Economics of Health Care:
Understanding Health Care Cost Drivers

Prescription drug spending is one of the fastest growing costs, followed closely by hospital care and physician services. Three main factors influence prescription drug costs—consumption, price fluctuations and drug types.

Americans continue to use more prescription drugs to manage their health. As billions of dollars are spent on promoting brand name drugs, both the cost and demand for these drugs continue to rise. Generic drugs (on average) are 20 percent less expensive than brand name drugs.²

Our country is spending more on health care because we are consuming more health care services. This includes the overuse and misuse of health care, which is a major contributor to rising health care costs. For example, some people may visit the emergency room when an urgent care clinic or doctor’s office visit could sufficiently meet their needs at a much lower cost.

Another significant cost driver is a result of doctors practicing defensive medicine. Over-testing patients is a precaution that many doctors take to protect themselves from malpractice lawsuits. Nearly three-quarters of doctors practice defensive medicine at an annual estimated cost of $650 billion.³

Medical advances are another significant cost driver. While new technology can be life-saving, there is a cost involved in making such treatments available. In comparison to Canada, the United States has nearly three times as many CT scanners and four times as many MRI units per person.⁴ Both machines cost hundreds of thousands of dollars each.

Approximately 70 percent of all health care costs are directly related to personal behavior.⁵ In addition, nearly three-quarters of all costs can be traced to cardiovascular disease, cancer, diabetes and obesity. Each of these costly conditions are preventable much of the time.⁵

Unhealthy behaviors can result in costly chronic conditions. For example, while smoking is harmful to the user, children also can become asthmatic from being around an adult’s secondhand smoke. Research shows that people with chronic conditions generally use more health care services, which include doctor visits, hospital care and prescription drugs. Insurance works by spreading costs across the sick and healthy—so an individual’s chronic condition affects everyone’s health insurance premiums.

Each year, thousands of Texans rush to emergency rooms to receive treatment for preventable injuries. For children and adolescents alone, medical costs for preventable injuries in the U.S. are $17 billion annually.⁶ Simple actions—such as buckling seatbelts and consistently using bicycle helmets—can help prevent injuries and reduce costs for everyone.

It’s probably no surprise that health care fraud is a key driver of rising health care costs. Approximately 3 percent of all health care spending—or $68 billion annually—is lost to health care fraud.⁷ This type of fraud comes in many forms and is committed by people who provide health care services and by those who receive services. Many consumers forget that ultimately we all pay for the activities of those who abuse the system.

The health care industry also is experiencing displaced costs. Private insurers’ payments to health care providers have traditionally increased since 1999, while payments by Medicare and Medicaid have decreased over this same time.⁸ This process is shifting the costs from Medicare and Medicaid to private insurers, requiring private insurers to pay increasingly more and resulting in increased private insurance costs.⁸

Approximately 46.3 million Americans do not have health insurance⁹, and this growing number contributes to the increasing cost of health care for everyone. It is not unusual for people without health insurance coverage to wait to seek medical care. This can complicate a simple health problem, making it more costly to treat. In addition, people without health insurance coverage often seek treatment for nonemergency ailments in the emergency room—an expensive alternative to visiting the doctor’s office.

Another challenge to affordable health care coverage is maintaining a balance between relatively healthy people and those who experience more health issues. The sustainability of health insurance coverage is based on having a variety of people in a collective pool —both healthy and unhealthy—to share the risk of the group.