How pharmaceutical companies use of maximum pricing power is leading to double digit annual increases for prescription drug prices and health insurance premiums.
In this episode you’ll learn:
- Why health insurance premiums are skyrocketing, particularly Obamacare individual polices.
- How much are drug prices increasing.
- Why pharmaceutical companies have maximum pricing power.
- How Gilead chose an $84,000 price for its hepatitis-C drug.
- What are the solutions to slow the rate of growth in prescription drug prices and health insurance premiums.
Why Health Insurance Premiums and Drug Prices Are Exploding
My family of five has a high deductible health insurance policy we purchased on the Idaho health insurance exchange and issued by Blue Cross of Idaho.
Given the high deductible, we pay most of our medical costs out of pocket and receive no subsidy for our $1,162 monthly premium payment. That premium is 22% higher than what we paid in 2015. The good news is the policy covers the cost of preventive generic prescriptions.
Why A 49% Health Insurance Premium Increase
For 2017, Blue Cross of Idaho submitted a 49% rate increase for our current policy with the Idaho Department of Insurance. That would cost our family $1,731 per month or over $20,000 per year for health insurance.
Given these high premiums you might think Blue Cross of Idaho is making a windfall profit but that is not the case.
In February 2016, Fitch, a rating agency, downgraded the rating’s outlook for Blue Cross of Idaho’s Financial Strength to negative from stable. Fitch stated, “BCI’s historically strong operating performance has deteriorated over the past two years due primarily to higher care utilization rates associated with its participation in Idaho’s state-based health insurance exchange associated with the Patient Protection and Affordable Care Act (A.C.A.).”
That means participants who purchased individual health insurance polices are filing more and costlier medical claims than Blue Cross of Idaho anticipated.
Fitch says insurers in Idaho and other states have had similar higher than expected claims and underwriting losses related to their individual health insurance business.
Blue Cross of Idaho in its rate justification filing with the Idaho Department of Insurance said in 2015 it collected $230 million in premium payments for its individual healthcare insurance business and paid out claims of $251 million. After administrative costs, taxes and commissions, Blue Cross of Idaho suffered an underwriting loss of $57 million.
Fitch says, Blue Cross of Idaho “implemented significant rate increases on its exchange business in both 2015 and 2016 in an effort to bring pricing in line with developing claims experience. It is currently unclear if the increases will be sufficient to return the company’s operating performance within the next two years to the level of stability it experienced historically.”
Apparently Blue Cross of Idaho still has not stabilized its underwriting losses given its request for an average 29% premium increase in 2017 including the 49% increase for my family’s Bronze HSA plan.
Blue Cross of Idaho attributes 41% of its requested premium increase to higher costs for prescription drugs while 38% of the increase is due to higher medical claims costs, much of which is do to less healthy policy holders.
The Broken Economics of Obamacare
The aim of Obamacare was to ensure access to healthcare irrespective of preexisting medical conditions. Premiums would be risk adjusted based only on applicants’ ages and whether they smoked.
In order for the economics of the Affordable Care Act to work, the pool of policy holders needs to be numerous and broad, including both young and old, healthy and sick.
Unfortunately, many of the young and healthy are opting out and not buying health insurance. By law for the 2016 tax year, U.S. individuals who don’t have health insurance must pay a penalty equal to 2.5% of their adjusted gross income up to a maximum of $695 per adult. That penalty is significantly cheaper than buying a health insurance policy.
James Surowiecki recently wrote in the New Yorker, “Participants in the A.C.A. marketplaces are less numerous, and sicker than anticipated: 8.3 million fewer people enrolled through the exchanges this year than the Congressional Budget Office had projected. As a result, insurers in much of the country are fleeing the marketplaces. Kaiser estimates that between twenty and twenty-five percent of U.S. counties may have only one insurer offering coverage in 2017.”
“Lack of competition is a recipe for high premiums or low benefits (or both), further deterring younger, healthier people from buying policies. Which means the risk pool gets still older and sicker, which means insurance companies lose money and leave the market, which means the competition is reduced even further.”
Of course even if more young adults bought insurance, premiums would still be climbing significantly due to higher prescription drug prices.
Double Digit Drug Price Increases
Truveris, a healthcare data company that tracks drug prices, estimates prescription drug prices rose over 10% last year, its third year of double-digit increases. Branded drugs (i.e. those still on patent) rose 14.7% in 2015. Specialty drugs used to treat complex and rare conditions, including cancer, which tend to have the highest prices, rose 9.2%. Generic drug prices increased 3% last year.
