Stories about hospitals going bankrupt during the COVID-19 pandemic brought new attention around the challenges of health system economics. Health systems, hospitals, and other like organizations are all businesses, and like any other businesses, management of revenue, costs, and cash flow are never-ending management battles.

During COVID-19, several streams of income stalled for most health systems while cost categories did not reduce at the same rate. Most elective and routine procedures and visits all but vanished. Costs reduction was more complex, opening a deeper conversation about what makes up health system costs.

One set of healthcare cost categories that get a lot of attention are prescription drugs and medical products. Studies conducted in 2018 have calculated that these two categories make up about 12.8% of total US healthcare spending. Understanding exactly what percent of total income from a health system or hospital goes towards paying for drugs can be difficult to track, even more so in volatile times. While we typically think of insurers footing the bill for drug costs, health systems usually also have internal pharmacies and are directly impacted by changes in wholesale drug prices.

A 2019 report conducted by the University of Chicago and funded by the American Hospital Association noted that average total drug spending per hospital admission increased 18.5% between 2015 and 2017. Of that, outpatient settings experienced in an incre health system economics ase of 28.7% while inpatients increased 9.6% in the same period. Importantly, the study also mentioned that more than 90% of hospitals surveyed reported having to identify alternative therapies to mitigate the impact of price increases and shortages.

A Race to Demonstrate Value Beyond the Pill

Over the same period, drug makers have been working hard to create value beyond their pills and work closely together with HCPs and other drug buyers to advance their goals. The objective in doing so is to demonstrate the drug maker’s commitment to the disease area, the patient population, and invest in services that help to reduce barriers to purchase (e.g. copay financial support programs). At a high level, building strategic partnerships with health systems from research through to treatment has become an imperative in the life sciences industry.

Pricing naturally becomes a topic of conversation at the heart of the relationship between drug makers and health systems, and certainly with insurers. The majority of drug products in the US today are priced with a ‘fee for service’ model. Under this pricing model those buying the drug product pay for each pill that’s dispensed, regardless of the outcomes that the drug product drives. There may be different prices for different buyers, but the principle of “price per pill” is held constant.

In a common scenario like this, imagine identical drugs given to two patients at the same hospital that have two completely different outcomes. One patient might recover fully and exit the health system. Another may not recover, stay in the health system or even require more intensive and costly care. In this scenario, both drugs cost the hospital the same to dispense. Those may or may not be fully covered by a patient’s insurance, sometimes leaving hospitals to foot a component of that cost.

Health System Economics: Creating Strategic Alliances for the Future

Is it possible for the health system goal to minimize cost and the drug maker goal to build strategic alliances to be achieved at the same time? While there is no silver bullet, value-based pricing arrangements (VBA) can offer a step in the right direction and a window into the future.

Under these agreements, the purchaser agrees to pay the drug maker on payment terms tied to the clinical outcome of the drugs. Both parties agree to specific and measurable outcomes called quality measures and align on verifiable clinical testing methods conducted by a third-party. The result of this scenario at scale is that the purchaser now has a lower cost per drug dispensed, considering that some instances may not always drive desired clinical outcomes.

These types of arrangements have been successfully piloted by rare disease companies for products like Spark’s gene therapy Luxturna or Alnylam’s RNAi drug Givlaari, or in other situations where the cost is significant on a per patient basis, or where the patient population is very small. Successes these companies are seeing are creating the groundwork for larger shift in pricing practices that will eventually move to disease areas with much larger patient populations.

What does it take to create leadership position as a drug maker leader in this space today; to build strategic alliances and demonstrate your commitment to total cost management for your customers?

1. Organizational Alignment: Strategic alignment on the value of VBA style contracts throughout the organization. Commercial, market access, and medical affairs can only act in sync with one another to investigate and establish these types of contracts if there is absolute alignment from corporate strategy down to brand and marketing plans around their intent, objectives, and metrics.
2. Data and Analytics Maturity: The establishment of a VBA requires significant investment and capability around data and analytics within an organization. This maturity allows companies to manage the lifecycle of the data required to personalize the pricing and reimbursement process for each patient within each health system and insurance organization.
3. Digital Stakeholder Engagement: Active management of the partnerships required for VBAs need more than just back-end infrastructure for transacting. Leaders in this space are building digital hubs that offer avenues for engagement of all the parties involved to centralize data and accelerate informed decision making.