A Funny Thing About Drug Pricing
A University of Chicago law student with a prior career in the pharmaceutical industry whom I interviewed for a job the other day shared some knowledge regarding drug pricing that I thought quite interesting. It hadn’t occurred to me, though it seems perfectly obvious, that drug companies price drugs over which they possess a patent monopoly according to the avoided costs of the next best treatment for the diseases they address. If an insurer typically has a hundred heart attacks in its risk pool every year, and a new wonder-drug will prevent fifty of them, it will pay just under its cost for treating the fifty avoided heart attacks for a supply of the drug sufficient to achieve this result.
And it turns out, according to my source, that pharmaceutical companies do typically set the unit price of non-copycat patent drugs in relation to the avoided cost for insurers for on-label use. But then a funny thing happens. The pharmaceutical manufacturer begins promoting down-label and off-label uses of the drug – i.e., use of the drug by patients who are not as at risk of the condition as those for whom the drug was approved to treat, and use of the drug to address other conditions than that for which it has been approved, respectively.
The avoided costs for treating down-label and off-label patients is typically less than for on-label patients, if it can be quantified at all. But at this point, the decision whether to administer the drug is within the hands of the doctor and the patient, and the insurer reimburses for the drug at the price that was negotiated based on the higher on-label rate of cost avoidance. Over time, the down-label and off-label use of a drug can and often does exceed the on-label use, often by a significant degree. As a result, an insurer will often find itself paying out significantly more in reimbursement for a patent drug than the cost of avoided medical treatment the drug achieves. Yet another hidden cost driver in the Freakonomics of our crazy health care system.
A comment from Austin Frakt follows.
Pharmaceutical manufacturers have so many ways to milk insurers. Co-pay rebates to policyholders being another (hat tip to recent Planet Money focus on this). These are just a few of the ways in which insurers really aren’t the big problem in health care. They’re played by providers.
Drug Discovery: U.S. vs. Europe
An interesting paper by Donald Light was posted on the Health Affairs website on 25 August 2009. “Global Drug Discovery: Europe is Ahead” aims to debunk two popular misconceptions about pharmaceutical research: (1) That the U.S. has eclipsed Europe in drug research productivity and (2) that most new drugs are therapeutically important. In summary Light’s findings are as follows.
- Using data on all 919 new chemical entities (NCEs) approved between 1982 and 2003, Light shows that Europe still leads the U.S. in percentage of NCEs discovered and percentage of NCEs deemed “global” (introduced into four or more of the G7 countries).
- From results produced by the European Federation of Pharmaceutical Industries and Associations, Light shows that between 1990 and 2000 the U.S. has not increased its productivity of pharmaceutical research as measured by the percent of NCEs discovered divided by the percent of funds invested (1990 U.S. value 0.76, 2000 value 0.75). Meanwhile, Europe has increased its productivity (1990 Europe value 0.99, 2000 value 1.17).
- Finally, Light cites numerous studies that have found that about 11-15 percent of NCEs are therapeutically important and this rate has held steady for forty years. The rest are not clinically more effective than previously existing treatments.
It is well-known that we pay relatively higher prices for drugs in the U.S. than elsewhere. It is often argued that one benefit of high prices is high rates of innovation and more effective NCEs. Yet, U.S. innovation rates and rates of clinically important NCEs are not particularly high, nor are they growing. Of course, European companies benefit from high U.S. prices as much as U.S. companies do and people in the U.S. benefit from European drugs as much as Europeans do. So, despite Light’s findings it isn’t clear to me that they are in and of themselves arguments against the compensating benefits of high U.S. prices. If it were the case that U.S. purchasers only bought from U.S. firms then Light’s argument would be air tight.
If Light’s findings are accurate, what is clear is that European pharmaceutical companies are operating more efficiently than their U.S. counterparts. The obvious question is why? The answer is beyond the scope of Light’s article.
Medicare’s Structure and Payment Systems Part III: Prescription Drug Plans
This post originally appeared on The Finance Buff.
