A Bogus Solution for High Drug Costs

Americans’ prescription drug bills are on the rise. Total drug spending increased by nearly one-quarter in the past couple years. Much of that increase is on high-tech, specialty drugs — such as those used to treat cancer, hepatitis, rheumatoid arthritis and multiple sclerosis. Drugs whose patents have not yet expired are sometimes very expensive; especially those recently approved. By contrast, most of the drugs Americans take are actually cheap generic drugs. Generics are cheap because they are no longer protected by patents and different manufacturers can compete on price. Consumers opt for a generic drug about 88 percent of the time when filling a prescription. Nonetheless, policymakers have a solution; but it’s the wrong one.

Drug makers have taken a lot of heat lately for the high prices of some of their newer drugs. They often counter that prices for most drugs are merely “list prices,” sort of like the sticker prices on new cars. The actual price of a brand drug, net of rebates, is often much lower. For example Sovaldi — the breakthrough drug for Hepatitis C — has a list price of about $1,000 per pill (you need 84 pills to cure Hepatitis C). But large purchasers, like pharmacy benefit managers (PBMs), large employer plans and large insurers, negotiate steep discounts that bring the wholesale cost of Sovaldi down to about $600 to $750 per pill. As is common in most markets, the wholesale price varies slightly from one purchaser to the next. General Motors gets a better deal for its employees’ drug plan than small employers with only 100 workers. This is also true for older brand drugs used to treat common conditions like hypertension or high cholesterol. To a lesser extent, it is somewhat true for generic drugs as well. Large firms get better drug plan discounts, most of which are passed on to consumers and workers in the form of lower retail prices.

Lately a few liberal politicians (and their left-of-center policy advisors) have begun a witch hunt to lay some of the blame for high drug prices on other stakeholders in the health care industry. They worry that drug plan managers are not passing all the discounts they receive on to their clients (i.e. employers and insurers) and consumers. As a result, proponents have suggested that employers (and their workers) could potentially benefit if PBMs were forced to reveal the wholesale prices they pay for drugs.

Economists, the Federal Trade Commission and even the actuarial consulting firm Milliman, Inc. are rather skeptical. This theory doesn’t make sense because no other competitive industry works that way. Regardless of the industry, wholesale prices are negotiated among private parties and are generally considered proprietary. For example, if all hardware stores knew the wholesale prices Home Depot negotiated, they would all bargain aggressively for the same price. The likely result is that wholesalers would set one uniform (higher) price and just stop giving Home Depot lower prices. Home Depot would no longer be able to leverage its buying power for the benefit of its customers and pass on discounted prices to consumers. Besides, just because I don’t know what Home Depot paid for a piece of lumber doesn’t mean I don’t benefit from the lower prices it negotiated with its wholesalers.

The benefits of greater price transparency primarily applies to retail markets — rather than wholesale markets.  Indeed, consumers often benefit when they compare prices at retail pharmacies. But I’ve never had a problem calling a pharmacy and asking what a given drug will cost me once the pharmacy knows my health plan. Indeed, I’ve probably ask a pharmacy tech the price of a prescription drug half a dozen times this year. By the way, it pays to confirm the price in advance to prevent being charged more than your drug plan’s contractual discount (which sometimes occurs).

Drug plan managers currently have a variety of ways to compete for the business of health plan sponsors, who are their clients (the insurers and employers). Some use pass-through pricing where they contractually agree their clients receive all drug discounts. Clients then pay a negotiated management fee for the services of a PBM. Other drug plan managers agree to accept lower management fees but are allowed to keep some portion of the manufacturers’ drug rebates, earning a small profit on each drug reimbursed. This is known in industry parlance as spread-pricing. Regardless of how the arrangement is negotiated, most drug rebates ultimately benefit consumers and workers.

Drug plans managed by PBMs use a variety of techniques to control costs for their clients and consumers. An estimated 70 percent of Americans have drug benefits through an insurer or employee health plan. Relatively few patients are unable to afford their medications. Arguably, much of the reason has to do with competition. According to industry data, nearly one-fourth (23 percent) of retail prescriptions are fully covered by insurance and requires no copayment by the patient. An additional one-third (34 percent) cost the patient $5 or less. And three-fourths (78.6 percent) cost the patient $10 or less.

The bottom line. Some drugs are expensive because they are new; others because they are breakthrough therapies. However, most drugs are a great value. When consumers walk into their pharmacy, most can rely discounted prices negotiated on their behalf. Passing poorly-thought out regulations on drug plans will not lower what Americans pay for drugs, but could increase them by reducing the ways drug plan managers are allowed to compete on health plan costs.



