Advances in pharmacology are driving a revolutionary change in medical treatment. New drugs are bringing more effective, safer treatments for a variety of ailments. These treatments can, in some cases, obviate costly and risky inpatient procedures and, for some conditions, introduce effective treatment for the first time. Increasingly, the right to good health care becomes inextricably linked with access to prescription drugs.1-5Expenditures for prescription drugs in the United States are increasing much faster than total health spending. They accounted for 7.9 percent of total health spending in 1998, up from 5.6 percent in 1993. Drug spending accounted for one fifth of the entire increase in health spending during 1998. It is the fastest growing component of spending on personal health. From an increase of 8.7 percent during 1993, growth rose steadily to 15.4 percent in 1998.6 Given its continued rapid growth, prescription drug spending appears likely to reach about 10 percent of the health care total in 2000.7
A frequent response by insurers or employers to rising prescription drug expenditures has been to reduce utilization, commonly by increasing copayment requirements, or to reduce or withdraw coverage.8 Seventy million Americans lack prescription drug coverage. Others are losing coverage or are being asked to bear increased cost sharing which is leading to underutilization in many cases.9-11 Much of the loss of drug coverage is due to loss of employer-based health coverage by retirees. A survey of retiree health plans found that between 1993 and 1997 the proportion of employers providing health coverage to Medicareeligible retirees dropped from 40 percent to 31 percent. (Among large employers, the drop was from 63 percent to 48 percent.)12 Even fewer beneficiaries have Medigap coverage for prescription drugs.13
Another cost-cutting response of insurers and employers has been to limit pharmaceutical benefits to products in formularies.14 When such a change is instituted, commonly a beneficiary who is being treated effectively with one drug is required to switch to another. The result is that some patients are harmed.15,16 Current formularies are heavily influenced by the deals that individual insurers are able to strike with manufacturers.17 To provide a sound basis for formularies, it will be important to develop independent assessments of the advantages, disadvantages, and cost effectiveness of different medications.18 However, that will take many years. To make vital medications affordable in the meantime, it is essential to address price directly.
Assessing the impact of reduced prescription drug coverage on quality of care has not often been a priority for purchasers or payors. However, several studies suggest strongly that prescription drug copayment requirements do harm some patients, particularly those in the poorest health.19 Seventeen percent of Americans reported being unable to afford to fill a prescription in 1998.20
For several years, drug prices had remained fairly flat, and rising expenditures reflected mainly increasing utilization.21,22 Now the prices are increasing more than twice as fast as overall inflation.23 As measured by the year-to-year change in the average retail price of prescriptions, prices were up 7.1 percent in 1998 over 1997.24 This reflects both price increases for existing drugs and the introduction of costlier new drugs.25
The drug price burden is distributed unfairly among Americans. For those who have insurance coverage that is provided by a large purchaser of drugs; (for example, a government agency, managed care organization, hospital chain, or major employer) there is the benefit of markedly lower prices. But manufacturers compensate themselves for this by charging far higher prices to all other Americans.26,27
Current price trends, if unabated, will seriously erode benefits under prescription drug coverage plans. Whether the payor is one person or the US government, as the cost burden increases, coverage is put at risk. Ever larger subsidies not only are not a sustainable solution but also may mean ever greater waste of public resources.
Pharmaceutical coverage might reasonably be considered an important component of a comprehensive universal national health program. Cur-rently, however, there is particularly wide interest in creating an outpatient prescription drug benefit for Medicare beneficiaries, a large sector of the population that, notwithstanding a high level of need, is largely without such coverage. APHA has called for the addition of a prescription drug benefit to the Medicare program, at the same time recognizing that drug pricing will be a major factor determining whether a Medicare drug benefit is practicable.28
While the goal must be affordable medicines, insurance coverage alone will not suffice. The price factor must be addressed, as well as the importance of reducing excessive utilization. However such efforts should be grounded in considerations of quality, not merely of cost.
Purpose of the Paper; Policy Objectives
Public policy must address the problems posed by prescription drug prices.
We focus on the manufacturer’s price. Wholesaler and retailer margins are smaller components. Of the average retail payment for a prescription in the third quarter of 1999, the manufacturer is estimated to have received 75.7 percent, the wholesaler 2.3 percent, and the retailer 22 percent.29
A look at three factors clarifies why prescription drugs are so expensive for Americans: (1) the drug industry clears extraordinarily large profit margins after R&D costs are accounted for, (2) it spends wastefully on advertising and market-ing, and (3) it subjects American buyers to the high end of large international price disparities.
