Advice to Trump: Leave Medicare Drug Prices to the Free Market

President-elect Donald Trump has bashed drug prices on numerous occasions. During his campaign, he championed the idea of having the government directly negotiate the price of Medicare drugs for Part D drug plans. Trump seemingly dropped the idea later in his campaign only to resurrect it again mid-January. Many Democrats also believe the government could secure a lower price for the drugs Medicare reimburses on seniors’ behalf. However, Republicans have long opposed the idea of government meddling in private markets and codified a non-interference clause in the Medicare Modernization Act of 2003.

Here’s the kicker: Medicare drugs are already negotiated by the large pharmaceutical benefit managers (PBMs) that administer Medicare Part D’s private drug plans. About a dozen large PBMs dominate the market. These include Express Scripts, CVS Caremark, Argus, Optum and Cigna among others. These are the same companies that manage drug benefits for employers and insurers. Many state Medicaid programs also rely on PBMs to administer Medicaid drug benefits.

Large PBMs negotiate drug prices across all their book of business combined — not just for one plan. With multiple clients, large national PBMs can negotiate lower prices from manufacturers, and therefore possess far more bargaining power than individual firms. PBMs use a variety of techniques to control costs for their clients and enrollees. They also negotiate with pharmacies and build preferred pharmacy networks.

Could the government do a better job? Probably not. As renowned health economist Alain Enthoven explained it over a decade ago:

…[I]t is not obvious that allowing the government to negotiate with pharmaceutical companies will lead to lower prices than those achieved by private drug plans. There are several good reasons why not. Negotiations are a bargaining process. The relative balance of bargaining power determines at which price the deal is struck. People often confuse market power with bargaining power. The thinking goes, the larger the share of the market the buyer represents, the greater the bargaining power and thus the lower the prices negotiated. That line of reasoning fails with drugs, however, because the seller is frequently a monopolist with an exclusive patent. That means the seller cannot be threatened with replacement by a substitute. Instead, the only threat is that the two sides fail to agree and the drug is withheld from the market. Rather than market share, a party’s bargaining power is determined simply by the ability to say no — to walk away from the table without an agreement. Whether the government or a private drug plan has greater bargaining power is not clear. Who can walk away more easily and declare some brand-name drug will not be covered on the formulary? Private plans like Kaiser Permanente or UnitedHealth Group are able to negotiate deep discounts with pharmaceutical companies precisely because of the plans’ ability to say no — to pay for some drugs and to exclude others, allowing the market to judge the resulting formulary. But when the government negotiates, there are few drugs it can exclude without facing political backlash from doctors and the Medicare voters.

If the government were to consolidate the purchasing of Medicare drugs to one government entity, variations in drug prices would likely narrow to where the average price could actually be higher than some of the previous discounts. Any deeper discount obtain by Medicare would likely be offset by higher prices for private plans. Requiring Medicare to get a fixed discount off average wholesale price, for example, would virtually guarantee all other drug prices would go up.

When drug plans create pharmacy networks they negotiate for the lowest possible prices. Negotiated discounts are the result of bargaining power — the ability of the drug plan to deny business to a drugmaker if their bid isn’t favorable. PBMs have the ability to say “no” and deny a given drugmaker their business in favor of a therapeutic substitute. This is something Medicare cannot do politically. Medicare cannot threaten to exclude one hospital from its network to negotiate a lower price. Neither can Medicare say it will only pay providers the lowest price bid by competing firms. If President-elect Trump and Members of Congress want to rein-in drug prices for Medicare, the best way is to make it easier to bring new drugs (and competing generics) to market.

Comments (4)

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  1. Jimbino says:

    There is no free market without price signalling. In order to establish a free market in drugs, the gummint should order all drug prices (and procedure prices) to be posted on-line by healthcare providers.

  2. Allan says:

    “Advice to Trump: Leave Medicare Drug Prices to the Free Market”

    Good advice, advice that should have been considered more deeply when when Part D was passed with bipartisan support and a signature from a Republican President. I think even the NCPA was at least lukewarm to the bill which works against a true free marketplace. I believe some of the high prices we are seeing today are a result of too much third party coverage for pharmaceuticals.

    If government must assist preferrably they should do it outside of the free marketplace with the least impact on it possible.

  3. Barry Carol says:

    The three biggest PBM’s are Express-Scripts, CVS-Caremark and Optum Rx which is owned by UnitedHealth Group. These three firms now control roundly 75% of the market for drugs on behalf of payers from health insurers to self-funded employers. All three probably control more insured lives than CMS would if it negotiated on behalf of Medicare. The ability to say no, though, is a key issue. I agree that it’s highly likely that it would be easier for a private entity like a PBM to do that than for a political entity like CMS.

    However, the PBM’s don’t actually negotiate drug prices in the sense that you imply. Instead, they negotiate rebates with manufacturers which are a percentage of the list price and are usually volume driven meaning that certain volume goals must be achieved to earn the full rebate. There are two things wrong with the rebate system in my view. First, as a percentage of list price, the PBM’s benefit when the list price goes up because the dollar value of their rebate goes up too. Not all of the rebate is passed through to the insurer or self-funded employer in most cases. The bigger problem is that insured individuals with high deductible health plans are exposed to paying the full list price. This was a big problem in the case of the Epi-Pen on which the manufacturer, Mylan Labs, repeatedly raised the price since it acquired the drug in 2007. The PBM and the payer / client benefit from the rebate but the insured patient gets screwed as do patients who are uninsured unless they qualify for a given drug company’s charity program.

    I also agree that streamlining the FDA’s drug approval process to bring about more competition in both the development of new drugs and allowing new manufacturers to enter the market for generic drugs is a good idea. Allowing Medicare to negotiate drug prices is a dumb, misguided idea that would be destined to fail if it’s tried.

  4. Paul Nelson says:

    Furthermore, the rebates sometimes are related to market share and bundled. Its all very complex.