Meeting Summary - Pharmaceutical Pricing Practices, Utilization and Costs

II. Pricing Practices in the Pharmaceutical Market

The second session of the conference explored pricing practices in the brand-name pharmaceutical market, factors influencing manufacturers' pricing decisions, pricing practices across markets and purchasers, and the potential impact of price transparency on pricing practices. The session included five formal presentations:

Jack Hoadley, Ph.D., Division of Health Financing Policy, Office of the Assistant Secretary for Planning and Evaluation (ASPE), DHHS, presented findings from an April 2000 DHHS report indicating that pharmaceutical manufacturers charge different purchasers varying prices for prescription drugs.
Anna Cook, Ph.D., Mathematica Policy Research, Inc., explained why different purchasers pay difference prices for prescription drugs.
Joseph DiMasi, Ph.D., Tufts Center for the Study of Drug Development, Tufts University, presented an analysis showing the impact of new drug prices in different therapeutic classes on pharmaceutical expenditures from 1995 to 1999.
Robert Freeman, AstraZeneca Pharmaceuticals, gave his perspectives on the factors that brand-name prescription drug manufacturers consider when deciding to invest in a new product and when setting prices for new products.
Stephen Schondelmeyer, Pharm. D., Ph.D., PRIME Institute, University of Minnesota, argued that the U.S. pharmaceutical market is not an efficient market and recommended government regulation to increase the transparency of drug prices.

The session also included a Panel Discussion and a discussion of Research Questions.

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1. Prescription Drug Coverage, Spending, Utilization, and Prices: Report to the President--Jack Hoadley, Ph.D.

Dr. Hoadley highlighted findings from the April 2000 DHHS report Prescription Drug Coverage, Spending, Utilization, and Prices: Report to the President (which is available online at aspe.hhs.gov/health/reports/drugstudy). The DHHS report documents, to the extent possible, the complex arrangements by which prices for prescription drugs are determined at different levels of the pharmaceutical distribution chain: drug manufacturers, wholesalers, retailers, insurers, PBMs, pharmacies, and consumers. As illustrated in Figure 1, different purchasers pay different prices for the same brand-name prescription drug. Cash-paying customers--i.e., individuals for whom there is no third-party payment at the point of sale--pay higher prices than do Federal facilities and agencies, insurers and PBMs, and others. These customers, who include Medicare beneficiaries with poor or no prescription drug coverage, are among the people least able to afford high prescription drug prices.

Dr. Cook explained that the manufacturers of brand-name drugs charge each purchaser the highest price they can and that different purchasers have different price sensitivity.

In general, the more ability a purchaser has to drive market share toward the utilization of particular products, the more willing a brand-name drug manufacturer is to offer thatpurchaser rebates or discounts. PBMs, HMOs, and other purchasers get rebates because they can influence the utilization of drugs by applying a formulary to a broad patient base. Hospitals, clinics, and HMOs that purchase drugs directly from manufacturers get rebates because they can influence the prescribing patterns of doctors. Cash-paying customers do not have the ability to drive market share and therefore do not get rebates or discounts.

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3. Price Trends for Prescription Pharmaceuticals: 1995-1999--Joseph DiMasi, Ph.D.

Dr. DiMasi presented conclusions about U.S. prescription drug pricing trends in the period 1995-1999 from an analysis he conducted as a consultant to the Drug Value Group at the Schneider Institute for Health Policy, Brandeis University:

Prescription drug prices were related to the purchaser's price sensitivity and the drug's value (benefits and risk).
Price trends for different therapeutic categories of prescription drugs--e.g., antiarthritics, antidepressants, antihistamines, antihyperlipidemics, antihypertensives, antiulcer drugs, and different types of antibiotics--varied over the period of the study.
New prescription drugs varied substantially in their impact on drug expenditures over the period of the study. Some new brand-name drugs were introduced at significant discounts to existing drugs that are highly substitutable with the new drug. Entirely new classes of compounds to treat a disease or condition were often priced at a premium relative to older brand-name drugs.
Among the factors that affected prescription drug launch prices were the drug's length of use (acute vs. chronic), convenience of use, and relative safety and efficacy. For example, patients using drugs for long periods are likely to be more price sensitive than patients using drugs for short periods, so average launch prices for drugs for acute conditions tend to be higher than drugs for chronic conditions (with some exceptions such as AIDS antivirals).

