Drug Prices That Matter

Drug Prices That Matter

Too often, drug pricing analyses do not shed light on how much drug expenditures are actually increasing because these studies examine the wrong price.

The latest iteration is an analysis by Rx Savings Solutions. According to the Wall Street Journal, Rx Savings Solutions documented that dozens of drug makers raised the list prices on hundreds of medicines for 2019. The average list price increase was 6.3%. Based on these findings, many people might reasonably conclude that patients will be paying more for their medicines in 2019 compared to 2018. While such a conclusion may be reasonable, it would likely be wrong.

The Rx Savings Solutions analysis, which is similar to many other studies on this topic, evaluated the changes in list prices. And, as I have argued previously, list prices are not the statistic that matters. Changes in list prices do not necessarily correlate with changes in the prices that patients, health insurers, and the government pay – the price that actually matters. As a result, analyzing list prices provide inaccurate insights regarding medicines’ cost trends.

This confusing outcome results from a little appreciated quirk in the drug pricing system. Unlike most industries, pricing in the pharmaceutical industry works in reverse. For most industries wholesalers purchase products from manufacturers paying the manufacturer price. Wholesalers will then mark-up this price, and sell the product to retailers. Retailers will then mark-up this wholesale price and sell to consumers. This final retail price is, consequently, a multiple of the initial manufacturer price.

In the pharmaceutical industry, drug manufacturers announce a list price for their medicines. This is not a manufacturer price, however. Instead, middlemen (formerly known as pharmacy benefit managers, or PBMs) then negotiate discounts and rebates using the list price as the basis of the negotiation. The prices insurers ultimately pay on behalf of consumers (the transaction price) are, consequently, a fraction of the list price instead of a multiple of the manufacturer price.

If transaction prices were a constant fraction of the list prices, or if the gap between the list prices and the transaction prices were small, then changes in list prices would accurately reflect the changes in transaction prices.

This has not been the case. In fact, 42% of the gross expenditures are not realized by manufacturers, indicating the gap between the list price and the transaction price is quite large.

The gap, particularly due to PBM’s, is also growing. PBMs share, according to Drug Channels, grew 10% in 2017 and now equals $153 billion. And the 2017 growth rate is slow compared to recent trends. Between 2012 and 2017, the rebates received by PBMs grew 15.6% a year on average.

These trends indicate that the average growth in list prices should have been significantly higher than the average growth in transaction prices. This has been the case. Over the same time period, list prices grew more than three times faster than the transactions prices according to IQVIA data.

The annual national health expenditure data provides additional reasons to question the connection between list price changes and health expenditures on pharmaceuticals. In 2017 list prices grew 6.9% – similar to the 6.3% figure cited by Rx Savings Solutions. However, transactions prices grew 1.9 percent in 2017, and actual expenditures on medicines grew even slower – a mere 0.4 percent.

These data illustrate that changes in list prices do not foretell what the changes in actual costs will be. And, it is the costs that are meaningful for most patients, payers, and hospitals.

None of this means that the current drug pricing structure makes sense, or is working the way it should. In fact, the confusion created by the divergent trends between list prices and transactions prices argues that a better drug pricing system is needed.

This system would eliminate the opaque discount and rebating practices that define the current system and move toward a more transparent pricing structure. Further, patients should be empowered to become more effective health care consumers and insurers should play a more effective role managing true health care risks.

Creating this better pricing system requires an accurate assessment of the current environment, however. List price trends can’t do this. Worse of all, the inaccurate picture painted by list price trends encourages ill-considered reforms that would harm innovation and worsen health care quality.

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Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.