The Case Against Drug Price Negotiation
You may have heard that the federal government is soon to begin negotiating the drug prices Medicare and Medicaid pay biopharma companies.
You may be struggling with or at least mystified by the complicated mess that is healthcare delivery in the U.S. and found this negotiation to be welcome news.
Sadly, it is not. Unfortunately, drug price negotiation as it is laid out in the federal Inflation Reduction Act is not actually negotiation in the common sense understanding of the term.
Worse, the IRA’s negotiation process will layer on more complexity, confusion and cost to our already overburdened healthcare system.
First, some background. Drug price negotiation was grafted onto the IRA as a fig leaf for the IRA’s stated goal of reducing inflation.
The problem was that the IRA’s injection of $500-plus billion into our economy, operating at full throttle and beset with supply chain blockages, was inflationary.
We’re living with towering interest rates not seen in a generation, all brought on in an effort to cool the inflation induced, in no small part, by the IRA.
So, to bolster the IRA’s inflation-fighting credibility, the legislation’s drafters added funding for more IRS agents to scoop up more money from taxpayers, raised the minimum corporate tax to 15%, and empowered the government to negotiate drug prices.
Whether the first two measures will have any inflation reducing effect is questionable—an increase in the number of IRS auditors may only irritate taxpayers and the corporate tax increase will be passed on to consumers.
But drug price negotiation, as set forth in the IRA, will be healthcare inflationary.
Now, there are a host of things wrong with the IRA’s drug negotiation provisions, not the least of which is that, though the legislation’s drafters labeled it “negotiation,” it is anything but.
Negotiation is about consensual bargaining. All parties involved are free to enter into an agreement, make a deal—or not.
The IRA rewrites the definition of negotiation by establishing a system whereby manufacturers must agree to sell their products at a price determined by the government or take one of two punitive alternatives.
One, pay a fine of up to 1,900% of the prior year’s sales of the drug under negotiation. Even for a large biopharma company, 19 times the prior year’s sales is a boatload of money.
The second opt out is for a company to make do without selling any of its medicines to the government.
Since a biopharma company like, say, Pfizer may have over 500 medicines in its portfolio, and since 53% of drug spending is through the government’s Medicare and Medicaid programs, this is not a realistic option.
The negotiation is a process whereby the government assembles data about a drug—its efficacy, its uses, the cost of manufacturing it, the R&D that went into creating it—and takes input from patients, the drug’s inventor/manufacturer and many other stakeholders.
Then, after some opaque internal process, it comes up with a take-it-or-leave-it maximum fair price.
As the government deliberates over the maximum fair price it will pay, biopharma companies are free to comment. But once that is set, there is no appeal procedure.
In sum, to add to the Orwellian terminology of the IRA, the legislation’s drug pricing provisions amount to “nonconsensual negotiation.”
Price Controls Never Work
At first blush, the IRA’s negotiation provisions might seem like a great idea. Wouldn’t it be nice to have a government agency set a more affordable price for all the things we buy?
Bread and eggs have risen sharply in price—wouldn’t it be nice to see $1 a loaf and $1 a dozen?
All the bids for a new roof for your house come in at around $7,500. Wouldn’t it be nice for the government to set a maximum fair price at $2,500?
You have your eye on a new Apple iPhone15. Apple lists the price at $1,100. Wouldn’t it be nice for the government to set the maximum fair price at $500?
The problem with forced, take-it-or-leave-it negotiation is that it’s a form of price control, and price controls never work.
When Richard Nixon tried them to fight inflation in the 1970s, he ended up engineering a decade of … inflation. Price controls have devastated the lives of Venezuelans and Zimbabweans.
Whether for flour or rent or medicine, price controls cause shortages and delays, and fuel crime in the form of black markets.
You will be hard pressed to find an academic study from left or right on the political spectrum showing anything other than how price controls distort supply chains and cause all manner of misery.
Price controls can’t repeal the laws of human nature.
For example, if an iPhone costs Apple more than $500 to design and manufacture, once its inventory of already built iPhones is depleted, it will cease investing in and manufacturing more iPhones if the maximum fair price it can charge is limited to $500.
It’s the same for drugs. It costs about $2.7 billion to bring a medicine from concept to FDA-approved product, researched and developed for safety and efficacy, manufactured in quantity, and delivered to pharmacies.
If an inventor company can’t sell its medicine at a price that will allow it to make up the $2.7 billion investment, it won’t do it.
Drug price controls will divert research and development spending away from prescription medicines to products like over-the-counter lozenges and “cosmeceuticals.”
New, cutting edge, treatments and cures will be delayed or never even begun. The supply of existing medications will shrink, and shortages will become commonplace.
Depress Innovation, Fuel Inflation
The IRA’s drug price negotiation provision fuels healthcare inflation because it depresses innovation. Drugs might seem expensive, but they are, in fact, a powerful solution to healthcare inflation.
