceutical Sector in the United States, in
Introduction to Health Care Delivery: A Primer for Pharmacists, ed. R.L. McCarthy
(Gaithersburg, Md.: Aspen, 1998).

[n4.] R.W. Dubois et al., Explaining Drug Spending Trends: Does Perception Match
Reality? Health Affairs (Mar/Apr 2000): 231 239.

[n5.] Barents Group LLC, Factors Affecting the Growth of Prescription Drug
Expenditures (Washington: NIHCM Foundation, 9 July 1999).

[n6.] Express Scripts, 1999 Drug Trend Report, www. express-

scripts.com/newsviews/industryreports/ drugtrendreport.htm>> (30 January 2001).

[n7.] Barents Group, Factors Affecting the Growth.

[n8.] Express Scripts, 1999 Drug Trend Report.

[n9.] CMS, National Health Expenditure Projections: 2000 2010, March 2001, Table 11,
www.hcfa. gov/stats/NHE-Proj/proj2000/tables/t11.htm>> (16 March 2001).[n10.] The
Top 200 Drugs, Drugs Dispensed Most Often in U.S. Community Pharmacies, Total
Prescriptions (New and Refill), 2,140,799 in Sample, American Druggist (February
1996): 19 20; The Top 200 Drugs, Drugs Dispensed Most Often in U.S. Community
Pharmacies, Total Prescriptions New and Refill (2,248,672,000 in sample), American
Druggist (February 1997): 32, 34; The Top 200 Drugs, Drugs Dispensed Most Often in
U.S. Community Pharmacies, Total Prescriptions New and Refill (2,355,489,000 in
Sample), American Druggist (February 1998): 4850; and The Top 200 Drugs, Drugs
Dispensed Most Often in U.S. Community Pharmacies, Total Prescriptions New and
Refill (2,486,066,000 in Sample), American Druggist (February 1999): 42 43.

[n11.] Technically, the result is obtained through division, not subtraction, since factors
accounting for growth in spending are multiplicative, not additive.

[n12.] American Druggist reports the original raw data for the top 200 drugs and the
aggregate for the marketplace each year, along with statistics about how these numbers
have changed over time.
[n13.] Since drugs in a growth phase are more likely to remain on the top 100 list for two
consecutive years, using a fixed basket of only those drugs that are among the top 100
drugs for two consecutive years would overestimate the spending increases.

[n14.] It should be noted that we are basing projections off the CMS estimates to
illustrate a potential range without the assumption that these estimates would represent
the midpoints.

[n15.] More detailed information may be obtained from dmullinsrx.umaryland. edu>>.

[n16.] The most recent year shows an increase over the previous year. The 2000 number
is incorporated in the 7.5 percent compounded decline.

[n17.] CMS, National Health Care Expenditures Projections Tables.

Jn

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