Know More About Drug Price Reform Than Your Senator

For anyone who may have fallen behind on their MyC-SPAN recommended watch list this summer, you may have missed the June 12th and June 26th hearings where Health and Human Services secretary, Alex Azar, testified on the administration’s new plan to combat drug prices. (Yes MyC-SPAN is a thing, yes I have an account, no you don’t have to invite me to your dinner parties).

First, it goes without saying, there are many senators who are well versed on the complex healthcare-related issues facing the United States. Nevertheless, several of the statements made and questions asked during the hearings make it abundantly clear that many congressional representatives are lacking the depth of information necessary to adequately explore the actions being proposed. This article is a precursor to a post that will more acutely address the good, the bad, and the ugly of the June hearings and the drug price reform measures being discussed.

This article will review a handful of concepts that are fundamental to understanding the current state of the US pharmaceutical industry. From Medicare to middlemen to gag clauses and beyond, this article will (in both words and pictures) help to set a base from which you can assess the severity of, and potential solutions to, the US drug price debate.

The ABC’s (and D) of Medicare Drug Price Negotiations

Medicare is a program that has been rolled out incrementally since Part A was signed into law by Lyndon Johnson in 1965. Medicare was founded with the mission of assisting retired seniors, living on fixed incomes, in efforts to obtain affordable health insurance. Permissible underwriting and age discrimination, made insurance so expensive that many elderly individuals were going without coverage. Medicare was instituted on the idea that individuals will pay in throughout the course of their lives and receive subsidized coverage as they age. See below for a quick review of what is covered under each part:

Prescription drug spending now accounts for roughly 23% of Medicare expenditures with Part D drug spending consuming the greatest proportion of that amount.[i] As Medicare represents the largest insurance pool in the United States, conversations are underway as to how the agency can curb costs by leveraging negotiating power. Under Parts B and D, Medicare is prohibited from negotiating prices with drug manufacturers.

The below chart will highlight the key points and takeaways related to Medicare price negotiations.

Medicare Part B prescription drug benefits are generally straight forward. As an enrollee in a Part B plan, beneficiaries are covered for clinical services, labs, and drugs administered by a physician in his or her office. For all drugs administered under the Part B program, beneficiaries are responsible to pay 20% of the price charged to Medicare. The price charged to Medicare is calculated by first taking the average price negotiated by private drug buyers. After the average price is calculated, an additional 6% is added to the final bill in order to cover the administering physician’s overhead costs.

The cost to Medicare Part D plan enrollees is far more complicated. Because Medicare Part D is a stand-alone plan, it requires its own monthly premium. As in Part B, beneficiaries are also required to pay a percentage of their prescription drug costs. This cost can vary dramatically compared to the flat 20% paid under part D. For a quick recap on how Part D plans are acquired and how premium amounts are calculated, see the below graphic.

After a plan has been chosen and premiums paid, beneficiaries then work through a series of coverage levels. This is in contrast to the flat 20% of costs paid under Part B.

As is seen above, Part D beneficiaries will be responsible to pay as much as 100% to as little as 5% of their drug costs. The proportion of the drug price a beneficiary will be responsible to pay is dependent on the dollar amount he or she has spent on prescription drugs to that point in the coverage year.

The deductible period is a common phase in most plans. It stipulates that beneficiaries must cover 100% of their costs up to $405. The coinsurance period is also straight forward. In this phase beneficiaries cover a flat 25% of drug costs (much like the 20% paid under Part B). The “donut hole” is a term referring to a phase in a beneficiary’s plan where he or she will be responsible for a greater percentage of prescription drug costs. This higher cost persists until the beneficiary has paid $5,000 of their own money in prescription drug costs.

The final phase, reinsurance, is commonly referred to as catastrophic coverage. This phase kicks in after the $5,000 spending ceiling, and persists until the end of the coverage year. In this phase Medicare steps in to cover 80% of total drug costs leaving the plan provider and beneficiary to cover the remaining 20%. The reinsurance payments made by Medicare to Part D plan providers are on the rise and now account for 41% of total Part D spending. This is up from 16% of total Medicare Part D spending in 2007.[ii]

It should also be noted that any Part D beneficiaries with sufficiently low incomes will receive additional Medicare government assistance in paying coinsurance and premium amounts. Supplemental help can range from additional subsidies to cover monthly premiums, to fully subsidized premiums and zero required coinsurance amounts. Roughly 23% of Part D beneficiaries qualify for this support.

The room for misalignment in incentives between Part D plan providers and Medicare is substantial. The most obvious problem exists during the catastrophic coverage period wherein Medicare steps in to pay a considerable portion of total costs. This misalignment is made evident as catastrophic payments continue to be one of the major drivers of increased Part D spending. As will be discussed in greater detail below, plan providers have little incentive to negotiate good prices for drugs that will inevitably move beneficiaries into this coverage phase.

Rebates, Kickbacks, and Middlemen

Pharmaceutical companies’ sales tactics have become so engrained in American drug culture, it has become the plotline of many TV sitcoms. The attractive pharmaceutical sales rep, with limited (if any) medical background, goes in to a doctor’s office to flirt and push the new and latest drug.