Cardiovascular medications, for example, which treat high blood pressure and high cholesterol now cost pennies a day, but even when they were new, on patent, they brought healthcare costs down dramatically.
They reduce the incidence of heart attack and stroke, and thereby diminish the need for a vast number of surgeries, hospitalizations and long-term care.
Or, consider Hepatitis C medications. Today, a course of treatment costs about $25,000. The medicines cure Hepatitis C, a devastating, ultimately fatal, liver disease.
Before they were invented, the only potential cure was a liver transplant. There aren’t enough donor livers to fill all the needs of all the patients on the liver transplant lists.
If you were lucky enough to qualify for a liver transplant, the cost of the surgery, hospitalization and aftercare—you would need blood monitoring and to be on life-shortening immunosuppressant drugs for the rest of your life—is approximately $878,400.
If inventors can’t recoup their investment and aren’t rewarded for the huge risks they take, they will put their time, talent and money elsewhere.
It’s important to bear in mind that it takes about a dozen years to research and develop a new drug and that most new medicine research doesn’t pan out.
Only about one in a thousand new medicine projects result in an FDA approved drug. The few successes pay for all the good tries that don’t pan out.
Prices Already Negotiated
What’s particularly vexing about the IRA drug price negotiation is that what the government now pays for drugs is already fully negotiated.
Medicare pays drug companies the average of the lowest price negotiated by the many private insurance plans. Medicaid gets 23.1% off the low Medicare price.
If you’ve ever fought with a health insurer over your coverage, do you really think they’re not astute negotiators?
Perhaps the reason the IRA’s government negotiation is really a take-it-or-leave-it gun-to-the-head of biopharmas by Medicare and Medicaid is that it’s highly unlikely that, in a truly free and open, fair, negotiation process Medicare and Medicaid could negotiate better terms than the private insurance industry.
The Role of PBMs
If the prices the government pays for drugs are already negotiated, what’s behind the pressure to address drug prices?
If the IRA’s drug price negotiation isn’t the solution, what is?
The answers to these core questions lie in the arcane pricing system that’s evolved among drug manufacturers, middlemen and insurers, and in insurance plan design.
Biopharma companies do not sell their medicines directly to pharmacies. Instead, their medicines move from biopharma manufacturing site to warehouses and on to pharmacies through a system more or less controlled by pharmacy benefit managers.
PBMs are the middlemen who have contractual relationships with the biopharma manufacturers, insurers, and pharmacies.
This PBM-centric system came to be because drug manufacturers did not want to be in the business of delivering medicines to individual pharmacies spread across 50 states, and insurers needed someone to process payments across the chain of transactions beginning with drug manufacturers and ending with patients.
The PBMs’ most consequential relationship—as to drug pricing—is with the insurers. The PBMs work with each insurer and assist the insurer in devising the insurer’s individual health insurance plans, most importantly each plan’s formulary—the list of drugs covered by the plan.
PBMs process payments for drugs after a prescription is presented by a patient at a pharmacy.
In theory, according to the contracts PBMs have negotiated with insurers and drug manufacturers, the PBMs bill insurers for the cost of a drug, less (1) discounts, generally made in the form of rebates, offered by the drug manufacturer, and (2) whatever copay and/or deductible amount is paid by the patient.
The PBM remits to the drug manufacturer the amount paid by the insurer, plus the copay and/or deductible amount paid by the patient.
In practice, the amount of the biopharma manufacturer’s discount or rebate that is passed on to the insurance plan and patient varies, to say the least.
PBMs are compensated either by taking a percentage of the rebate before passing on the balance to insurers, or by remitting the entire rebate to insurers and then billing the insurer a fee.
In many ways the crux of the problem with drug pricing is that drug prices, especially rebates and discounts, are based off the drug manufacturer’s list price.
List prices for medicines have become wildly distorted from the reality of what most patients pay.
That said, the list price system worked for just about everyone for a long time.
The formulary criteria erected by the PBMs for drug manufacturers to win placement on insurance plan formularies incentivized drug manufacturers to set high list prices—the higher the list price, the greater the discount the drug manufacturer could offer.
The higher the discount, in turn, the greater the incentive for the PBM to recommend to the insurer that the drug be placed on its plan formulary.
Insurers too are incentivized to like high list prices because, again, the higher the list price, the greater the discount/rebate and the discount/rebate, though shared with the PBM, also benefits the insurer.
Insurers can use the list price discount to reduce insurance premiums, thereby making their plan more competitive, or simply allow the savings to improve corporate profitability.
In dollars and cents, here’s how the pricing system works. Say a biopharma company gives a new medicine a list price of $1,000 for a month’s supply.
To entice a PBM to put the new drug on the formulary set up by the PBM, the biopharma offers a rebate of $400.
Such discounts, many approaching 60%, are the norm. Note that if the biopharma doesn’t offer a rebate, the new drug might be excluded from the PBM’s formulary or, if the formulary is for an insurance plan where drugs are “tiered”—lower to higher co-pays depending on the tier—the new drug might be placed on the highest co-payment tier.
