Source: CMS National Health Expenditure Data
Yesterday the House passed the ill-considered “Pelosi bill” that would impose draconian price controls on drugs. Ignoring the bill’s many adverse impacts, price control advocates like Speaker Pelosi appear to believe that these command and control schemes can solve the systemic health care affordability problem. But, as the latest government data illustrates, such efforts are a fool’s errand.
Consider that back in 1960 national health expenditures equaled 5.0% of GDP. Health expenditures have been growing faster than the economy ever since reaching 17.7% of GDP by 2018, the latest data available. Now consider the trends in retail drug spending.
Back in 1960, retail prescription drugs accounted for 9.8% of total health care expenditures, see the above chart. While the share of spending on retail drugs dropped between 1960 and 1980, by 2000 spending on drugs re-established its traditional share, which has remained between 9% and 10% of total health care expenditures through 2018.
If drug spending were driving the health care affordability problem, then the share of prescription drug spending should be rising as total health care expenditures continue to grow relative to the size of the economy. This clearly is not happening indicating that the focus on drugs as the key to controlling the systemic affordability problem is destined to fail.
While not driving the affordability problem, there are serious deficiencies in the current drug supply chain that harms too many patients. Reforms are warranted; but, reformers must target the right goal in order to be effective. When it comes to drug policy, the goal should be to fix the complex and opaque drug supply chain that, though no one’s intention, is ultimately harming patient outcomes.
While seemingly innocuous, many of the supply chain problems are rooted in the large and widening gap between medicines’ invoice prices (the prices that manufacturers announce) and their net prices (the prices paid on behalf of patients and which are, effectively, the prices reflected in the national health expenditure data).
These price gaps exist because the invoice prices announced by manufacturers are not effective market prices. They are more akin to the opening bids of a complex negotiating process. Pharmacy benefit managers (PBMs), on behalf of insurance companies, will then negotiate large discounts and rebates from these list prices (a rebate model). The actual price paid, the net price, includes these discounts. PBMs will also impose direct and indirect remuneration (DIR) fees on pharmacies, which are often retroactive and further erode the revenues received by the pharmacy.
The discounts and rebates have been growing faster than prices over the past decade, and based on IQVIA data, the gap between the net cost of drugs relative to the invoice cost expanded from 13.1 percent of net invoice costs to 28.2 percent. This expanding gap is consistent with the incentives of PBMs because their compensation is based on the size of the negotiated discount.
Several problems arise that include unwarranted costs being imposed on smaller pharmacies and excessive drug costs being imposed on patients. Ultimately, these costs harm patient outcomes.
Many small family-owned, long-term care, and specialty pharmacies play unique roles in the health care system. Take long-term care pharmacies as the example. These pharmacies specialize in providing patients in long-term care facilities, who often have complex drug regimens, with the medications, infusion drugs, and many other drug-related patient services they require.
Due to the opaque pricing system, the pricing environment is volatile causing long-term care pharmacies to lose money on over 60% of the generic medicines they dispense. Many long-term care pharmacies, particularly smaller ones, cannot absorb these losses. Ultimately, patients suffer as there is a growing risk that these valuable health services could be lost.
Then there is the problem of spread pricing, or the practice of charging insurers and state Medicaid programs significantly more than the reimbursement costs PBMs paid to pharmacies. PBMs then pocket the difference, which are typically in addition to the fees and other PBM charges already collected.
The problem of spread pricing is not insignificant. A study commissioned by the state of Ohio “found that this practice of “spread pricing” netted the three PBMs affiliated with the Medicaid program a total of $224 million in a single year — far more than reasonable payment for their services.” Further, “small independent pharmacies complain that the PBMs, through starvation-level reimbursements and later by steering prescriptions, aim to drive them out of business.”
If small independent pharmacies were struggling because their competitors were serving patients more effectively, then, while painful, such a transition would be serving the best interests of patients. However, the struggles of these pharmacies are linked to the inefficient pricing environment that distorts market power dynamics. As a result, due to current policy inefficiencies, the viability of important community health professionals is threatened to the detriment of patient outcomes.
Patients also suffer direct costs from the opaque pricing environment. Patients’ co-pays are often based on the higher invoice price, not the lower net price. Since PBMs earn more when the negotiated discounts are larger, they have an incentive to encourage high increases in list prices that are offset with even higher increases in discounts. As a consequence, patients using the most expensive medicines are paying co-pays that are rising at a faster rate than the growth in expenditures.
Further, patients without coverage do not benefit from the PBM negotiated discounts and can be exposed to the full invoice costs. Basing compensation on the size of the negotiated discount also creates a systemic incentive to favor more expensive drugs that can enable larger discounts.
There are several reforms at the state and federal level that can help reduce these costs.
States should disallow spread pricing practices in their Medicaid programs. To ensure that the spread pricing cost are not simply transferred into other fees and charges, Medicaid programs should demand greater transparency from PBMs (as should employer sponsored plans). As for the drug pricing system, the current rebate driven model should be replaced with a transparent net-price based system.
Overall, these reforms will improve patient outcomes by eliminating many of the current market weaknesses harming patients and smaller pharmacies. It is these important goals that reforms to the pharmaceutical industry can achieve. These benefits, which include lower drug costs for patients, are too important to ignore.
However, it is important to recognize that fixing the problems with the drug supply chain will not solve the affordability crisis plaguing the health care system. Attempts to do so, such as the Pelosi bill, lose the opportunity to fix the problems that afflict the drug supply chain, introduce new problems into the health care system, and allow the well-known affordability problems to fester.