Pharmaceutical companies go well beyond this architype. Regulators have spent a great deal of time trying to crack down on companies providing doctors monetary incentives. Nevertheless, there are still plenty of gray areas that are frequently exploited to incentivize doctors to prescribe more of the latest and greatest (and often most expensive) drug. Improperly incentivizing doctors has serious ramifications, from prescriptions being written for off label use to doctors prescribing the more expensive options when lower cost alternatives exist.

Despite efforts to crack down on direct incentives being made to physicians, a loophole still exists for the major negotiator of drug prices in the United States. Pharmacy Benefit Managers (PBMs) are exempted from anti-kickback statutes and are thus allowed to negotiate prices using a rebate structure that highly incentivizes inflated drug costs.

Pharmacy benefit managers Rather than leave drug price negotiations to the insurance provider, some organizations will employ Pharmacy Benefit Managers (PBMs). These organizations serve as middle men that negotiate drug prices on behalf of corporate employers, health plans, and labor unions.

PBMs make money by negotiating rebates with drug manufacturers. After the rebate is given, the PBM will pocket part of the rebate then pass the remaining savings on to its clients in the form of lower drug prices.

The rebate process is illustrated in the below graphic. The process begins when a drug manufacturer sets its list price. This list price is the amount individuals would have to pay if they did not have insurance. This environment heavily favors large insurance agencies or PBMs with a considerable client base. These entities will have the greatest leverage when pushing back against high prices. These prices are generally inflated and nowhere near what drug buyers will ultimately pay. PBMs make money by negotiating rebates with drug manufacturers. After the rebate is given, the PBM will pocket part of the rebate before passing the remaining savings on to clients in the form of lower drug prices.

As is shown in the above graphic, PBMs like artificially higher list prices because it increases the size of the rebate they will be able to negotiate without threatening manufacturers’ bottom line. The greater the rebate, the more the organization can pocket before passing along the remaining savings on to their clients. Higher list prices also force smaller players to employ PBMs as they now face greater hurdles in negotiating prices.

PBMs are so incentivized to keep prices high, there are many recorded instances of these groups colluding with drug manufacturers to increase list prices year over year. The result of these distortions is an unsustainable escalation in US drug prices. These actions increase premiums and make drug coverage nearly inaccessible for the uninsured.

PBM collusion is far from the only consequence of rebate-based negotiating. In some instances, drug manufacturers with a diverse portfolio of prescription drugs will leverage rebates offered to gain advantageous access to beneficiaries. They use their leverage to force preferred status for a new drug. For example, a manufacturer may stipulate that if a negotiator does not make its new drug the preferred prescription for treating an illness, then the manufacturer will discontinue rebates on other drugs offered under the negotiator’s plan.

In this situation manufacturers generally have a great deal of leverage. If plan beneficiaries do not have affordable access to their desired drugs they will be motivated to look elsewhere for drug coverage. This situation is emblematic of a common market failure in the insurance market where having a middle man leads to a non-optimal, inefficient allocation of resources.

This rebate model also does a great deal to thwart the administration’s efforts to control drug spending under Medicare. As was described above, beyond a given threshold, a government payer will step in to cover the majority of drug costs for Part D beneficiaries. To exploit this reality, a drug manufacturer may offer drug buyers (representing private Part D plans) incentives to include its drug as the preferred option for treating an illness until the government payer steps in to cover the inflated cost. Or they may offer higher rebates on lower price drugs in exchange for keeping big ticket drugs on the preferred medication list. Many of the big ticket drugs will move beneficiaries into the catastrophic period regardless of negotiations, so plan providers are much more incentivized to leverage their negotiating power elsewhere. This is a prime example of a serious consequence of government providers not being able to negotiate their own drug contracts.

Gag Clauses

Gag clauses are a relatively simple concept. In short, pharmacists are not allowed to tell patients (1) if a prescription drug they are filling would be cheaper paid in cash rather than through insurance or (2) if a cheaper alternative to what they are purchasing exists. In the first example, an individual’s plan may require a $125 copay for a popular antiviral. This drug however could be purchased in cash for $100. In this scenario a pharmacist would be prohibited from telling the patient of this potential savings.

In the second example, there may be a competing drug intended to treat the same illness available at a lower price point. There are a number of reasons a doctor may have prescribed a higher cost alternative. The physician may not have been aware of how the two alternatives were covered under the individual’s plan. Or he or she may not have known how the two drugs are priced relative to one another. Given the number of anti-kickback lawsuits currently underway, there is also the possibility that the doctor may have been improperly incentivized to write the prescription. Whatever the cause, the pharmacist will be unable to alert the patient of this cheaper alternative.

Comparative Effectiveness vs. Value Based Pricing

The difference between comparative effectiveness buying and value-based pricing is reasonably clear. It is the net result of these two concepts that is often misrepresented.