Profits: By all conventional measures (that is, whether earnings are compared with revenues, assets, or equity), the prescription drug industry has consistently led the Fortune 500 companies in profitability in recent years. The median return on equity for the Fortune 500 pharmaceutical firms, one and-one-half times the allindustry average in the 1970s and 1980s, soared to two and one quarter times the average in the 1990s.30,31
The drug industry’s high profits mainly reflect patent monopolies and the price-setting power these bestow. Brand-name drug makers’ efforts to suppress competition and current merger trends in the industry tend to magnify this power. Two other factors contribute heavily to profits: favored tax treatment32 and valuable technology transfer from the public sector.33,34 Thus, for example, as a result of special treatment under six different provisions of the corporate income tax code, the drug companies’ effective tax rate, that in 1996 would otherwise have been 35.2 percent, was only 17.1 percent. The average tax rate for companies in all industries was 26.7 percent.35
Repeatedly, in acts of striking generosity, the federal government, after investing tens of mil-lions of dollars to develop a new drug, has given a private manufacturer exclusive marketing rights. The government does not issue comprehensive reports listing transfers but, as reported by the Boston Globe, salient examples have included Taxol, Levamisole, Proleukin and AZT. In FY 1996, for example, NIH spent more than $1 billion on drug and vaccine R&D and is reported to have collected only $27 million in royalties. The Boston Globe surveyed 50 of the prescription drugs that reached the market between 1993 and 1998. It considered the 35 best selling of those products deemed most important by the FDA, and 15 orphan drugs. It turned out that federal dollars had helped in the discovery, development, or testing for 33 of the 35, and for 12 of the fifteen.36
Advertising and marketing: Out of $86 billion in 1998 revenues, the US pharmaceutical industry reported spending $8.3 billion to promote its products.37 (On direct-to-consumer advertising, the industry’s spending between January and October of 1999 exceeded its outlay for the same period in 1998 by 32 percent.)38 This may well be under-stated. In 1991, a Senate committee reported finding that much of what some companies reported as R&D expenditure was actually spent on postmarketing surveys designed to enhance the com-panies’ marketing strategies.39
International price disparities: Prescription drug prices in the US are the world’s highest. In various countries of Western Europe, for example, the prices average from 30 to 50 percent below those in the United States for identical products from the same manufacturers.40-42 The governments of those countries protect their people against high drug prices by negotiating the prices with the manufacturers or by setting the prices directly by regulation. The drug industry acknowledges that it charges higher prices in the US to offset those lower prices in other developed countries. (Poor nations are also facing drug prices higher than they can afford,43 even though a few manufacturers are considering whether to cut prices to some of those nations.44,45) According to the Pharmaceutical Research and Manufacturers of America, Americans pay higher prices because they bear the world’s drug research burden.46
The pharmaceutical industry’s defense against criticism of high drug prices is that it needs the money if it is to continue bringing medically valuable new products to the market. This contention then branches into two somewhat separate propo-sitions. One relates to the overall cost of R&D per new product brought to market. The other relates to conditions for attracting the capital needed for R&D.
Pharmaceutical manufacturers contend that product prices reflect the cost of developing new products, taking into account that not all R&D projects succeed. However, because they do not open their books, it is difficult to verify this asser-tion. A commonly cited industry cost estimate, $500 million per product brought to market, turns out to include not only actual costs but also the opportunity cost of having failed to invest their R&D moneys elsewhere while waiting for marketable products to emerge.47-49 The opportunity cost represents more than half the total estimate. However, the US Office of Technology Asses-sment called the industry estimate an arbitrary number and suggested a substantially smaller figure even with opportunity cost included.50
A public health assessment of the value of the industry’s R&D activities should consider also what proportion is devoted to developing copycat products and lifestyle products rather than drugs that represent critical therapeutic gain. Among the 1,223 new chemical entities brought to market from 1975 to 1997, only 379 (31%) represented therapeutic innovation. Thanks to the US Orphan Drug Act, implemented in 1983, 157 of these new products addressed rare diseases, as did 837 new indications of existing products. (However, this included very few for diseases prevalent mainly in poor nations).51,52
Secondly, the drug industry asserts it is a highrisk industry that needs super-profits to attract cap-ital. However, its consistently high net profit margins year after year, after research costs have been taken into account, hardly evidence high risk.53 Indeed, a review of the earnings of research-intensive drug manufacturers over a 12-year period by Congress’ Office of Technology Assessment concluded that, even with adjustment for risk, these companies were more profitable than other kinds of enterprises.54
