Let’s take a closer look at the numbers to see how all this works (or doesn’t).
In 2018, although list prices for branded drugs increased by 5.5%, net prices (what drug companies actually get after discounts and rebates) were essentially flat compared to the year before, having come in nominally 0.3% higher, though really lower when adjusted for inflation.105 So increased prices of some drugs were more than offset by the savings from other drugs going generic. Indeed, total spending (what the US is paying, in total, for drugs) is increasing, by about 4.4% in 2018 from the prior year, but it’s because more patients are being treated. That should be good news. That’s what progress looks like!
Of course, none of that matters if you are a patient who can’t afford what your physician prescribes—and there are all too many people out there who can identify with this. A major part of the solution requires lowering or eliminating out-of-pocket costs, as discussed in Chapter 4, but it’s worth exploring just how much waste there is in the middle zone between drug companies and patients due to payers’ and PBMs’ tactics.
In 2018, US drug spending based on list prices was $479 billion, yet net drug price spending was $344 billion, approximately 28% lower.106 That means that, even if we stuck to “cost-sharing” but simply linked what patients pay to net prices that PBMs negotiate instead of list prices, patient costs would be reduced by 28%, saving around $17 billion of the $61 billion in out-of-pocket costs Americans paid in 2018.107 Insurance companies and Medicare count on that $17 billion extra from patients to pad their own budgets, allowing them to charge slightly lower premiums/taxes, a perverse kind of insurance policy since it means that the sick subsidize the healthy.
Realistically, being able to negotiate secret rebates is a useful tactic for playing drug companies off one another, as PBMs have done with Gilead, AbbVie, and Merck to drive down the cost of hepatitis C cures in recent years. However, right now, some patients are increasingly bearing an unfair burden, and most Americans are being misled about the true costs of important medicines.108 To understand why and how, let’s begin with a quick rebate primer.
Rebates and How They Impact Patients
Imagine if an agent offered to help you buy a car and promised that you would only need to pay her 20% of whatever she saved you. You buy a car that is listed at $40,000 by the dealership, but you only end up having to pay $30,000, after your agent negotiates on your behalf. Your agent has saved you $10,000 and retains $2,000 as her fee, so really the car cost you $32,000, and you saved $8,000. That’s still good.
Now, imagine that a car dealership decides to cut out the middleman and list those same cars at $30,000, the same amount the dealership would have received after giving discounts to agents. That would be cheaper than going through an agent since you wouldn’t have to pay the $2,000 fee. The agent won’t direct buyers to that dealership because their prices leave no room for the dealership to offer any discounts, which means the agent won’t earn her commission. If anything, agents will encourage dealerships to raise their list prices, either directly or tacitly. If the agent can pressure the dealership to raise the list price of that car to $50,000, the agent will be able to negotiate it down by 40% to $30,000, earn a $4,000 commission, and come out looking like a hero to the buyer, though the car would now functionally cost $34,000!
This is what’s going on in the drug industry, and it is a big reason why list prices are increasing. The question, of course, is why don’t biopharmaceutical companies bypass the PBMs and sell their products directly to insurance companies? Yes, any company that did so would be ostracized by the agent community, but why should that matter?
The unfortunate truth is that as PBMs have grown, they have amassed wide influence. They have entrenched themselves as middlemen with massive bargaining power, which stems from how concentrated the PBM market has become. The top three PBMs, Express Scripts, CVS/Caremark, and United’s OptumRx, represent 80% of the PBM market and serve insurance plans covering half of the US population.
So, what’s the big deal? PBMs keep a piece of the rebate, but at the end of the day, they are saving patients money, and that’s what matters…right? And that’s the problem: saving patients money matters, but this system doesn’t actually do that. Though rebates save money for society as a whole, currently rebates actually increase the true share of costs patients shoulder.
As discussed, a portion of the rebates negotiated by and passed through PBMs is kept by the PBMs. Some of those rebates are passed on to the insurer, particularly for drugs covered by Medicare, less so when drugs are covered by private payers. But—critically—none of this makes its way back to patients, who are still subjected to cost-sharing through deductibles and copays based on the list prices of drugs.