The Federal Government estimates overall prescription drug spending was $300 billion in 2014, an increase of 12% from the previous year.
Expanding Role of Generics
What is surprising is overall prescription drug prices and spending are increasing at double digit rates even as the use of lower priced generic drugs is expanding.
The generic drug industry expanded rapidly after 1984 when the U.S. Congress passed the Hatch-Waxman Act which abbreviated the regulatory process for getting generics approved. In 1984, only 19% of drugs dispensed were generics. In 2014, 88% of prescriptions filled were for generics.
Prices Keep Soaring
Yet, prescription drug prices keep going up. Why?
Pharmaceutical companies suggest drug prices are high so they can recoup their research and development costs. That is only partly true.
Robert Frankil, the owner of Sellersville Pharmacy in Pennsylvania, said in the Los Angeles Times. “Why are these companies raising their prices? Because they can.”
Pharmaceutical companies indeed face high costs, spending on average $2.6 billion to get FDA approval and bring a drug to market. Only one in ten drugs that begins clinical trials is approved by the FDA.
Of the drugs that are approved only about 20% earn enough in sales to cover their development costs. This is data compiled by Emory University School of Law professor Joanna Shepherd in a paper titled, “The Prescription for Rising Drug Prices: Competition or Price Controls?”
The typical branded drug has approximately ten years to recover its research and development costs before its patent expires and it begins competing with generic drugs, which typically capture 70% of the branded drug’s market share within twelve months of the generic drug’s release.
Pharmaceutical companies do everything they can to extend the time they have exclusive marketing rights to a drug including filing additional follow on patents and repackaging the drug with new methods of delivery or additional features.
Maximum Pricing Power
Given high R&D costs and a short time window for exclusive rights to a drug, pharmaceutical companies have every incentive to set a price that maximizes profits after receiving FDA approval for a new drug.
Fortunately for pharmaceutical companies, the opaque structure of the healthcare market gives them maximum pricing power as long as there isn’t a substitute product and the patient, health provider and insurance company are willing to pay.
Frederick M. Abbott in his paper, “Excessive Pharmaceutical Prices and Competition Law: Doctrinal Development to Protect Public Health” shares an example of maximum pricing power involving Gilead Sciences who introduced the drug Solvadi in late 2013 to treat hepatitis C.
Setting An $84,000 Price Tag
Gilead set the price of the drug at $84,000 for a 12 week course of treatment, earning $14 billion in its first year on the market.
Solvadi was initially developed by the smaller biotechnology company Pharmasett, who Gilidead purchased in 2011 for $11 billion. Prior to its acquisition, Pharmasett planned on pricing Solvadi at $35,000 per treatment. The actual cost for a treatment is approximately $350.
Abbott writes, “The executives at Gilead essentially set out to determine what would be the maximum price that would stress the limits of political and public opinion, but not quite break it. This was with a clear understanding that the pricing of the drug would severely undermine state public health procurement budgets. Gilead has refused to furnish Congress with direct information regarding its cost of bringing the product to market, despite being requested to do so.”
As revealed in the Washington Post, Kevin Young, Gilead’s executive vice president for commercial operations wrote in an internal email, “Let’s not fold to advocacy pressure in 2014. Let’s hold our position whatever competitors do or whatever the headlines.”
The Washington Post reported, “Gilead considered a range of prices for Sovaldi and weighed the value to its shareholders against the “reputational risks,” meaning the potential outrage from patients, physicians and payers. The potential prices ranged from $50,000 to $115,000.”
As a Morgan Stanley pharmaceutical analyst explained in 2007 regarding high priced cancer fighting drugs, “market structure effectively provides no mechanism for price control in oncology other than companies’ goodwill and tolerance for adverse publicity.”
Insurance Companies Keep Paying
Why are insurance companies willing to pay these high prices?
Because there is public outrage from policy holders, patient advocacy groups and the medical community when they refuse to do so, particularly when it comes to life extending cancer drugs.
David H. Howard, Peter B. Bach, Ernst R. Berndt, and Rena M. Conti in their paper, “Pricing in the Market for Anticancer Drugs” shared how “Oregon’s Medicaid program recently proposed to limit coverage of anticancer drugs on the grounds that ‘in no instance can it be justified to spend $100,000 in public resources to increase an individual’s expected survival by three months when hundreds of thousands of Oregonians are without any form of health insurance.’ The proposal was withdrawn following a public backlash.”