This is the third and final post on the basics of Medicare’s structure and payment systems. The two prior posts in the series covered fee-for-service (FFS) Medicare (post I) and Medicare Advantage (MA) (post II). In this post I focus on the relatively new Medicare outpatient prescription drug benefit, Medicare Part D.
Part D Basics
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) added an outpatient prescription drug benefit to Medicare (Part D), starting in January 2006. The highly subsidized benefit is available exclusively through private insurance plans, either MA plans offering bundled Part A (hospital) and Part B (outpatient) insurance along with a drug benefit or stand-alone prescription drug plans (PDPs) that offer no non-drug coverage (i.e., they complement FFS Medicare).
Medicare Part D accounts for 12% of Medicare spending, and about 60% of Medicare beneficiaries are enrolled in a Part D plan. Most enrollment in Part D plans (72% of it) is in PDPs. While I will focus more on PDPs below, the drug benefits available through MA plans are identical in structure and share the same payment system as PDPs.
PDPs serve multi-state regions, of which there are 34. Each region has at least 45 PDPs offered in 2009. Part D plan benefits take two fundamental forms: basic or enhanced. Basic coverage either follows a statutory minimum standard or is actuarially equivalent to it, while enhanced coverage offers additional benefits for a higher premium. Standard coverage has an average monthly premium of about $34 (in 2009) and is designed so the average beneficiary pays, at most, 25.5% of the cost of coverage, while Medicare pays the remaining 74.5%.
Standard coverage cost sharing is characterized by different coinsurance rates in each of four ranges of total drug spending (the sum of spending by the plan and beneficiary). In 2009 the standard benefit cost sharing is: 100% coinsurance for drug spending between $0 and $295 (i.e. a $295 deductible), 25% coinsurance for drug spending between $295 and $2,700, 100% coinsurance for drug spending between $2,700 and $6,154 (the so-called “donut hole” or “coverage gap”), and 5% coinsurance for drug spending above $6,154 (catastrophic coverage). These dollar amounts are indexed to average per beneficiary outpatient drug expenditures (MMA statute).
Part D Competitive Bidding
In contrast to the way in which MA plans are paid for Parts A and B (see my MA post), Part D benefits are paid by Medicare via a competitive bidding system. All Part D plans (PDPs and the drug portion of MA plans) submit bids for the cost of standard coverage. From these bids a nationwide average is computed and a statutorily determined fraction of this average cost is set as the “base premium” (about $30 in 2009). Finally, a plan’s premium (charged to each enrolled beneficiary) is the base premium plus the difference between that plan’s bid and the national average bid.
Ignoring adjustments for beneficiary risk and other details (found here) a plan is paid by Medicare a fixed monthly per-beneficiary rate equal to the national average bid less the base premium. Because the payment is tied to national average bids (a market signal) this is a form of competitive bidding. In contrast, MA payments are not set competitively. They are set via administrative pricing in which payments are determined by Congress. The Part D competitive pricing mechanism theoretically should drive payment downward as plans compete to offer lower-premium plans.
The Drug Negotiation Controversy
Part D plans may negotiate with drug manufacturers for volume discounts, but Medicare as a whole may not. This prohibition on direct Medicare-drug manufacturer negotiation was among the more controversial aspects of the Part D program and has received considerable attention from policy makers and academe.
Another related element to Part D is that plan formularies have inclusion requirements. In particular, they must include “all or substantially all” drugs in six categories: antidepressants, antipsychotics, anticonvulsants, antiretrovirals, immunosuppressants, and antineoplastics.
Critics argue that Medicare’s lack of authority to negotiate drug prices leads to higher expenditures for plans, beneficiaries, and Medicare. Others have pointed out that providing Medicare the authority to negotiate directly with manufacturers would not lead to price reductions on its own. To achieve savings Medicare would also need the ability to exclude drugs from its formulary. This ability to tighten the formulary would provide the leverage to negotiate bargains.
Interest remains among policy makers and certain advocacy groups in reducing Medicare drug prices. This idea is part of President Obama’s agenda so the issue may arise as he looks for ways to finance health reform.
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