Voters are concerned about high and rapidly rising prices for prescription drugs. As a candidate, President Trump pledged he would take action to bring down prices or at least slow their rate of growth. This year, he directed his Secretary of Health and Human Services, Alex Azar, to implement a plan that will achieve that goal.
It won’t be easy. The root cause of high drug prices isn’t a corrupt and greedy industry, though there are certainly some bad apples who have unethically exploited regulatory loopholes in recent years. The real cause is the protection of intellectual property, which is a fundamental principle of a dynamic economy and crucial for the development of new and better therapies. Patents and market exclusivity rights for approved drugs provide strong incentives for entrepreneurs to take risks and discover new treatments, but they also allow successful innovators to set prices for their products with less regard for the competitive forces that hold down prices in other markets. The policy challenge is to establish the proper balance between promoting innovation and ensuring access to effective and affordable medicines.
Protecting intellectual property is a core responsibility of the federal government. The drafters of the Constitution believed the protection was fundamental to a prosperous society but also that it should be temporary, to ensure useful products would eventually be widely available and to provide a strong incentive for entrepreneurs to keep searching for new breakthroughs.
The Drug Price Competition and Patent Term Restoration Act of 1984 — known as Hatch-Waxman, for its primary authors, Sen. Orrin Hatch (R-UT) and Rep. Henry Waxman (D-CA) — paved the way for competition from generic drugs. Since then the growth of a robust market for generic products has helped keep prices for drugs lower than they would have otherwise been.
Federal policy also requires large price discounts, but only for certain purchasers of drugs. Drug manufacturers provide rebates to state Medicaid programs based on either the best price offered to other purchasers or 23.1 percent off a list price. In return, the states cannot exclude approved drugs from their lists of covered products.
The Medicaid rebate program lowered costs for the states and the federal government. Predictably, it also led the manufacturers to review their pricing policies for other purchasers, to minimize the effect of the required Medicaid rebates. After the rebate program went into effect, prices rose sharply for some clinics and hospitals that had previously received large price concessions from manufacturers.
Congress responded to rising list prices by creating additional price discount programs. A price ceiling was placed on drugs purchased by the Veterans’ Affairs medical system. And the 340B program places a ceiling on drugs purchased by certain not-for-profit and public entities serving larger than average numbers of low-income patients.
But these discount programs brought prices down only for select purchasers. Purchasers ineligible for the federally required discounts, such as employer-sponsored insurance plans, must negotiate prices with manufacturers. They typically end up paying much more than customers given preferential treatment in federal law.
In 2003, Congress created Medicare Part D, a drug benefit administered by competing private insurance plans. For the most part these plans are pharmacy benefit managers (PBMs), which also administer drug benefits for many private sector employers. Drug prices are set through private negotiations between the PBMs and manufacturers. The Department of Health and Human Services (HHS) is prohibited from negotiating prices directly with drug manufacturers for Part D.
In recent years, there has been a trend within the Part D benefit toward higher list prices for covered products coupled with larger rebate payments from the manufacturers to the PBMs. PBMs providing drug benefits have a strong incentive to secure large rebates to keep their premiums low. They have less of an incentive to secure low list prices because the federal government pays for 80 percent of drug costs beyond the drug benefit’s catastrophic threshold, set at $5,000 in 2018. Medicare’s payments for drugs above the catastrophic limit have risen from $9 billion in 2008 to $37 billion in 2017.
The pricing of pharmaceutical products is a difficult subject for public officials because society has an interest in both medical progress and affordable access to beneficial treatments. There is growing concern that current policies do not strike the right balance between innovation and competition.
There are no simple fixes. As policymakers consider how to improve existing policies, they should keep the following considerations in mind.
Supply Competition. Manufacturers of pharmaceutical products have maximum leverage over pricing when they face little or no competition. Government regulation can sometimes affect how quickly a product will face competition from another effective therapy. Rapid generic competition is critical, of course, but so too is competition among patented, brand-name therapies to prevent full monopoly pricing power for a single manufacturer.
Rebates. The financial benefits of rebates come through lower premiums for insurance plans. Shifting the savings from rebates into lower prices paid at the point of sale would benefit patients with the highest drug costs through lower cost-sharing payments. However, lower cost-sharing might increase overall drug spending (as a result of higher utilization of prescription drugs) and increase plan premiums (to the extent that funds from drug rebates used to underwrite the cost of the plan are reduced). That could mean higher prescription drug consumption and higher total costs to taxpayers and consumers.
Discounting. Requiring drug manufacturers to guarantee substantial discounts to a few favored purchasers is likely to mean higher prices for those who are excluded from such discounts. The overall goal should be to lower prices for all consumers. This is likely to require rethinking the current discount system in a systematic way.
The U.S. has a vibrant ecosystem of researchers, private-sector entrepreneurs, and capital investors that produces more new therapies than other countries. In this regard, current public policy has been incredibly successful.
There is no question, however, that conferring market exclusivity rights on important therapies will lead to high prices for purchasers or consumers in some circumstances. That’s basic economics. The challenge for policymakers is to minimize the number of monopolistic pricing situations and to create the proper balance of financial burdens when supply competition is limited.
Today’s ad hoc drug pricing arrangements are far from perfect. While there are no easy and politically safe answers, the system can be improved with sensible reforms.
Dr. Antos is the Wilson H. Taylor scholar in retirement and health policy at the American Enterprise Institute. Mr. Capretta is a RealClearPolicy Contributor and a resident fellow at AEI. They are the co-authors of “Prescription Drug Pricing: An Overview of the Legal, Regulatory, and Market Environment,” released this month by AEI.
