Why Healthcare Is Unsustainably Expensive ₋ and What We Can Do About It

It can seem like a bottomless pit. Last year total healthcare spending across developed markets was probably around $6 trillion, a 20% rise on 2019.¹ Even so, healthcare systems today are often in disarray, from France to Canada to the UK, with accident and emergency rooms full and ever-longer waiting lists. There are worries about equity of care for low-income populations, especially in the US. No matter how much governments increase budgets, health systems always seem to need more. Can anything change this? Across our research at Generation Investment Management, we look at companies that we believe can drive the global healthcare system in a more cost-effective, equitable direction.

Over time spending on healthcare has taken up an ever-larger share of government spending and GDP. In 1980 spending on health accounted for 8% of American GDP; by 2022 it accounted for 17%.² In 1980 10% of Britain’s public spending went to the National Health Service. Now it takes up 20% or more.³ Across the world, the price of pharmaceuticals continues to rise fast.⁴

The global rise in healthcare spending has had many benefits. Over time, life expectancy has considerably improved, as health services are able to offer a wider variety of high-quality treatments (see figure 1). Developing countries, we believe, should continue to spend more on healthcare ₋ and they are likely to, as they get richer.

To tackle healthcare costs effectively, we need to ask: why do healthcare costs rise so inexorably? A useful paper by the UK’s Office for Budget Responsibility (OBR) identified three main drivers of healthcare spending: demographics, income effects and ’other.’⁶ We take each in turn.

Demography first. Most people assume that an ageing population is the most important reason behind ever-costlier healthcare. But this is a misconception. The OBR notes that demographic factors “have explained little of the past change” in healthcare costs. A study from the OECD suggests that demographic factors will account for about a tenth of the long-term rise in health and long-term care spending.⁷ The effects of an ageing population are “merely” measured in the hundreds of billions of dollars, rather than the trillions.⁸

The real controversy in healthcare economics is over the importance of those two other factors: income effects and other factors (or, alternatively, demand and supply factors). We do not seek to adjudicate on which factor is more important. Both probably play a role.

Other researchers, however, argue that rising healthcare spending is to do with other factors ₋ in particular, rising costs (supply). The fundamental problem is that achieving productivity growth in healthcare is hard. In most sectors of the economy a new technology ₋ say, better computers ₋ lowers costs and raises productivity. In healthcare, however, new technologies tend to have the opposite effect, raising costs and lowering productivity. This is because they tend to make new treatments possible ₋ for example, new drugs for cancer or new surgical techniques.¹⁰

Healthcare also suffers from what economists call ’cost disease.’ Other sectors of the economy (for instance, manufacturing) can cut labour inputs into production, resulting in higher productivity and higher average wages. These gains are harder to come by in healthcare, however, because the ratio of human carers to patients is often fixed (ie, there should always be three or four nurses to every bed). To continue to attract staff, healthcare providers must continue to offer wages close to market levels, raising costs relative to output. As such, healthcare costs rise ₋ and by a large amount, given that in some health systems salaries account for as much as half of total costs.¹¹ Healthcare inflation tends to exceed headline inflation, which is testament to the power of cost disease.¹²

We believe companies with sustainable business models, which offer solutions to creating a more equitable, efficient and effective society, are more likely to thrive in the long term. We first explored these two dimensions within a healthcare context in a 2004 research roadmap, early in our firm’s history. While we continue to iterate our thinking and stay close to developments, this fundamental ’Healthcare Roadmap’ is largely unchanged, continuing to shape where we focus our time.

We tend not to invest in companies which try to limit demand for healthcare. Indeed we recognise that there remains huge unmet demand for healthcare services across the world. Our focus has not been on hospitals, healthcare-services organisations and insurance companies: their interests may be misaligned with a healthcare system that offers high-quality, cost-effective healthcare that is accessible to all.

Instead we focus more on the supply side ₋ on technological innovation, with the goal of reducing healthcare costs and cost disease, and in turn improving access and outcomes. Our interest is in sectors that often are growing faster in part because they lead to savings elsewhere in the system ₋ and hence are self-funding to some extent. The areas we invest in include medical devices, diagnostics and tools that go into research and development (R&D). This can include everyday supplies such as tubes and vials, as well as driving efficiencies in the development of drugs and diagnostics. The goal is to reduce costs downstream as a result of earlier diagnosis or better therapy selection, ultimately feeding into lower healthcare cost growth.

One company we have looked at, Edwards Lifesciences, focuses on structural heart disease and critical-care monitoring. Another, BD, produces everyday supplies such as needles and syringes. In many cases these companies’ products can substantially reduce hospitals’ costs. 10x Genomics and Illumina, two other companies, both contribute to driving efficiency in the development of drugs and diagnostics. In our view, this should reduce costs downstream as a result of earlier diagnosis or better therapy selection.

AlayaCare, a portfolio company of our Growth Equity strategy, is a software provider which allows home-based care to be more efficient ₋ potentially taking some care out of costly hospitals. Our research has shown the potentially huge benefits of better care in the home. This can be achieved when large parts of the process are automated, as well as by making the experience for care workers better (including via optimised schedules). BenchSci, another Growth Equity portfolio company, provides AI solutions for preclinical R&D. The company’s technology recently allowed top customers to reduce unnecessary experimentation by 40%, contributing to a new era of more efficient, AI-driven drug discovery.²⁰

Investments such as these, in theory, can have a huge impact ₋ not just on health outcomes but also on fiscal sustainability and therefore public services overall. We urge other investors to see the system-positive potential of a more sustainable healthcare system.