Comments (7)

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  1. Barry Carol says:

    Generic drugs overall are actually somewhat cheaper in the U.S. than in other developed countries. There are a relatively small number of exceptions involving drugs with relatively small sales potential where all but one or two manufacturers have left the market for various reasons and new competitors are stymied by the long lead time and the cost of winning FDA approval to enter the market.

    While it’s great that 88% of retail drug prescriptions are now for generic drugs, they account for only about 28% of the dollars spent on drugs. Specialty drugs are only 1% of prescriptions written but 33% of the dollars and traditional brand name drugs are 11% of prescriptions written but 39% of the dollars. Those two areas are where we’re getting killed on price compared to other developed countries. Specialty drug prices often vary by country based on per capita GDP as a proxy for ability to pay while no other industry works this way. Payers need to be more willing to just refuse to add certain drugs to their formulary if they can make the case that the value offered is not worth the price charged. Some payers are starting to experiment with contracts that only pay for certain specialty drugs if they work.

    For the record, PBM’s have four ways to make money which are (1) administrative fees, (2) rebates from drug companies for moving market share, (3) the spread between what they pay for a drug and what they bill the employer or insurer, and (4) profits from filling generic prescriptions by mail. They target a certain amount of profit from each account but they don’t care which bucket the profit comes from. If a particular client wants to capture all of the rebates from drug companies, for example, it will be charged more elsewhere. The end result for retail customers is a wash.

    The cheaper prices that the likes of Home Depot and Wal-Mart can extract from manufacturers are largely driven by a lower cost to serve. The average per unit cost of making, say, a gallon of paint, is a lot lower for long production runs than short runs and the distribution costs are lower for buyers who can buy by the truck load or even trainload than for small buyers who just need one or two cases. If the retailer sends its own trucks to the factory to pick up the merchandise, that makes them even cheaper to serve. For drugs, manufacturing costs are often minimal as a percentage of revenue. It’s a different animal completely.

  2. jimbino says:

    If I don’t like what Amazon or Walmart is charging, I can order from Alibaba and others. We need to eliminate the gummint imposed impediments to getting our drugs overseas.

    • Devon Herrick says:

      I predict that sometime in a week or two, Operation Pangea IX will commence. The DEA, FDA, Customs and Interpol will all get together and confiscate illegal medications shipped in from rogue pharmacies overseas. You will see press releases and read an article or two about it in the newspaper. By mid July, the rogue pharmacies will be back in business and you can order what ever it is you want!

      • Barry Carol says:

        I wonder what percentage of drugs from those overseas pharmacies are counterfeit and what recourse the buyer has if they are. I’ll continue to get my drugs from local retail pharmacies or from my insurer’s PBM.

        • Devon Herrick says:

          I believe some of it legitimate medications made under license in other countries. But much of it is probably unauthorized generics made in India that are not yet available in generic form in the United States. As far as being outright fakes, I don’t really have any idea. Up to a third of antimalarial drugs in some African countries are fake.

          • Gitmoray says:

            I have been helping my health insurance clients over the last 15 years, obtain generic drugs from overseas manufacturers, primarily from India, New Zealand, Turkey and sometimes Israel. What my clients can get today are the generics that we will one day (in the sometimes distant future ) get at Walmarts or Costco. Several of my clients take Rosuvastatin for their cholesterol at about $.75 per pill, where in the US they would have to buy Crestor (exactly the same) for about $5 per pill retail. Six years ago my clients would take overseas Atorvastatin Sodium, and their Dr’s would tell them they were poisoning themselves. The Dr’s wanted to prescribe Lipitor (same thing) at 6 times the price. Today many people take the same Atorvastatin (bought at walmart) my clients were getting 6 years ago, and the Dr’s are trying to push them to Crestor.

            The big problem with our system today is that the scammers are right in our Dr’s office.

            • Allan says:

              Why do you think the scammers are in the doctors office? When you fill a prescription for a medication the physician doesn’t earn anything.

              There have been and continue to be problems with all drugs, more so from drugs manufactured by factories outside the US and western nations. Additionally, some drugs, though chemically the equivalent to the brand name and other generics with the same active ingredient, will provide different drug levels. Coumadin and Synthroid are two that have presented the most common problems, but time release drugs can present a major problem.

              There are other factors that can also affect the activity of the drug that and that differs with each individual human body. The active ingredient is combined with different substances that can also cause problems and those problems can vary with each individual based upon their genetics and other factors.

              Additionally, the complexity is even greater than stated above. Did you know that some Statins are water soluble and others fat soluble? That affects absorption in different organs of the body. Some such as Lipitor are affected by common foods. In this case grapefruit.

              Before you make a defamatory statement, as you have above, make sure you know your subject.