Given all the complexity in the realm of prescription drug prices, Dr. DiMasi said, it is very important to get to the issue of the proper use and true value of both new and old prescription drugs.

Dr. Freeman explained that brand-name prescription drug manufacturers have to develop two types of information for new brand-name products, and this requirement affects the cost of new products development and registration: (1) information needed to satisfy FDA requirements that products be safe and effective; and (2) information that can be used at launch time to market the product to key customers.

When considering how to price a new prescription drug, a brand-name drug manufacturer takes a number of factors into account. The first consideration is the new product's price and value relative to other products. Value here refers to incremental clinical and economic benefits. Different classes of customers for prescription drugs--PBMs, employers and other health plan sponsors, managed care organizations, physicians, patients, etc.--have different, and sometimes conflicting, perceptions of value.

A large determinant of what pricing strategy a drug manufacturer adopts--i.e., premium pricing, neutral pricing, or market penetration pricing--is potential customers' price sensitivity. If a product has unique value, and there is no close substitute, customers tend not to be very sensitive to price; if there are multiple products and it is easy to compare them, customers tend to be more sensitive to price. There are price differentials among pharmaceuticals in different countries, just as there are price differentials among geographic areas for virtually any goods or services.

The pharmaceutical industry is a profitable industry, and there are allegations that its pricing structure results in monopoly profits. According to Dr. Freeman, the pharmaceutical industry charges R&D capital expenditures and launch expenditures as current expenses, and this accounting practice makes the industry look very profitable. If the industry were to capitalize these expenses, its profits would be more comparable to those for other industries.

Dr. Freeman does not believe that imposing price controls at either the retail or manufacturer level is an efficient way of increasing the affordability of prescription drugs or patients' access to prescription drugs. He does, however, support improving patients' access to prescription drug coverage.

Dr. Schondelmeyer said that an efficient market has four components: (1) many buyers and many sellers; (2) the existence of similar or identical substitutes; (3) complete information on product quality and price; and (4) easy market entry and transfer of resources. He believes that the U.S. market for prescription drugs lacks some of these characteristics--in particular, complete information on product quality and price.

Structural features that distinguish the U.S. pharmaceutical market from other markets include the following:

Directed demand for pharmaceuticals. Physicians prescribe drugs for their patients.
Differences in the economics of the pharmaceutical industry as a whole vs. individual therapeutic markets. In order to understand competition in the pharmaceutical market, it is important to look at competition in individual therapeutic classes. Nine of 12 therapeutic class markets have greater than 50% concentration, making the pharmaceutical industry a very concentrated industry.
Insurance coverage and subsidies increasing utilization. Third-party payments account for 75-80% of all prescriptions, and people with good prescription drug coverage have few incentives to curb their prescription drug utilization. If consumers paid out of pocket for all of their prescription drugs, utilization would be much lower.
Hidden prices, discounts, and rebates. Rebates for brand-name drugs are determined in confidential, private arrangements negotiated between manufacturers and PBMs or other purchasers, and no available data set provides information on the dollar amounts. In the April 1999 DHHS report on prescription drugs, a key limitation of the analysis was the absence of good information about rebates.

Three signals of market failure in the U.S. pharmaceutical market are the following:

Prices are not known by decisionmakers. Physicians do not know the prices of prescription drugs or think that prices should be a factor in their prescribing decisions; patients do not know the price unless they have to pay out of pocket at pharmacy, and corporate pharmacy and therapeutics committees (which select medications for a formulary) do not know prescription drug prices net of rebates.
Prices, discounts, and rebates are hidden in the market. Manufacturer's contracts declare that prescription drug prices and rebates are "proprietary and confidential" and cannot be disclosed to pharmacy and therapeutics committees or physicians.
United States vs. the world ironies. The United States has the highest prescription drug prices and the greatest amount of prescription drug price inflation in the world.