For example, a patient with a 20% copay on a drug with a $10,000-per-year list price must pay $2,000. After rebates, that drug might cost the PBM, say, $6,000. So, in actuality, the patient is paying $2,000 for a drug that cost $6,000—so the patient’s copay, in effect, is 33%, not 20%.109
It gets worse if the patient hasn’t yet met his deductible. If this patient has a $10,000 deductible that he hasn’t met, he might have to pay the full list price for the drug, in this case, $10,000, while his insurance company pockets the $4,000 rebate from the biopharmaceutical company! (Recall the car repair analogy in Chapter 4.) Payers defend this practice by claiming that rebates help to defray the cost of insurance for everyone, meaning that, perversely, sick patients are subsidizing insurance for the healthy. That’s not how insurance is supposed to work!
As the public learns more about PBM tactics, they are justly appalled and outraged. And it doesn’t stop with retaining a portion of drug rebates. PBM contracts with their clients are filled with all kinds of hidden pockets of profit, according to one leaked contract.110
In March 2018, the insurer United Health caused a stir in the world of health insurance by enacting what would seem to be a banal and obvious new policy: Beginning in 2019, United would begin passing rebates through to some patients.111 The details remain opaque—and whether consumers have derived any real savings remains to be seen—but this is an overdue gesture designed to assuage Americans’ anger over their growing out-of-pocket expenses. United’s program will cover plans affecting only seven million Americans, but hopefully more plans will follow.
Unfortunately, if insurance companies appear to be giving with one hand, they’re likely taking away with the other. In 2018, a new so-called benefit called a “copay accumulator” began appearing in health plans across the country. As mentioned in Chapter 4, copay accumulators are designed to negate the efforts of drug companies to help patients pay out-of-pocket costs for drugs, particularly the costs of specialty medicines that can reach tens of thousands of dollars per year per patient. The goal is to ensure that no matter what anyone does to help a patient afford their medications, insurance won’t kick in until the patient has suffered financial strain.112
Almost anyone would agree that this system is heartless and needs to be reformed. Drug manufacturers’ assistance programs are steps on the path to making drugs affordable to those who need them, but they are not a fix in and of themselves. No matter what rebates or coupons biopharmaceutical companies offer, it won’t make any difference if PBMs and insurance companies remain bent on making healthcare feel unaffordable to patients, on nudging them into foregoing care, and on extracting what they can from vulnerable patients to lower the cost for healthy people, who have no idea of the costs they will face should they develop a chronic disease and need care.
Bad Press and Higher Costs
Drug companies get bad press when they are seen raising their list prices, even when their non-public net prices are actually flat or down. PBMs offer preferential coverage status (e.g., a lower copay than a competitor’s drug) and therefore more market share to companies that are both willing to charge a higher list price, swallowing the bitter pill of bad press, and a
ccept a lower net price that insurance companies want, so that these PBM middlemen can feed off the rebate in between. If a drug company were to just offer a low list price, it would save the insurance companies and society that ultimately pays the bills just as much money and save itself the bad press, but then the PBMs couldn’t profit from rebates. Unfortunately, because patients’ out-of-pocket costs are linked to list prices, they suffer the consequences of PBMs’ business model.
Do PBMs Have a Role—Any Role—to Play?
Whether or not insurers should continue to rely on PBMs to manage drug price negotiations is a point of ongoing debate.113 One could argue that the bloated administrative costs of PBMs’ complex scheming and the profits they generate represent a layer of rent that society can do without.
By my crude estimate, if what PBMs skim off the top by these controversial means were redirected to patients, it would shave over a third from their out-of-pocket spending on drugs.114 As an added bonus, doing away with PBMs would help close the gap between list prices that Americans see (and are outraged by) and the net prices that more accurately reflect the cost of drugs to society.