What the PBM does with the $400 rebate is murky, the subject of all manner of confidential contracts with the many parties in the supply chain.
It might pass on the full amount of the $400 rebate to the insurer in the form of billing the insurer $600 for the drug and bill a separate fee of $40 for its work.
Or, the PBM could pass on $560 of the rebate to the insurer while billing the insurer $600 (netting $40 for its work).
Depending on the terms of all those contracts, the biopharma may receive a payment of about $560.
Concern over PBM practices centers on suspicion that a PBM could seek more from an insurer than it pays to a biopharma or pass on far less of the drug discount than what would constitute a fair fee for its services.
For example, a PBM could bill an insurer $800 for the $1,000 list price drug that’s been discounted by $400, and take a profit of something in the neighborhood of $200.
Most Patients Lose
Where does this leave the patient?
The patient with traditional health insurance with, say, a $30 co-pay will pay $30 for the $1,000 list price drug.
If the patient has a co-insurance plan, where the patient pays a percentage of the drug’s price, say 30%, the patient will pay $300 for the drug.
Of course, if the co-insurance is higher for a drug in a higher tier, the patient could be on the hook for 50%, or $500.
If the patient has a high deductible plan, say the patient must spend out of pocket $5,000 before insurance kicks in, the patient might have to pay the full $1,000 list price.
And if the patient is uninsured, they pay the full list price.
Pricing System Flawed
What we’ve ended up with is a pricing system not unlike that of the auto industry.
It’s based on list prices, but no one’s supposed to actually pay the list price. Except, increasingly, some patients do.
High list prices are good for PBMs, neither good nor bad for patients with traditional health insurance, bad for patients who pay co-insurance or have high deductible health insurance plans.
It’s the worst system for those least able to afford list prices, the uninsured.
The drug pricing system is bad for biopharma because, unless a patient is part of a traditional health insurance plan, it amplifies the cost of drugs from the patient’s perspective.
Drugs are only 15% of healthcare spending—the other 85% is doctors, hospitals, insurance, home healthcare, etc., etc.—but insurance plan design can make it so that drugs loom much larger in an individual patient’s personal budget.
This puts pressure on the political system to do “something about drug prices” and gives rise to counter productive schemes like the negotiation provisions imbedded in the IRA.
R&D Critical to Cost
The bottom-line, truth be known, intent of the IRA’s drafters is to impose government price controls in the guise of negotiation on just about all prescription medicines so that we end up with a drug pricing system akin to that of other developed world countries.
The IRA starts with negotiation of 10 drugs in 2026, adds 15 more in 2027, 15 more in 2028 and, starting in 2029, 20 additional drugs per year going forward.
The problem with this is that the other rich countries, with their own complex and confusing procedures for concocting what their governments will pay, essentially pay biopharmas only for the cost of manufacturing a drug plus a very modest profit on the manufacturing cost.
This might seem reasonable, but what goes unaddressed and uncompensated is the cost of research and development.
Figuring out, for example, the statin drugs—how to reduce the amount of cholesterol a human liver produces, how to produce and deliver such a medicine in quantity with reliable safety and efficacy, and how to formulate the drug so that it is simple for patients to use—took years of laboratory trial and error and multiple, hugely expensive clinical trials to confirm safety and efficacy.
Once the recipe for a drug is known, manufacturing it—pressing the ingredients together into a pill in the case of small molecule drugs like statins—is not that expensive.
It’s the recipe that’s the hard work, the work that takes a long time, the work that costs a lot.
To reimburse a company for its manufacturing cost only is to take no responsibility for the R&D, for the cost of figuring out the recipe.
And, if no one pays for the R&D, the R&D won’t happen. New medicine R&D would come to a halt, R&D budgets would be diverted to other endeavors, and patients would lose—in the form of fewer new treatments and cures—enormously.
Fortunately, the US mostly pays for the world’s new medicine R&D.
This is profoundly unfair, with Canada, France, the UK, Japan, Germany, and others not paying their fair share of R&D.
No biopharma, commanded by a foreign government to sell its drugs at manufacturing cost, or be prohibited from selling its drugs, has been willing to deny patients access to life saving medicines.
In some sense, we justify this state of affairs on the grounds that, though we pay more than our fair share, it’s worth it.
We pay a lot, but we get a lot in the form of life extending new treatments and cures. And, as we’ve seen, as expensive as some drugs may seem, they actually reduce healthcare costs.
The unfortunate response of policymakers to calls to do “something” about high drug prices, at least as reflected in the IRA, was to take about the most counterproductive action they could: import the innovation-sapping, patient-harming price control system used by too many rich countries.
But the problem with high drug prices in our country is really an international relations problem.
An authentic solution is obvious and straightforward: if the rest of the developed world is made to pay its fair share of the costs to discover and develop life-saving medicines, drug prices in the U.S. will come down dramatically.
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