Dr. Schondelmeyer advocated government regulation to increase the transparency of U.S. prescription drug prices. The goals of price transparency, he said, would be to improve economic efficiency in the prescription drug market; help get accurate price information in the market; empower buyers to better negotiate; give access to actual price information to policymakers and researchers; and make pharmaceutical firms more accountable for prices.

Following the formal presentations, a diverse panel of about 25 stakeholders and researchers provided their perspectives on pricing practices in the pharmaceutical market. Their comments centered around several themes as noted below.

Different Prices for Different Purchasers

One panel member argued that the focus on different prices for different purchasers is misplaced. Aggregate U.S. drug expenditures are rising at double-digit rates, while hospital costs are going up only a few percentage points a year. Although a few integrated health systems and some PBMs are better at getting prices down than others, clearly something more fundamental is going on than just steering. Another panel member commented that Figure 1 showing different prices paid by different purchasers is static, but U.S. policymakers should be concerned with what is going to happen over time.

Rebates from Brand-Name Drug Manufacturers

There was considerable discussion of drug rebates offered to PBMs and other large purchasers by brand-name drug manufacturers.

Rebates to PBMs. A brand-name drug industry representative confirmed that a key consideration in a manufacturer's decisions to offer rebates is the purchaser's ability to drive market share toward specific brand-name products. Market share stipulations are often connected to incentives such as the inclusion by a PBM (or health plan or health plan sponsor) of a specific brand-name drug in its formulary or pharmacist and patient incentives to influence market shares of rebated products. PBM representatives on the panel explained that a PBM's ability to drive market share is a function of the willingness of the PBM's individual customers--health plans and health plans sponsors--to put into place formulary designs, copayment steerage mechanisms, etc., to drive the market toward specific brand-name products. PBMs' use of rebates and other strategies to control costs in their customers' prescription drug programs was discussed at length in the session Strategies for Controlling Costs and Increasing Value From Pharmaceutical Expenditures.
Medicaid rebates and best price. Under the Omnibus Budget Reconciliation Act of 1990, Medicaid programs receive rebates from drug manufacturers equal to the difference between the average manufacturer price (AMP) (i.e., the average price paid by wholesalers) and the manufacturer's "best price" (i.e., lowest price the manufacturer offers to any private purchaser at any time during the year). The minimum rebate to Medicaid must be 15.1 percent of the AMP.
Inability of retail pharmacies to negotiate rebates. A representative of a nationwide retail pharmacy chain that purchases $10 billion of pharmaceuticals a year reported that the chain has only a minimal ability to negotiate rebates with brand-name drug companies. On the other hand, the pharmacy chain is able to negotiate discounts with generic drug manufacturers.
Inability of cash-paying customers to benefit from rebates. Many panel members expressed concern about the fact that cash-paying customers, including Medicare beneficiaries, do not benefit from drug manufacturers' rebates and pay higher prices for prescription drugs. Physicians said that some Medicare patients and uninsured patients are unable to afford the medications they need. The question that arises is: How can we deliver the same price break to uninsured people? One panel member reported that a new group of purchasers has recently been entering the prescription drug discount stream--the cash card group. This is a group of about 5 or 6 million people, many of them seniors, who have cash cards from the American Association of Retired People (AARP), Readers Digest, or other organizations. People in this group do not have prescription drug coverage, but can use their cash cards to go to pharmacies and get discounts.

Relationship Between Brand-Name Drug Manufacturers' R&D Costs and Drug Prices

Noting that manufacturers' R&D costs are typically cited as the justification for the prices of pharmaceutical products, some consumer representatives on the panel suggested that it would be helpful to have more information about what drug manufacturers spend on R&D. They noted that a Nader group study of orphan drug trials found almost no relationship between what a company spent on R&D and the prices of the drugs. Furthermore, it was reported that a transatlantic consumer group with 65 member organizations recently passed a resolution asking the European Union and the United States to move toward more transparency in drug development costs, so that better data on drug development costs will be available to consumers and others.