Current revenues of the industry’s dominant companies offer adequate margin to accommodate substantial price cuts. Among the 10 largest US pharmaceutical companies, the median ratio of 1998 net income to reported R&D expenditures is 1.5 (range 0.6 to 2.0).55 In 1998, the aggregate profit of 12 Fortune 500 drug manufacturers exceeded the entire industry’s spending on R&D.56
There is no firm link between a nation’s drug price level (or an individual company’s) and the level of R&D there. Many factors other than price affect research and development investments.57 For example, more new medicines in worldwide use have been developed in the UK than in Germany and Sweden combined,58,59 notwithstanding higher drug prices in the latter countries.60
A report from Merrill Lynch noted that a price cut’s negative impact on drug company revenue can be overwhelmed by the resulting increase in sales volume. The report went on to estimate that, were all 39 million Medicare beneficiaries to get a 40 percent discount on manufacturers’ prices, sales volume would go up with the result that the manu-facturers’ total revenue would drop no more than 3.3 percent, and might even show a slight increase.61 Likewise, universal coverage for medicines would assure the pharmaceutical industry of high sales volume. Reforms that restrain or reduce prices without substantially cutting drug makers’ total US revenues would appear to merit serious consideration. Price reductions will mean a higher volume of sales, but the marginal cost of producing additional drugs is low. Volume growth, taken together with low marginal costs, suggests that manufacturers could even produce all the medications Americans need without requiring marked increases in revenue.62
To serve the public’s health, public policy should:
We deem these ends to be attainable.
A Survey of Methods Available to Public Policy Makers
One possible method for holding prices in check that is available to both private and public payors, is to use pharmacy benefit managers (PBMs). PBMs are companies that manage the drug benefit plans of managed care organizations and large employers. They work to extract price discounts from drug companies, generally in return for giving preference to a company’s product line, perhaps even creating a formulary around that company’s line. Typically, the arrangement provides for a manufacturer rebate based on the volume of retail sales generated. The manufactur-ers’ discounts obtained by PBMs may often be over-estimated, since a substantial share of their savings stems from pharmacy discounts, utilization review and other measures.63 While the task of the PBM is most simply seen to be the purchase of discounted drugs, a preferable role definition might be the management of drug use.
That model has suggested the possibility that using a more expensive drug could actually lower the total direct medical costs.64
Some PBMs reward pharmacists who persuade physicians to switch to the PBMs’ preferred product. Proponents argue that PBMs promote competition and thus reduce prices. Yet, as forprofit entities, PBMs themselves become another cost element. Because their price negotiations are secret, it is hard to keep them from syphoning off some rebate money to themselves. Studies of PBMs tend to focus on their structure and the range of services they provide. The impact of PBMs on quality of care, and even on costs is for the most part unstudied.65
In the context of proposals for a Medicare prescription drug benefit, drug manufacturers have voiced a strong preference for involving PBMs. Thereby they could avoid the pressures for accountable pricing that they fear would arise in direct transactions with a federal agency. Mean-while, the federal Department of Justice has had large PBMs under scrutiny, concerned that their complex and confidential financial agreements with manufacturers might be violating fraud or anti-kickback laws.66,67
A variety of other possible methods are available for containing drug prices through public intervention, methods that range from direct price controls to fostering more competitive markets. These include:
A fact not widely appreciated is that the Federal Government already has the power to enforce “reasonable” pricing for an important subset of pharmaceuticals, those produced under privately held patents arising out of Federally funded R&D.77 The Bayh-Dole Act of 1980, designed to hasten development of marketable products out of federally funded research, empowers the government to ensure that such products are made available to the public on reasonable terms.78 Yet the government has apparently never exercised this power.79,80 A measure passed overwhelmingly in June of 2000 by the U.S. House of
Representatives as an amendment to an appropriations bill basically calls on the government to exercise it.81 In principle, any of methods 1, 4, 5, or 11 could provide a definition of reasonable price.
A more fundamental approach than any of the foregoing would take into account other areas of public policy that impinge on the issue, apart from pricing policy per se. While it is beyond the scope of the present paper, there would be merit in a study of how most efficiently to support pharmaceutical R&D with priority attention to the most vital needs. One approach would be to fund R&D separately, and drug pricing then would be expected to cover just the costs of manufacturing and distribution. One variant of that approach would be public assurance of R&D funding in return for industry provision of medications to meet the pop-ulation’s needs at affordable prices.
Action by APHA
References
