What drives health spending, and how can we hit the brakes on rising costs?


Feb 28, 2023

It’s no secret that health care is unsustainably expensive in the United States. Health care spending accounted for 18.3% of our GDP in 2021, at an average of $12,914 per person. That spending is only expected to grow, with McKinsey predicting that health expenditures will increase 7.1% by 2027, while the economic growth rate for the same time period is only predicted to be 4.7%

To summarize: our health spending is going to continue to outpace everything else. 

It’s not new that the US spends the most on health care, yet has some of the worst outcomes. But why does health care cost so much? Decades of engrained, fee-for-service business models and misaligned incentive systems perpetuate and exacerbate high costs. Yet, despite the systemic nature of the problem, individual innovators possess power to help lower costs for the communities they serve. In order to effectively do so, innovators should understand what, exactly, contributes to the high cost of care. 

Why does care cost so much?

There are a number of reasons health care spending in the US is so expensive. Below I highlight three of these sizable influencers. Note, these are not necessarily the three biggest contributors to high health care costs, simply three areas that play a major role, which innovative business models have the ability to tackle.

  1. The complexity of health care administration

Health care is incredibly complicated on the back end. Roughly one third of all health care spending comes from complex and duplicative administrative tasks, such as submitting and processing payments, sharing patient records, and more. Currently, there’s limited standardization and a lack of simplification in the care delivery system, making administrative tasks unnecessarily confusing to navigate even when compared to other countries who have multiple health payers. 

  1. The high cost of prescription drugs 

Prescription drugs play a major role in health management, but are also a major driver of care costs. Prices are negotiated through pharmacy benefits managers (PBMs), which determine which drugs are covered by insurance, negotiate where drugs are sold,, and pay pharmacies for the drugs they sell—a complex and often confusing process depicted in the chart below. Savings negotiated by PBMs are rarely passed on to patients, further driving up care costs. 

Source: PharmaNews Intelligence

  1. The overutilization of care

There is a vast overutilization of care problem in the US. Common examples of overuse are the overprescribing of antibiotics—particularly for conditions that don’t require antibiotics as a treatment. Overutilization has been a pervasive problem for years; in 2014, it was estimated that unnecessary overuse of care ranged from 10%-30% of all health care spending. This is exacerbated by a number of contributing factors, such as misaligned incentives for care provision, and poor care coordination, which can lead to duplication of care, raising care costs and lowering quality.

What can be done to solve this problem?

One of the hallmarks of disruptive innovation, as defined by Clayton Christensen, is making a product or service more affordable than what is currently on the market. While permanently tackling the high cost of care will take broader systemic action, innovators can begin to tackle some of the main drivers of high costs by developing innovative business models.

  1. Push for standardization

Focusing on discovering ways to streamline care processes can eliminate not just increased confusion and costs, but also work to cut out unnecessary care. Many tech-forward companies, such as Simplify Healthcare, are seeking to simplify back end processes for payers by streamlining them as much as possible. Simplify’s platforms automate administrative processes for payers and care providers alike, saving users time and money. 

  1. Cut out the middleman wherever possible

One of the sayings that comes to mind when I think of the complexity of care is “too many cooks in the kitchen.” The number of players in health care hikes up prices, particularly in the pharmaceutical industry. 

An example of an innovator seeking to address this complication is Mark Cuban’s Cost Plus Drugs. Instead of utilizing the traditional pharmacy benefits manager model of negotiating prices for drugs, Cuban contracts directly with drug manufacturers to offer generic drugs at low prices. 

  1. Focus on primary care innovations, particularly ones that are more comprehensive than traditional care models 

Greater primary care presence is linked to lower rates of overutilization of care, versus areas with fewer primary care providers, and also lowers the rate of patients immediately going to the hospital for even minor care needs.

Virtual care platforms can play a role in this expansion by bringing coordinated primary care into people’s homes. Digital provider organizations such as Circle Health don’t just treat common primary care concerns, but also provide mental health care and gender-specific and affirming preventative care, making their platform a one-stop shop for many care needs. 

While innovators need to work within existing regulatory constraints, regulation changes often follow successful innovations (such as the allowance of nurse practitioners to be full service providers in some states following the success of CVS’ MinuteClinic). 

There is still a long way to go to effectively control rising care costs, but innovators’ efforts to improve these root cause issues provide hope for more affordable care in the future.

Jessica is a research associate at the Clayton Christensen Institute for Disruptive Innovation, where she focuses on business model innovation in health care, including new approaches to population health management and person-centered care delivery.