That same paper showed newer anticancer drugs don’t significantly improve survival rates over older drugs. “The scientific knowledge embodied by new drugs is impressive, but progress in basic science has not always been accompanied by proportionate improvements in patient outcomes. Gains in survival time associated with recently approved anticancer drugs are typically measured in months, not years.”
Yet, with an average cost of $65,000 per treatment, newer anticancer drugs are significantly more expensive. Consequently, the study found “the average launch price of anticancer drugs, adjusted for inflation and health benefits increased by 10 percent annually—or an average of $8,500 per year—from 1995 to 2013.”
Clearly most consumers can’t afford these high drug prices if they are reliant on their own financial sources to pay for them. That’s where health insurance kicks in. Most insurance policies have annual out-of-pocket maximums. Consequently, policy holders end up paying less than 5% of expensive cancer treatments. With insurance companies picking up the bulk of the tab for high priced drugs, consumers can be indifferent as to whether a treatment cost $20,000 or $100,000.
Stuck In The Middle
Insurance companies end up stuck in the middle. On one side there are sick patients and their clinicians demanding access and payment for the latest medicine. On the other side, pharmaceutical companies set the maximum price they can get away with without stoking a public or political backlash.
Of course, sometimes pharmaceutical companies go to far, such as the recent example of Mylan, the maker of the EpiPen, an injector that releases epinephrine to reverse severe allergic reactions.
Mylan after raising prices 500% for its EpiPen in the past decade finally reversed course after widespread media coverage over its pricing practices.
One way pharmaceutical companies try to exploit the situation is to set the price of new drugs 10% to 20% higher than existing treatments, a level that falls within a “zone of indifference.”
Howard, Bach, Berndt, and Conti write, “The zone of indifference gives manufacturers the ability to set the prices of new drugs slightly above the prices of existing drugs without reducing quantity demanded. As costlier drugs come to market, oncologists become habituated to higher prices, giving manufacturers leeway to set even higher prices in the future. The characteristics of the market for anticancer drugs, including patent protection, which protects producers from direct competition, and generous third party payment, allow this dynamic to persist.”
How Doctors and Hospitals Profit From High Drug Prices
Surprisingly, medical professionals themselves also profit from high drug prices.
Howard, Bach, Berndt, and Conti report, “Oncologists and hospitals buy intravenous, physician-administered drugs from wholesalers and bill insurers. They profit on the spread between the reimbursed price and the wholesale cost. Medical oncology practices derive more than 50 percent of their revenues from drugs, and many oncologists report that they face financial incentives to administer anticancer drugs.”
“Oncologists’ drug choices are responsive to profit margins. The use of irinotecan—brand name Camptosar—decreased following the expiration of its patent, even though the price dropped by more than 80 percent, possibly reflecting declines in the spread between the reimbursement level and oncologists’ acquisition cost.”
Significant jumps in prescription drug costs lead to higher insurance premiums, which pushes more consumers out of the insurance market as they can’t afford the premiums and would rather take the risk they won’t get sick.
Solutions To Contain Drug Costs
The solution to skyrocketing prescription drug prices are both market based and regulatory.
Greater availability and use of generic drugs is one key to controlling drug prices.
According to the Generic Pharmaceutical Association, use of generic drugs contributed $254 billion in healthcare savings in the U.S. in 2014 and $1.68 trillion over 10 years.
There is currently a backlog of over 3,500 generic drugs awaiting approval by the FDA and the time to approval has lengthened from 30 months in 2012 to 48 months today.
Easing this backlog and increasing the efficiency of the approval process will help temper drug prices.
At the same time, regulators should take action against pharmaceutical companies pursuing excessive pricing strategies and other anti-competitive practices for both generic and brand name drugs.
A recent example is Valeant Pharmaceuticals which is being sued by mutual fund giant T. Rowe Price for fraud due to its alleged use of a “a secret pharmacy network, deceptive pricing and reimbursements and fictitious accounting to shield the company’s brand-name drugs from generic competitors and artificially inflate revenue and profits,” according an article in the USA Today.
Alternatively, governments could enact further price caps or reference pricing schemes for prescription drugs. Reference pricing is when there is a maximum reimbursement amount by insurance companies for a particular class of drugs. Pharmaceutical companies are free to charge more than that but consumers have to pay the amount of the reference price.
Use of price caps and reference pricing is common in the European Union. A potential downside is it could discourage additional innovation in the pharmaceutical sector.
It seems clear, however, that something will need to change. Households and businesses cannot continue to stomach double digit price increases for health insurance premiums that are being driven by rising pharmaceutical prices.