Still, someone has to do the work of managing formularies and negotiating drug prices, just as someone has to do the work of organizing health insurance overall. That said, there are precedents for eliminating PBMs from the process. Today, not all insurers sub-contract with PBMs, choosing instead to create their own formularies and negotiate directly with drug companies.
If PBMs do continue to play the role of drug rebate negotiators, they should compete based on their overall level of effectiveness and efficiency, without the perverse incentive to encourage higher drug prices in order to negotiate steeper rebates. If, as a recently proposed federal bill directs,115 PBMs were required to pass the entire rebate to their insurance-company customers, many of these perverse incentives would go away—as would a portion of the PBM industry’s profits (so it will not come as a surprise that the PBMs lobby hard against this kind of reform). So be it. Ultimately, the PBMs that do a more effective job of negotiating rebates will have more competitive overall fees and win more business for themselves from insurance companies—and that’s how it should work.
The Cost of Bureaucracy
Any close look at PBMs reveals a complex shell game of rebates, copays, accumulators, and other mechanisms payers use to pad their profits. But it raises another question: How much does it cost to design, implement, and administrate such a complex system? You may have already come across statistics to that effect, such as “Administrative costs are 8 percent of health care spending in the US and 3 percent on average among wealthy countries.”116
In March 2018, The Economist analyzed what they called the “excess profits” (those above the 10% return on capital that they deemed reasonable) of the two hundred largest healthcare companies, ranging from pharmaceutical companies to pharmacies to payers.117 They concluded that excess profits only represented about 2% of total healthcare spending (or 4% of what they estimated the US overspent relative to other countries) and that even if these excess profits were eliminated, it would not represent a tremendous savings. In addition—and despite what much of the public believes—The Economist found that pharmaceutical companies were not the worst offenders in this regard. Looking back a couple of decades, the study pointed out that while average drug prices (net of rebates) had risen by about 5% annually, their development costs have also climbed steeply, cutting their return on capital in half since the late 90s and nearly eliminating excess returns. Meanwhile, the profits of the middlemen, including PBMs, insurers, wholesalers, and pharmacies, have, over the past 15 years, climbed from 20% to 41%, and that they represent two-thirds of the healthcare industry’s excess profits.
This is not to suggest that the public should direct its ire to whichever stakeholder in the healthcare industry commands the highest profits. What matters is the value that each is offering for what they are charging. My argument is that drug companies are ultimately building a generic drug mountain that will serve mankind for the rest of time at a low cost, while the countless middlemen who extract high rents from society, including from desperate patients, warrant greater scrutiny and reform.
As with children’s stories, where there is a hero, there is necessarily a villain, and therefore rising list prices give the public the sense that it is the drug companies engaged in callous extortion despite payers’ best efforts. But in reality, it is America’s flawed and fragmented health insurance system that perversely incentivizes middlemen to embrace higher drug prices in exchange for their secret discounts and unfairly foists healthcare costs onto patients under the guise of having “skin in the game.”
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105“Hep C Drugs,” National Prescription Coverage Coalition, accessed Oct. 15, 2019
106IQVIA Institute for Human Data Science, Medicine Use and Spending in the U.S.
107Consider that saving patients 28% by lowering drug prices by 28% would render the entire biopharmaceutical industry a non-profit and shutter innovation. So pegging patients’ out-of-pocket expenses to net prices instead of list prices is a much more surgical solution, which payers would compensate for with a tiny increase in premiums, less than 1%, though could also absorb by slashing their own bureaucracy.
108Noam N. Levey, “Rising Health Insurance Deductibles Fuel Middle-Class Anger and Resentment,” Los Angeles Times, July 17, 2019, https://www.latimes.com/politics/la-na-pol-health-insurance-angry-patients-20190628-story.html#null.
109Neeraj Sood et al., “Follow the Money: The Flow of Funds in the Pharmaceutical Distribution System,” Health Affairs, June 13, 2017, https://www.healthaffairs.org/do/10.1377/hblog20170613.060557/full/.