Profitability of the U.S. Brand-Name Pharmaceutical Industry

With regard to the pharmaceutical industry's profitability, one representative of the retail pharmacy industry commented that he understands what Mr. Freeman said re: the industry's capitalizing R&D expenses over time, but the pharmaceutical industry's after-tax profits are 20-25% vs. retail pharmacies' profits, which are about 2-3%. Even if drug manufacturers changed their accounting measures, their profits would be very high. Another panel member commented that, while manufacturer's profits should not be exorbitant, if drug manufacturers are not allowed to make profits, they will bail out of the market.

Some panel members suggested that research is needed on the relationship between reimbursement or payment levels and drug manufacturers' profitability and innovation. Specifically, research is needed to answer the following question: What effect would extending full prescription drug coverage to Medicare beneficiaries have on drug prices and ultimately the profitability and innovation of drug manufacturers--and what are the tradeoffs?

Perspectives on the "Value" of Perscription Drugs

Some panel members challenged Dr. Freeman's comment that the brand-name prescription drug industry prices its products to the value of consumers, noting, for example, that brand-name drugs are not priced to the value of an elderly person on an $8,000 income who needs three prescriptions to treat a chronic disease. A drug company representative responded that the drug industry does not sell directly to these patients. Furthermore, even if the prices were cut in half, the affordability problem for uninsured low-income people would remain. Some physicians and researchers agreed, noting that the introduction of ever-more costly drugs will only exacerbate the affordability problem for low-income patients. The fact that there are multiple, and often conflicting, perspectives on the value of prescription drug utilization and expenditures was discussed further in the session on Pharmaceutical Utilization Issues.

Problems With Coompetition in the U.S. Pharmaceutical Market

Economists on the panel agreed with Dr. Schondelmeyer's observation that in order to understand competition in the U.S. pharmaceutical market, it is important to look at the level of competition in each therapeutic class. One economist reported that the general economic literature indicates that duopolies do not do very much for competition. He suggested that the goal in the prescription drug market should be to get four or five competitors in each therapeutic class.

Several questions arose with respect to competition in the U.S. pharmaceutical industry, including:

Why isn't there more competition within therapeutic classes when three or four or more brand-name drugs are somewhat substitutable?
Within those pharmaceutical market segments where there is competition, why are the full benefits of competition not being realized?

Wall Street analysts on the panel reported that the generic industry remains quite competitive, even though there has been a lot of consolidation in the generic industry in the last 5-10 years. Historically, the generic industry has suffered from fratricidal competition. To encourage the development of new generic drugs that will ultimately create a more competitive marketplace, purchasers need to make sure that they operate in a way that helps keep the generic industry alive.

Another question that arose in the discussion of competition in the U.S. pharmaceutical industry was: What do we know about how the launch of generic drug products affects prescription drug utilization and costs? Some panel members, including researchers and representatives of PBMs and the generic drug industry, noted that brand-name drug manufacturers often have developed a new brand-name product with improved efficacy or reduced side effects by the time the patent on an old brand-name product expires. If patients switch to the new brand-name product, the patent expirations on their older products will not lead to as much generic competition. A representative of the generic drug industry said it would be useful to conduct research on the following question: What happens over time to a therapeutic market when there are generic product entries? Are there shifts in volume from one brand-product to another brand-product within the same therapeutic class?

