January 23, 2016
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The mystery of prescription drug prices

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How can it be that the same exact prescription drug can have such markedly different prices?

Recently, my patients with commercial insurance were paying $15 out of pocket per vial for analogue rapid-acting insulin. A Medicare patient was paying $40 per vial for the same insulin until she entered the “donut hole,” at which point her price went to $102 per vial.

To investigate further, I went to my local pharmacy and found the price to be $270.49 for one vial of the same insulin when purchased without insurance. Are pens cheaper? Checking online, I found that a patient here in Phoenix without insurance could purchase five pens of this same insulin for anywhere from $437.77 at a Kroger Pharmacy to $511.00 online at HealthWarehouse.com. Why the great variation in prices?

Free market economics

We live in a world of scarcity and high demand for resources. Therefore, we must make choices. Prices help us do so. A price is a ratio of subjective valuations: I prefer this over that and am therefore willing to pay more for this than that.

Richard O. Dolinar

Prices are how we communicate our preferences in the marketplace. In a free market, exchange is voluntary and mutually beneficial. Determining the true price of something is a discovery process in which competition among sellers and buyers establishes the price of a good or service and its relation to other goods and services. The true price occurs at the intersection of the supply and demand curves. It is at this point that all willing buyers will have a willing seller and all willing sellers will have a willing buyer.

Prices, thus, relay critical information about consumer preferences and by so doing help producers determine the cheapest and most efficient way to assemble resources and create goods consumers want. It is a dynamic process, with price changes occurring in response to changing market conditions. The prices generated are not only public, but are often advertised for the world to see. Competitors see one another’s prices and try to beat them, which benefits the consumer.

Health care regulation, pricing

Health care is a highly regulated sector of the U.S. economy, especially for pharmaceuticals. State and federal governments purchase 60% of the prescription drugs sold in the country. Instead of using a market approach for the sale and distribution of prescription drugs, the government has developed a political one. This directly affects the price of drugs.

For example, via the political process, the government has divided the entire health care market into multiple segments, with each segment having unique rules and regulations to contend with. These include Medicare, Medicaid, Tricare, the Veterans Administration and the 340 B Program. Other segments include managed care and standard commercial payers.

The manner in which prices are set in each of these segments is often complex and opaque. For example, by law, Medicaid guarantees a rebate from the manufacturer of at least 23.1%, but that is only a ceiling. The price is pushed down further by discounts and charge-backs. Similarly, the VA is entitled to at least a 24% rebate, but often the price is even less than this. The actual prices in these two programs are further affected by extremely complex formulas generated by law and data derived from the commercial side. Thus, the drug prices from all of the different segments are linked to each other, and a change in one price affects the others.

All of this intervention restricts what manufacturers are able to do on the commercial side because those actions could reduce their revenue on the government side. The extent of the forced discounts, rebates and charge-backs can be very large and result in a substantial decrease in revenues. For example, Credit Suisse estimates Eli Lilly and Company in 2014 gave rebates for Humalog (insulin lispro recombinant) averaging 56% of its list price, according to The Wall Street Journal.

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Much like the sticker price on a car, the list price of a prescription drug is a start for negotiations, but not usually the finish. From a negotiating perspective, it is important to have an initial list price that is high, so there is room to lower it during negotiations and still generate enough revenue to keep the company solvent. And from a regulatory perspective, it is important that this initial price be high, so when the mandatory rebates are applied in the VA and Medicaid programs, sufficient revenue remains to run the company.

Effect on the uninsured

This system adversely affects the individual who has no insurance and is not enrolled in a government program. As a simple example, assume the sticker price on a drug is $100 and the company can handle mandatory government rebates, discounts and charge-backs up to a 50% cut in the price and still be profitable. Also assume that in a free market the actual price of the drug would be $50 and that this is a highly regulated market; the other prices generated for this drug product are derived from the sticker price and not generated in the market. The drug price would need to be high, and to be an actual price, someone has to be charged it. That someone is the patient without insurance, who will pay the full sticker price of $100 for the drug. In a free market, that patient would have to pay only $50, but because of the forced discounts to lower the price for certain constituents, this uninsured consumer has to pay twice the amount he or she would otherwise have to pay.

Branded vs. generic drugs

Other government interventions contributing to higher drug prices include an annual tax on brand-name pharmaceutical companies and the Medicare Coverage Gap Discount.

The tax on brand-name pharmaceutical companies exempts producers of generics. It was initiated by the Affordable Care Act in 2012 at a tax of $2.8 billion. The amount is set to increase each year, reaching $4 billion by 2018. With the cost of development of a new drug currently averaging $2.6 billion, the tax means there will likely be approximately two new drugs that won’t be developed each year.

The brand-name companies also are billed for half of the donut hole each year to pay the Medicare Coverage Gap Discount. The bill is adjudicated, but it is not itemized, leaving the companies blind as to what to expect their bill to be and to plan for it accordingly.

The United States comprises 4.6% of the world’s population and consumes 30% of the world’s drugs. In 1984, 19% of the U.S. prescriptions were filled with generics. By 2014, the percentage had increased to 88%. Some have been critical of the pharmaceutical industry regarding the pricing of not only brand name but also generic drugs. They turn to government for help. But as this commentary argues, a significant portion of the price of drugs is directly attributable to the government.