The Road to Price Controls
Last month, the Spanish government cut what it will pay for medicines by 7.5 percent. Greece’s government reduced what it pays for drugs by up to 25 percent, prompting some companies to pull their medicines from the Greek market entirely. Even the leaders in the new British government said they might have to move away from Britain’s free pricing system for prescription medicines in favor of a scheme that pays for drugs based on how that government measures a particular medicine’s “value.”
This is what happens when governments get into budget troubles and are hard-pressed to fund bloated healthcare commitments. Medical products make easy targets, since more powerful unions protect hospitals and healthcare providers. It’s inevitable here in the United States also, owing not only to our mounting budget woes, but also the shortsighted political dealings by drug makers themselves.
Conventional wisdom says that U.S. pharmaceutical companies made out well under the Obama health plan by bargaining with the White House. In reality, all they did was invite the same kinds of price regulation taking root in Europe.
Under the Obama health plan, U.S. pharmaceutical companies can expect the same kinds of price regulation taking root in Europe.
The deal undermines the competitive pricing that supports real innovation. It will inevitably increase drug costs inside Medicare, inviting the kind of politically driven price controls that discourage investment. For good measure, the Obama health plan is full of new tools that will enable Medicare to set rules not only on prices, but the clinical criteria for accessing new medicines.
The Deal
The core of the drug industry’s deal is a promise to plug the “doughnut hole” in Medicare’s Part D drug benefit. This is the financial gap between the initial coverage limit and the amount of spending needed to trigger the program’s catastrophic insurance, where Medicare starts picking up 95 percent of a patient’s drug costs.
The pharma companies agreed to rebate half of a beneficiary’s costs in this coverage gap, so long as patients stayed on their branded medicines. The deal cleverly counts this rebate toward the running tally that Medicare keeps on patient’s out-of-pocket costs (even though people aren’t actually spending any money). This creates imaginary drug charges that accelerate people through the coverage gap and onto the government’s catastrophic reinsurance.
Take a hypothetical senior with $3,500 in annual drug charges. Right now, a Medicare drug plan only covers the first $2,830 of those costs. The rest seniors pay themselves. It’s only once patients accrue a total of $4,550 in annual charges that Medicare’s catastrophic coverage kicks in to cover 95 percent of all additional spending. Most of those catastrophic charges are borne by the government, which picks up 80 percent of the costs (drug plans pick up the next 15 percent). Beneficiaries have a 5 percent co-pay.
When the pharmaceutical industry’s deal takes effect, rather than maneuver out of the ‘doughnut hole,’ more seniors will have incentive to blow through it.
Previously, such a hypothetical senior might switch from a branded medicine to a sensible generic alternative to bring their total spending below $2,830. For a senior living in New York City, going from a branded cholesterol-lowering drug like Crestor to a generic alternative like Zocor would lower out-of-pocket costs for that drug alone from an average of about $125 a month to $10 in the coverage gap, and to $5 month once they reach their catastrophic cap.
But when the pharmaceutical industry’s deal takes effect, rather than maneuver out of this doughnut hole, more seniors will have incentive to blow through it.
That’s because drug companies will be picking up half the costs in the doughnut hole, effectively subsidizing seniors onto Medicare’s more generous catastrophic reinsurance. Healthcare analysts at the investment bank Morgan Stanley estimate that drug firms will earn an extra $22 billion over the next decade off seniors who hit the catastrophic limit sooner as a result of the pharma deal. To tip the scales further in favor of branded drugs, seniors get a much smaller rebate from generic drug makers if they choose a generic medicine.
For the branded drug makers, cutting down on generic switching was a key aim of their deal. It came, however, at a significant long-term cost—undermining the market forces that make drug plans affordable and innovation possible.
The Road to Price Controls
When the pharma deal inevitably forces premiums—and in turn government costs—higher, it will reignite calls for drug price controls. Conveniently, the Obama plan already gives Medicare the legal tools it needs to impose them.
That authority flows from the new Independent Payment Advisory Board (IPAB). Its mandate is to cut $4 billion a year from Medicare’s spending, mostly by reducing payment rates. One way is to ratchet down existing price schedules. More efficient (and ruinous to the drug industry) would be to merely import into the Medicare benefit the lower government drug pricing schedules required by Medicaid and the Pentagon. IPAB will focus mainly on medical products, since providers like hospitals have exempted themselves from the board’s focus.
For the branded drug makers, cutting down on generic switching was a key aim of their deal. It came, however, at a significant long-term cost.
The Obama plan releases IPAB’s decisions from judicial review, the need for advance public notice, or even appeals from patients. The administration envisions that its decisions will be too unpopular to subject to public scrutiny, and for good reason. Its inevitable target will be the more expensive, but also most novel, “single source” medicines. These are drugs that don’t have treatment alternatives because they represent unique innovation. For that reason, they also command a premium, precisely because they are effective and have few therapeutic alternatives.
We know IPAB will turn its attention to the priciest drugs because that’s where Medicare has always focused its attention each time it gained an authority to set rules on the price and access to categories of medical products.
For one thing, the Centers for Medicare and Medicaid Services is preoccupied by the costly treatments, using price as a proxy for waste even if lower-cost but more widely used products represent more cumulative misspending. Moreover, the remote bureaucracy also prefers to aim its coverage rules on low-use but expensive treatments because it’s more efficient to regulate small numbers of expensive products to cut spending. This approach also leaves fewer beneficiaries and drug makers affected, and thus fewer chances for opposition or complaints to Congress.
This is how access to new treatments, and the clinical issues embedded in these decisions, is weighed in a political process.
In time, IPAB’s new controls will spread outside the Medicare drug program and infect the entire market as commercial drug plans emulate Medicare’s rules. The Obama health plan gives wide latitude to those implementing the bill’s regulation of drug benefits that will be sold inside the new, state-based insurance exchanges. The Department of Health and Human Services is likely to look to the Medicare drug program in designing these new regulations. How to cover drugs was the very first decision made by officials in Massachusetts when they set up a state health plan on which the Obama health legislation is modeled.
By offering discounts to Medicare’s drug customers that aren’t available to other patients or drug plans, the pharma companies have undermined their demand to preserve competitive markets as the primary tool for measuring the value of innovation. The pharma companies sacrificed the most innovative slice of their enterprise to eke out incremental sales from their biggest, but least novel, brands.
Scott Gottlieb is a practicing physician and a resident scholar at the American Enterprise Institute.
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