Finally, one panelist asked: What do we know about how the launch of new over-the-counter (OTC) drug products affects prescription drug utilization and costs? A Wall Street analyst suggested that drug manufacturers launch an OTC version when they need to breathe new life into a product. The marketing expenses associated with the launch of OTC products are huge; and many OTC products are not profitable for several years. Some panelists noted that there is often continued use of brand-name prescription drug products even after a product comes out in an OTC form. At least for people who have prescription drug coverage with low copays, it may be cheaper to get the brand-name drug (with a low copay) than to pay out of pocket for the OTC product. Furthermore, the OTC product is typically less potent than brand-name product, so people may prefer the brand-name product. Finally, some OTC products have indications that differ from those of the prescription products (e.g., OTC form for heartburn vs. prescription form for ulcers). Some panelists said that it would be useful to conduct research on how the launch of OTC products affects prescription drug utilization and costs within therapeutic categories.

Transparency of Prescription Drug Prices

There was disagreement among panel members about Dr. Schondelmeyer's recommendation that prescription drug prices be made more transparent. Some panel members--including consumer representatives, health care purchasers, and researchers--said that it would be useful to have more transparency of prescription drug prices and drug manufacturers' R&D costs. Price disclosures could be made via any of a number of vehicles: publishing prices in the FDA Orange Book or parallel publication, publishing prices via commercial price databases, publishing prices on the Internet, disclosing actual net price on all invoices, or disclosing actual net price in all purchaser contracts. Other panel members--including drug industry representatives and some researchers--questioned whether price transparency should be required in the pharmaceutical sector, noting that it is not required in other sectors.

Pricing and Value of Brand-Name and Generic Drugs

Some panelists asked whether the enormous differences in the prices of brand-name drugs and generic drugs really represent a difference in value. One panelist suggested that the use of generics could be promoted through techniques used to promote brand-name drugs (e.g., sampling or detailing).

What Additional Information would Improve the Performance of the U.S. Pharmaceutical Market?

An economist on the panel commented that although there is a sentiment among economists that more information is better than less, when one competitive condition is absent in a market--as it is in the U.S. pharmaceutical market--getting more of one element isn't necessarily better. A question policymakers should ask, therefore, is: What kind of additional information would improve the performance of the U.S. pharmaceutical market? This question elicited numerous responses, which are summarized in Strategies for Controlling Costs and Increasing Value From Pharmaceutical Expenditures.

Conference participants suggested that the following questions might be addressed as part of a research agenda in the area of pricing practices in the pharmaceutical market:

How do the prices and changes in the prices of U.S. pharmaceutical products compare to external benchmarks (e.g., overall inflation in the economy, overall inflation in health care, prices in other countries)?
How competitive is the U.S. pharmaceutical market, considering it therapeutic class by therapeutic class? Are drug manufacturers making monopoly profits?
What is the relationship between pharmaceutical companies' R&D costs and the prices of brand-name prescription drug products?
What are the advantages and disadvantages of requiring that prescription drug manufacturers make their R&D costs more transparent?
To what extent does the move to new, more expensive prescription drugs in different therapeutic classes represent value to society? Would the money be better spent if it were used to broaden access to prescription drugs?
What can be done to encourage greater price competition between brand-name pharmaceutical products, generic products, and OTC products within specific therapeutic classes?
What information might help improve the performance of the U.S. pharmaceutical market? Should the prices paid for prescription drugs (including rebates from drug manufacturers) by different purchasers and at various points along the distribution chain be made more transparent?
How can information that might improve the U.S. pharmaceutical market's performance be developed and conveyed?
What are the implications of the Medicaid best price?
What, if anything, should be done to increase physicians' and insured patients' sensitivity to the prices of prescription drugs? What is the effect of three-tiered patient cost-sharing arrangements on prescription drug utilization and costs?
How affordable are prescription drugs for Medicare beneficiaries with fixed incomes, uninsured children, disabled people with high needs and limited resources, etc.? Will making the pharmaceutical market more competitive make prescription drugs affordable for such individuals? If not, what, if anything, should be done?
What is the relationship between third-party reimbursement levels and profitability and innovation in the prescription drug industry?
What effects would the enactment of a Medicare prescription drug benefit that gives the Federal Government power over the prices of prescription drugs have on drug manufacturers' earnings, profitability, and ability to innovate?