Three Blind Men And The Health Care Industry – Pacific Research Institute

Three Blind Men And The Health Care Industry

Today’s hearing in front of the Senate Finance Committee will, unfortunately, be another wasted opportunity. Surely, Senators will make grandiose speeches and be shocked at the cost of drugs. They will also continue to support the very policies that are causing the problems the hearing is supposed to address.

A February 25th editorial from the New York Times exemplifies why this opportunity for effective reforms may very well be lost. The Senate hearing is not a day of reckoning as the Times claims. It should be an opportunity to identify the policy changes that could address the problems that plague the system.

Before discussing the problems, it is worth noting what the U.S. is doing well. Patients in the U.S. have access to more cutting-edge medicines than patients in any other country. Between 2011 and 2017, U.S. patients had access to nearly 90% of the new drugs that were launched. Patients in the country with the next highest access rate, Germany, could only access 71% of these medicines. Canadians, who many erroneously believe are the answer to what ails the U.S. market, have access to less than one-half of these new medicines.

There are many areas in need of improvement as well. In light of these problems, the Senate Finance Committee hearing should objectively evaluate the disincentives that plague the pharmaceutical market and focus on reforms that would correct these deficiencies.

A problem already identified by Health and Human Services Secretary Alex Azar is the industry’s inexplicable dual pricing system. To see why this is a problem consider that in 2017 (the latest data available) total expenditures on prescription drugs grew a mere 0.4%. Overall health care expenditures grew 3.9%, nearly 10 times higher. Expenditures on professional services (e.g. doctors) and hospital care grew even quicker, 4.1% and 4.6% respectively.

This trend doesn’t change over the long-term either. Over the past 10-years, expenditures on prescription drugs grew, on average, 3.6% annually compared to overall health expenditures that grew 4.3% annually.

Such figures contradict the general belief that prescription drugs are driving the health care affordability problem. This contradiction between the general perception of drug costs and the actual expenditure trends indicates that disincentives currently plague the pricing system; removing these disincentives should be Congress’ primary focus. To see why requires a bit of detail.

When pharmaceutical companies sell their medicines, they do not receive the list price of the drug. Instead, the list price is better envisioned as the beginning of a negotiation process. Through this negotiation process, manufacturers pay large discounts to pharmacy benefit managers (PBMs) on behalf of insurance companies. These discounted prices are referred to as the net price of the drug.

The growing influence of PBMs, and the reality that PBMs earn more money when the discounts paid are larger, has caused list prices to grow quickly, but discounts to grow even faster. These discounts are now often 60% of the list price, or more. The result is net prices are growing slowly.

This complex system would be inefficient, but acceptable, if patients shared in these discounts. The problem arises because typically patients do not benefit. The co-pays and co-insurance payments that patients owe at the pharmacy counter are based on the inflated list prices, not the discounted net price.

Thus, there are effectively two prices paid for every transaction at the pharmacy counter – patients pay a cost based on the list price while insurers pay a cost based on the net price. The discrepancy between these costs explains the otherwise contradictory outcomes.

As a simplified example of this adverse pricing system, a patient with a 25% co-insurance rate would pay $25 for a drug with a $100 list price. The insurer’s cost is not $75, however. Assuming that a 60% discount was negotiated by the PBM, the insurer’s cost is only $15 – the $100 list price minus the $60 discount minus the $25 patient co-insurance paid by the patient.

Therefore, the actual cost of the drug depends on who is being asked. From the manufacturer’s perspective, the cost of the drug is $40 – the net prices manufacturers received; from the insurer’s perspective the cost was $15; from the patient’s perspective, the cost was $25.

Of course, no one is wrong. It’s all perspective. But, a system that creates contradictory pricing trends is bound to be inefficient and unstable. In this case, the inefficiency is manifested as the contradictory trends of slower growing systemic costs for medicines, but faster growing patient costs.

Put differently, patients are not benefiting from the cost savings the system is generating. This is the problem that requires fixing.

This brings us back to Secretary Azar’s proposal. If implemented, the Secretary’s proposal would effectively eliminate the discounts paid to the insurers and encourage these discounts to be directly paid to patients at the pharmacy counter. If implemented correctly, the change would eliminate the pressure to raise list prices in order to create larger discounts. And, the change would ensure that patients directly benefit from all drug discounts.

The Secretary’s actions can only benefit the Medicare and Medicaid markets, however. Broader benefits require an act of Congress. This is why the New York Times editorial is so problematic. Grandstanding and vilification make dramatic television, and perhaps even dramatic reading. But it rarely leads to effective policy solutions.

Congress should refrain from playing politics with the pharmaceutical market and instead implement serious policy reforms. Such reforms should focus on improving price transparency and eliminating the disincentives plaguing the pharmaceutical market. The result will be a more effective pharmaceutical market to the benefit of patients today and greater innovation tomorrow.

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.

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