RD4 - Pharmaceutical Expenditures in the Commonwealth of Virginia


Executive Summary:
Like other states, Virginia has experienced rapid growth in expenditures on pharmaceuticals in recent years. The recent increases in government-funded pharmacy expenditures are of concern because they force a reallocation of tax revenues away from other possible uses. In response to this concern, Item 266C of the 2000 Appropriation Act directed the Secretary of Finance, in cooperation with the Secretaries of Administration and Health and Human Resources, to conduct a study that examines the trends in Virginia's pharmaceutical expenditures, the drivers of those trends, the impact of pharmaceutical utilization on the quality of health care, and budgetary impacts within government-funded health care programs. Consistent with the mandate, this study concentrates exclusively on government-funded pharmaceutical expenditures. The impact on consumers, while important, is beyond the scope of this study.

Pharmaceutical Expenditure Trends

In FY 2000, Virginia spent approximately $223 million, 2.2 percent of its total general fund budget, on prescription drugs. This is an increase of 86 percent from the $120 million spent in FY 1996. Total funds spent on pharmaceuticals in FY 2000 were approximately $441 million. (*1)

The Department of Medical Assistance Services is the largest government purchaser of prescription drugs in the state, followed by the Department of Human Resource Management. Together, these two agencies accounted for over 90 percent of all government pharmaceutical expenditures over the past six years.

Increased utilization of prescription drugs has been a key factor in higher expenditures. In Virginia's Medicaid program, prescriptions per recipient have risen from an annual average of 18.5 in FY 1996 to 25.5 in FY 2000. In the state employee health benefit plan, the average number of prescriptions per member rose from 8.9 to 10.3 in three years. (*2)

Utilization Factors

• Advancements in medical science: The introduction of new therapies for previously untreatable diseases, improvements in rates of diagnosis and awareness of disease, and longer life spans all contribute to greater numbers of individuals receiving drug therapy treatment and remaining under treatment longer.

• Demographics: The increasing number of elderly individuals in the population have and will continue to be a significant factor in rising pharmaceutical expenditures for the foreseeable future. Older patients tend to have more chronic diseases or multiple conditions and, consequently, higher pharmaceutical use than other age groups in the population.

• Changes in accepted medical practices: Many new treatment protocols call for more pharmaceutically intensive treatment of diseases, such as drug-therapy intensive disease management programs.

• Direct-to-consumer (DTC) advertising: Advertising to consumers by pharmaceutical manufacturers has increased substantially in recent years. In 1999, prescription drug manufacturers spent $1.8 billion on DTC advertising, up 38.5 percent from the $1.3 billion spent in 1998 and 33 times the $55 million spent on DTC ads in 1991. (*3)

Increased prices for prescription drugs have driven expenditure growth. The average net price per prescription (after rebates) in the state Medicaid program increased 53 percent in five years, from $22.40 in FY 1996 to $34.36 in FY 2000. In the state employee health benefit plan, the average net price per prescription (after rebates) increased 28 percent, from $33.84 to $43.38, in three years. The average price per prescription at the Department of Mental Health, Mental Retardation and Substance Abuse Services' aftercare pharmacy increased 168 percent, from $20.54 in FY 1997 to $55.03 in FY 2000. (*4)

Price Factors

• Increases in the prices of existing products and the introduction of new, higher priced, branded products both contribute to higher pharmaceutical expenditures.

• The average cost per prescription filled by DMHMRSAS's aftercare pharmacy increased 168 percent in four years. A significant factor in this increase is the use of new atypical anti-psychotic medications. In May 2000, the average price for an atypical drug was $184.87 compared to $24.02 for non-atypical drugs. Atypical medications accounted for approximately 22 percent of total prescriptions filled at the aftercare pharmacy in FY 2000. This represents an increase of 74 percent from the number of atypical prescriptions filled in FY 1999.

• In the Virginia Medicaid program, the average cost per claim (before rebates) in FY 2000 was $43.06. The average cost per claim for 36 of the more high profile new drugs was $121.61 that same year. (*5)

The Pharmaceutical Market and Factors Driving Expenditures

To plan effectively for future expenditures and to ensure that these expenditures are managed to maximize the gain in health outcomes per dollar spent, it is critically important to understand the factors that give rise to the increased costs. The pharmaceutical market is driven by a variety of interrelated forces, including the large number of different decision makers and the complex set of relationships between these parties. Attempts to influence one component of this market, without the benefit of the larger market picture, have the potential to lead to unintended and, very possibly, undesirable outcomes that could outweigh any benefits achieved.

Supply of Pharmaceuticals

The long-run supply of new therapies is determined, in large part, by the amount of investment in research and development. The amount of investment in R&D is determined by the expected future revenue streams from sales of the developed product. Since investment in R&D has increased rapidly in the past two decades, it can be expected that a large number of new pharmaceuticals will be entering the market over the next decade. This trend is reinforced by the increased understanding of the human genome.

The increased genetic information is expected to provide many new targets for innovative therapies.