110Bob Herman, “Inside a Drug Pricing Contract,” Axios, updated March 15, 2018, https://www.axios.com/inside-express-scripts-pbm-contract-8be2f09d-cbfa-4275-9855-7bc9c4fcc1a7.html.
111”UnitedHealthcare Launches Expansion of Direct-to-Consumer Pharmacy Discounts to Millions of Americans,” UnitedHealth Group, March 6, 2018, http://www.unitedhealthgroup.com/Newsroom/Articles/Feed/UnitedHealthcare/2018/0306DirecttoConsumerPharmacyDiscounts.aspx?r=1.
112Brooke Wright, “Trending in Benefit Design: Copay Accumulator Programs,” Hiro (blog), Feb. 5, 2018, https://www.hirc.com/blog/trending-benefit-design-copay-accumulator-programs.
113Robert Goldberg, “Reduce Drug Prices By Eliminating PBM Rebates,” The Hill (blog), Feb. 14, 2017, http://thehill.com/blogs/congress-blog/healthcare/319479-reduce-drug-prices-by-eliminating-pbm-rebates.
114Extrapolating to the whole PBM market from the financial statements of Express Scripts, a PBM with 28% market share in 2017, and assuming that even as much as 75% of PBM gross profits are derived from rebates which are then spent on unnecessarily complex administration and profits (which would mean that 25% of gross profits covers the cost of necessary administration), then PBM profits and excess operating costs that one conceivably could try to eliminate add up to ~$23 billion, which is 6.7% of the estimated $344 billion of total net US drug spend in 2018 per IQVIA. The fraction of just retail drugs that PBMs are responsible for, which are around 71% of all drug spending, would be closer to 10%.
IQVIA Institute for Human Data Science, Medicine Use and Spending in the U.S; Express Scripts 2017 10-k SEC filing: Timothy Wentworth, “US Securities and Exchange Commission, Form 10-K: Express Scripts Holding Company” (annual report, Washington D.C., 2017), https://www.sec.gov/Archives/edgar/data/1532063/000153206318000004/esrx-12312017x10k.htm; “Select Emerging PBMs Gain Market Share,” Health Strategies (blog), Feb. 23, 2017.
115”Wyden Calls for Increased Drug Pricing Transparency to Lower Costs,” United States Senate Committee on Finance, March 15, 2017, https://www.finance.senate.gov/ranking-members-news/wyden-calls-for-increased-drug-pricing-transparency-to-lower-costs.
116Carolyn Y. Johnson, “The Real Reason the US Spends Twice as Much on Health Care as Other Wealthy Countries,” The Washington Post, March 13, 2018, https://www.washingtonpost.com/news/wonk/wp/2018/03/13/the-real-reason-the-u-s-spends-twice-as-much-on-health-care-as-other-wealthy-countries/?utm_term=.0bb0bf775941.
117“Which Firms Profit Most from America’s Health-Care System,” The Economist, March 15, 2018, https://www.economist.com/news/business/21738934-it-not-pharmaceutical-companies-which-firms-profit-most-americas-health-care-system.
8
When a Drug Won’t Go Generic: Proposing Contractual Genericization
The Biotech Social Contract calls on the drug development industry to make drugs that will go generic without undue delay, thereby adding to that mountain of generic drugs. But if drugs don’t, won’t, or can’t go generic, they pose a significant threat to the contract and the sustainability of the industry. Some drugs, such as gene therapies and CAR-T cell therapies, are truly uncopyable—someone can claim they have made a copy, but the FDA won’t trust the copies to be close enough to the original to allow its use in place of the original. As a consequence, no exact copies will come to market to compete on price with the original in the way generics do.
This situation creates two problems: (a) the prices for these drugs might never drop, and (b) the companies selling them have less incentive to innovate and create new drugs to replace revenues that would normally be lost to generic competition. Drugs that don’t go generic exist outside of the Biotech Social Contract—and in violation of it.
The Great American Drug Deal Page 11