Drug Co-Payments Increase Hospital Outpatient Spending

Higher drug co-payments save money on drug spending, but cost money on outpatient spending and have much smaller effects on overall spending.

In the past 15 years, national spending on prescription drugs has grown dramatically, far outpacing the growth rate of spending on hospitals and physicians. In response to these rapid spending increases, many health insurance plans have reduced the generosity of their prescription drug benefits. Consequently, patients have been paying substantially more out of their own pockets for prescription drugs. Ostensibly, the benefit designers are seeking to reduce drug spending by increasing the prices, or co-payment, faced by consumers.

In Is Drug Coverage a Free Lunch? Cross-Price Elasticities and the Design of Prescription Drug Benefits (NBER Working Paper No. 12758), authors Martin Gaynor, Jian Li, and William Vogt use a large dataset of health insurance claims, together with information on benefit design, to identify the effects of changes in workers' employer-provided prescription drug benefits on drug spending, outpatient spending, and inpatient spending. Their study differs from previous work because they allow for dynamic adjustment by consumers; they explicitly control for selection; they use a large, nationally representative dataset; and, they address substitution between drugs and other types of health care.

There are two central findings of the research: first, there is substantial substitution between use of prescription drugs and use of outpatient care. Increases in out-of-pocket drug prices lead to decreases in the demand for drugs but to sizeable increases in both demand and spending on outpatient care. The authors do not find detectable changes in inpatient spending as a result of increases in drug co-payments, however. Second, the researchers find strong evidence of dynamic adjustments on the part of consumers: the effects of one year after an increased co-payment are substantially larger than the contemporaneous effects.

Further, consumers substitute outpatient care for drugs in response to rising drug prices. These effects, too, have a significant dynamic component: there is substantially more substitution to outpatient care one year after an increase in pharmaceutical cost sharing than at the time of the change.

In total, the authors find that the expenditure savings on prescription drugs are substantially offset by increases in outpatient spending. A $1 increase in drug price reduces drug spending by $23.62 in the first year, and $32.57 by the second year. However, total medical spending decreases by far less than that amount: $20.88 in the first year and $21.23 by the second. Thus, in the long run, total spending falls by about 65 percent as much as drug spending; that is, 35 percent of the savings achieved by reductions in drug spending are offset by consequent increases in other medical spending. Therefore, higher drug co-payments save money on drug spending, but cost money on outpatient spending and have much smaller effects on overall spending. These findings suggest that high consumer cost-sharing might not be as effective a mechanism for controlling spending as has previously been thought.

-- Les Picker