By making much less expensive substitutes available for branded drugs, generic drugs add a significant element of price competition to the market. By providing close substitutes for branded drugs, generic drugs make the demand for the branded drug much more sensitive to price. It is interesting to note that the introduction of generic drugs does not necessarily result in reductions in the price of the branded version of the drug. However, for those buyers in the market who are sensitive to price, the approval of generic drugs represents an opportunity for significant savings.

Demand for Pharmaceuticals

The demand for prescribed medications is derived from the demand for medical care and good health. However, no medication can be demanded without a physician's prescription. The large number of different decision makers and the complex set of relationships between these parties complicate the demand for pharmaceuticals. A number of factors determine the demand for pharmaceuticals. The main factors include substitutability among therapies, demographics, advertising, and prices.

The substitutability among therapies, both actual and perceived, has an effect on how responsive demand for a prescription drug is to its price. The existence of close substitutes for a drug will tend to result in lower prices than would occur in markets without close substitutes. The aging of the population increases the demand for pharmaceuticals. The elderly population often has a greater need for medical care, and hence pharmaceuticals, than other age groups. The increase in advertising expenditures has resulted in more people seeking care for existing conditions and, in some cases, requesting specific therapies. Advertising is valuable because it alerts consumers to available therapies. However, advertising has the potential to shift prescription behavior away from the best or most cost effective therapy.

Firms charge different prices according to the sensitivity of a particular market to a change in price. As a market becomes more competitive, established firms and potential competitors must decide whether it is better to maintain a high price but accept a loss of market share, or charge a lower price to compete for market share. However, if pharmaceutical firms were only able to charge the much lower competitive price and were not able to earn the higher rate of return during the patent term, then the rate of return on investment in pharmaceutical innovation would fall, and some investment projects, possibly many of them, would no longer appear profitable, at least in the near term. There is an inherent trade-off between receiving the most benefit from drugs already developed by charging low prices and encouraging a high rate of research and development by charging higher prices.

Effects of Pharmaceutical Utilization on Health Care

Expenditures on pharmaceuticals are often associated with significant benefits. The benefits of pharmaceutical spending may be in better health outcomes for those using the therapy, although the value of these benefits can be very difficult to measure. In addition, under certain circumstances, there is good evidence that the medically-appropriate use of specific drugs may be associated with reductions in non-pharmaceutical medical expenses such as emergency admissions, hospital days, nursing facility care, surgical costs, and physician office visits. However, the issue depends critically on the context in which the drug is used and the intervention with which it is compared.

In Virginia, over $18 million was allocated for the funding of new anti-psychotic medications in the 1998-2000 biennium. The expanded availability of these new medications allowed more individuals to remain at home with their families in their communities as opposed to spending time in an institution. Total admissions to state mental health facilities dropped 32 percent in those two years. Populations in Virginia's state mental health facilities also decreased during that time frame.

Results from the Virginia Health Outcomes Partnership program for Medicaid asthma patients projected direct savings to Medicaid of $3 to $4 for every incremental dollar spent providing disease management support to physician. The disease management program provided guideline information about recommended asthma drugs and new state-of-the-art medications for asthma. The dispensing of drugs recommended by the guidelines for asthma rose sharply during the study period for patients of physicians participating in the disease management training. The rate of emergency visit claims for patients of participating physicians who received feedback reports dropped an average of 41 percent from the same quarter a year earlier, compared to only an 18 percent drop for comparison community physicians. (*6)
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(*1) These figures represent the estimated general fund portion of net pharmaceutical expenditures (exclusive of any indirect pharmaceutical expenditures paid for in managed care contracts) for the Department of Medical Assistance Services, Department of Mental Health, Mental Retardation and Substance Abuse Services, Department of Health, Department of Corrections, Department of Juvenile Justice, and Department of Human Resource Management. The total general fund budget in FY 1996 reflects total general fund expenditures and funds transferred out to higher education components from the Annual Report of the Comptroller to the Governor of Virginia. FY 2000 figure is preliminary estimate based on year-to-date expenditures and FY2000 appropriations to higher education components.
(*2) "Prescriptions per recipient refers to the number of individual transactions, new or refill, per individual. The days supplied per prescription are variable. This information is not intended to make a comparison of utilization increases between agencies, as many factors, such as population mix, length of prescriptions, and co-payments may differ.
(*3) National Institute for Health Care Management (NIHCM) Foundation. "Prescription Drugs and Mass Media Advertising." September 2000.
(*4) This information is not intended to make a comparison of cost increases between agencies, as many factors, such as population mix, length of prescriptions, and co-payments may differ. The data presented reflects the cost trend in each agency for years in which data is available.
(*5) Department of Medical Assistance Services. These figures do not include drug rebates, as rebate data for individual drugs is not available.
(*6) Rossiter. Louis F., and others. ''The Impact of Disease Management on Outcomes and Cost of Care: A Study of Low-Income Asthma Patients." Inquiry 37 (Summer 2000): 188-202.