<strong>Health Care Costs and Drug Companies: Who Profits?</strong>

September 21, 2004

by Todd Chatman, editor-at-large
As the ACS Blog noted recently, U.S. health premiums have been rising faster than income for the past four years, including a jump of 11.2% this year alone. As a consequence, fewer jobs now come with health benefits. According to this survey of 3,017 companies by the Kaiser Family Foundation and the Health Research and Educational Trust, "There are at least 5 million fewer jobs providing health insurance in 2004 than there were in 2001." And to many, the future looks bleak. "There is a great sense that there is just no answer to this problem," says Drew Altman, president of the Kaiser Family Foundation.

But health care costs are not the only things that are sky high these days. According to a new book, The Truth about the Drug Companies: How They Deceive Us and What to Do about It, by Dr. Marcia Angell, the pharmaceutical industry has also been making astounding profits. Writing in "The New York Times Review of Books," Angell summed up the situation this way: "In 2001, the ten American drug companies in the Fortune 500 list (not quite the same as the top ten worldwide, but their profit margins are much the same) ranked far above all other American industries in average net return, whether as a percentage of sales (18.5 percent), of assets (16.3 percent), or of shareholders' equity (33.2 percent). These are astonishing margins."
So what's the relationship between skyrocketing health care costs and the "astonishing" profits of pharmaceutical companies? Well, according to the National Coalition on Health Care (citing a report in the Christian Science Monitor -subscription required), "Since 1995 the average annual rate of increase for prescription drug expenditures (on average 15 percent per year between 1995 and 2001) was higher than for any other type of health expenditure." The Newsbatch summary of health care issues puts it even more plainly: "Prescription drugs are the fastest-growing part of the nation's health care expense." Such claims are backed by figures from the Dept. of Health and Human Services. According to the Center for Studying Health System Change, the cost of prescription drugs as a percentage of the total U.S. health care bill has fallen recently, but there's no doubt that the price of prescription drugs is a critical component of overall health care costs. Is it possible that the cost of prescription drugs-and therefore, the overall cost of health care-would come down if the companies making those drugs pocketed a little less profit?
Not surprisingly, the pharmaceutical industry has a simple answer to that question: No. It has offered a number of reasons why its current margins are justified, even as more and more Americans are finding it impossible to cover the rising cost of health care. For starters, it says its profits are not that high at all. In a 28-page rebuttal(PDF) to Angell's book (excerpted here, the Pharmaceutical Research and Manufacturer's Association (PhRMA) says its industry "is not nearly as profitable as some statistics and critics would suggest." PhRMA cites a "1994 report by the non-partisan Congressional Budget Office (CBO)," which stated that "properly measured, pharmaceutical company profits are only slightly above the average for companies in all industries."
More importantly, PhRMA argues, its profits-and the high drug prices at their source-are justified because they're all part of a cycle of innovation that's good for society. "[P]rofits help attract investment, investment leads to pharmaceutical research, and research yields new medicines for patients," PhRMA claims. And, according to PhRMA President Alan F. Holmer, if pharmaceutical companies make money, that's only because they're willing to take massive risks.
"This is a very high risk industry with potentially high reward," Holmer argued in a radio interview with Diane Rehm and Angell on September 10th. "We talk about rocket science sometimes," Holmer said, but creating a new prescription drug is "much harder than rocket science. Dr. Angell says that we should really treat these companies and regard them as something like public utilities. Well believe me, public utilities aren't going to come up with a cure for cancer, or for Alzheimer's, or in the case of my family, for cystic fibrosis. This is a very very high risk enterprise."
But in the same interview Angell argued that the industry's claims about the relationship between its risks and rewards are overblown. First, she claimed, even if drug development is risky, the industry's profits are still wildly out of line with what it spends on research and development. According to Angell, the annual statements of the 10 pharmaceutical companies in the Fortune 500 show that in 2003 they spent $30 billion on R&D, and $67 billion on marketing and administration, while they pocketed $37 billion in profit.
Angell argued that such profits were excessive, challenging Holmer's basic claim that drug development is risky at all. "You can hardly call an industry risky," Angell said, "if, year after year for over two decades, it's the most profitable in the United States. This is very low risk. It's as though you were to accuse somebody who went to Las Vegas with a thousand dollars and every time came home with fourteen thousand dollars-of gambling. He's not gambling, he's making money, and it's being done regularly."
Angell is not alone in this view; in a 2001 report(PDF) on the cost of drugs, Public Citizen called research and development costs nothing more than a "scare card" the pharmaceutical industry plays when anyone tries to challenge its profits. "The central claim of PhRMA's campaign is ominous," Public Citizen wrote. "[I]f anything is done to restrain high U.S. prescription drug prices, then research and development (R&D) to find new drugs for life-threatening diseases will suffer."
But while reasonable minds might disagree about whether research costs justify the profits made by pharmaceutical companies, PhRMA argues that the industry's profits are really irrelevant to the cost of health care in the U.S. It cites Princeton economist Uwe Reinhardt who claims, "Even if the pharmaceutical industry had no profits, little effect would be had on health expenditures." Using data from 1996, Reinhardt estimated that "even if all of the profits on that year's drug spending had been confiscated and rebated to American health care users," the average American would have paid only $50 less for health care that year.
Reinhardt's hypothesis is unlikely to be tested anytime soon, but, according to Angell, there are signs that American consumers and legislators are increasingly skeptical that there's really nothing to be done about high drug prices. One such sign is the movement by some states to help their citizens import cheaper drugs from Canada and elsewhere (although recent siezures of imported drugs suggest that the FDA may be cracking down on such efforts). Meanwhile, although the Medicare reform act passed last year expressly forbid the government from using its power as a large purchaser of drugs to negotiate lower prices, groups like the Center for American Progress have been quick to suggest ways to change that. Public opinion is also overwhelmingly in favor of some way to reduce prices. A recent Harris Poll found that "66% of all adults think that prescription drug prices are unreasonably high. This is an increase over the number who felt this way in three earlier surveys conducted over the last three years."
Whether these developments will have any effect on either pharmaceutical profits or the cost of prescription drugs is unclear, but nearly all sides seem to agree that something must be done to ensure that Americans who need prescription drugs can afford them. According to Princeton's Reinhardt, the solution is for pharmaceutical companies to use their considerable resources to "agitate to get people insurance, because insured Americans don't give a tinker's damn about drug prices."
"[T]he real social piece in health care for the drug industry would be to make sure that sick Americans don't bleed to death fiscally when they buy drugs," Rienhardt adds. "And it is so simple. It is just that simple. And [the drug industry] should be the champions of that."