ccording to many legislators and the media, pharma companies, abetted by Madison Avenue, lead the corporate villain list, just below auditors and errant CEOs. The critics' complaint: Compelled by clever-and expensive-advertising, gullible consumers are pressuring physicians to write prescriptions, then rushing out to buy unnecessary drugs, thereby pushing pharmaceutical costs up at double-digit rates.

The numbers seem to support the accusation. Medications accounted for more than 10 percent of healthcare spending in 2001, up from about 6 percent in 1990. And the leap of logic that many critics make, as Michigan Senator Debbie Stabenow told the New York Times recently, is that "excessive advertising only leads to higher prices at the pharmacy."

Ah, if only healthcare costs were as simple to understand as accounting methods. But the truth is more complicated than a single, villainous industry scenario. It also includes an institutional force that is hard to reform or control: namely, third-party payment systems that erode personal accountability in healthcare consumption.

Third-Party Payments In the early 1960s, according to the Department of Health and Human Services, pharmaceuticals accounted for more than 10 percent of total healthcare spending. Although that number fell to half that by the 1980s, it returned to 9 percent by 2000. During the next four decades, marketing spending as a percentage of sales remained roughly constant, 25–30 percent of sales for most companies, according to financial reports. So, although marketing spending has increased in absolute dollars as pharma sales have grown, it has been constant as a percentage of sales.

So what really accounts for the increase in Rx costs? A critical factor is the growing divide between who selects and uses the medicines and who pays the bills.

The evidence suggests that changes in third-party payments have had a significant impact on healthcare spending trends. Between 1960 and 1980, the proportion of total medical-care spending covered by third parties, including government programs, rose from 48 percent to almost 70 percent. During the same period, healthcare costs increased at almost twice the rate of the gross national product, rising from 5 to 9 percent of GNP, or from $27 billion to $246 billion (a $27 billion to $100 billion quadrupling calculated in constant 1960 dollars).

Although factors other than third-party reimbursement have contributed to the rise, they don't explain its magnitude. The US population grew by about 25 percent during the same period; the over- 65 age group grew by about 50 percent.

Even as Medicare and corporate health insurance programs became institutionalized during those decades, most US consumers paid for drugs out of their own pockets. That kept pharma spending growth in check while growth in medical spending exploded. As a result, the proportion of healthcare spending on pharmaceuticals fell by half.

During the 1990s, the situation made an about-face. Although the proportion of medical care spending reimbursed by third parties rose marginally-from 74 to 79 percent-there was a dramatic shift to third-party payment for pharmaceuticals. (See "Out-of-Pocket Nose Dive," page 74 and "Payment Shift," page 76.) In 1992, only 38 percent of full-time employees had Rx coverage. By 2001, that number had reached 88 percent. That increase in third-party payment, driven in large part by employers' desire to attract and retain talent in a competitive economy, clearly contributed to the rise in medicines' share of the nation's healthcare bill.

With third-party payment came a jump in drug spending. Between 1990 and 2000 it tripled, from $40 billion to $122 billion, growing from 6 to 9 percent of healthcare spending. During the same period, all other healthcare spending put together didn't even double, rising from $655 billion to $1,177 billion.

A Rand study recently published in the Journal of the American Medical Association (JAMA) gives further evidence of the impact of third-party payment on Rx spending. (See "Higher Co-Pays=Less Spend.") The study revealed that doubling patient co-payments from $5 to $10 per prescription cut spending by 22 percent-from $725 to $563 per year per person. The study included more than 400,000 employees in 25 large private companies, but regardless of whether it is representative, the impact of third-party payment on reimbursed Rx drug spending is clear: The more people must pay out of their own pockets per prescription, the less they spend overall. And that effect is independent of how much pharma companies spend on sales and marketing.