In the United States drug manufacturers are only required to prove their medications are more effective than a placebo. In the world of pharmaceuticals, the net patient benefit need not be any more related to its price than to the color of its label. This means insurance providers and doctors generally have little to no insight into which of two alternatives is more effective. If Drug A is in fact more effective than Drug B, insurance providers may be willing to pay more for Drug A if the benefit is substantial enough. Similarly, doctors’ recommendations between drug alternatives are often reliant on hearsay or the limited sample size of their own patients. Comparative effectiveness studies have been suggested as a method of combating this issue.

As was discussed in the third article of the ACA review series, efforts to implement comparative effectiveness measures have been largely shut down. Drug manufacturers have little to gain if the drugs in their portfolio are proven less effective than competitors. This is especially true if proven less effective when compared to competitors offering lower prices.

Value based pricing, while also related to patient benefit, is mostly about increasing the profit margins of drug manufactures. Consider an example where Drug A is approved to treat the common flu and viral meningitis. Suppose it could be sold profitably to patients for $100. Because the flu can sometimes become dangerous and only infects individuals one to two times a year, insurance providers are willing to cover 60% of the cost. Patients with the flu likely find the time out of work and not feeling well far more costly than their $40 copay. This willingness to pay combined with the frequency of the common flu will drive considerable demand for the new drug.

The client base for the viral meningitis treatment is much different. If meningitis is allowed to escalate it can become quite expensive. It can cause irreparable harm to the patient and in severe cases can lead to death. Insurance companies and patients stand to lose a great deal if the illness is not treated. Thus, the price point here can be much higher.

The drug company, not able to charge two prices to two groups, must make a decision. Does it take a greater customer base at a lower margin or a smaller customer base at a much larger margin? This is an extreme example and, based on the occurrence rate of the flu and viral meningitis, has a pretty obvious answer. But there are plenty of real world examples where drug manufacturers are pushing to be able to charge two different prices for different illnesses being treated.

The real difference between these two models is how net benefit is defined. In comparative effectiveness studies net benefit is defined as the value a patient receives in contrast to other alternatives on the market. i.e. At the grocery store do you like the brand-name or store-brand lima beans better? Value based pricing is about maximizing profit margins for each patient based on their level of desperation. i.e. If you are a business traveler booking a flight, not getting on the flight may mean you will miss an important meeting. Thus, based on your customer data, the airline knows it can charge you $200 more than the vacation traveler looking to book a seat on the same flight.

Laws Around Prescription Importing

The pharmaceutical industry’s main lobbying organization (PhRMA) has been extremely successful in negotiating objectively protectionist legislation that increases drug company profits. Protectionist policy here being government actions taken to shield corporations from competitive forces. One of these efforts includes the prohibition of drug importation from other countries.

Pharmaceutical companies enjoy the ability to set a US price that is different than the price it charges internationally. For example, a company may decide its most profitable price point abroad (where it is balancing profit margins with quantity demanded) is $120. In the United States however, it charges $500. US citizens and wholesale drug manufacturers are prohibited from importing the drug at the cheaper price point.

In contrast, if Apple decided to start selling it’s iPhones in the United States for $2,000 while the price point remained at $900 in Canada, it would not take long for consumers to start importing the phones at the lower price point. Yes, there would be costs related to procuring the item from a different country, but not costs exceeding the additional $1,100 they would have to pay in the United states.

Direct to Consumer Advertising

Pharmaceutical advertising is big business in the United States. Most people reading this can likely rattle off a few drug names that treat everything from dry eyes, to stroke, to erectile dysfunction.

This ability to list off prescription drug names and their uses is something unique to the United States’ pharmaceutical market. The United States and New Zealand are the only two countries in the world that allow pharmaceutical companies to directly advertise and make claims regarding a drug’s purported benefits. In the United States pharmaceutical companies spend over $6 billion in advertising every year.

This spending has been an area of debate for many years. It is a form of “arming” consumers with information they are not prepared to do anything with. Doctors complain of uncomfortable encounters with patients who insist on a specific brand or formulation that may not be right given the situation. It also causes problems in situations where a physician does give the patient a choice. Do you want this complicated sounding drug you’ve never heard of, or the drug in the commercial with the happy family that comes on at least 20 times a night? Of course, consumers are likely to chose the happy family drug. Which one costs more or will provide you with the greatest benefit for the price you’ll pay? You don’t know, and your doctor doesn’t know.

Conclusion and Next Steps

Drug spending now accounts for 23% of Medicare costs. If nothing is done it will continue to drive deficits and keep lifesaving medications out of reach for millions of Americans. This is no longer an issue we can afford (pun intended) to sweep under the rug. Saving lives, putting money back in the pockets of working Americans, and being better stewards of tax payer money are hardly partisan objectives.

In the following article we will take a look at what is currently being proposed to tackle the issue and how it is being argued for and against.

[i] https://money.cnn.com/2018/05/15/news/economy/medicare-drug-spending/index.html

[ii] https://www.kff.org/medicare/fact-sheet/the-medicare-prescription-drug-benefit-fact-sheet/