Encouraging competition enables growth
The current drug pricing market is dysfunctional, an obvious conclusion to anyone paying attention. But why?
Like much of the health care sector, the current government-driven third-party payer system does not align the interests of patients and the companies that manage patients’ drug benefits (called pharmacy benefit managers, or PBMs). These misguided interests inflate patient costs and often encourage the use of expensive drugs when more affordable alternatives exist.
Solving these problems is an essential precursor to creating a patient-centered health care system. Several current congressional proposals, including Disconnection of Revenue from Tortuous Destruction Act and Modernizing and Ensuring PBM Accountability Act, dealing with these adverse consequences. Reforms are not a panacea. but they face several key shortcomings of the current system.
Despite the clear pro-market benefits of these reforms, some conservative groups falsely claim that reforming PBM practices would move the health care system “one step closer” to a fully socialized system. Nothing could be further from the truth.
Markets are distorted when regulations do not align the incentives of market participants or when prices are opaque. Market efficiency is also compromised when consumers (in this case patients) have limited ability to seek out competitors who can meet their needs more effectively and efficiently, an issue because three PBMs control 80% of the pharmacy benefit market and are all subsidiaries of major health insurers – CVS Health/Caremark, Express Scripts
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The misalignment of interests occurs because PBMs control the list of approved drugs (ie, the formularies) that determine which treatments patients can access. Because of this control, doctors cannot base their prescriptions solely on patients’ medical needs, they must consider the drug formula when making treatment decisions.
From an efficient market perspective, PBMs’ control of the aggregate caused the billing system to malfunction. Like any purchase, the total amount spent on a drug depends on the actual transaction price. This transaction price (often referred to as net price) is the list price announced by the manufacturer minus any unknown discounts that PBMs negotiate on behalf of insurers.
Drug manufacturers’ motivation is to ensure that their drugs receive the best possible placement in PBM formularies – otherwise, patients will not be able to access the manufacturers’ drugs. This means that manufacturers must accommodate the needs of PBMs in order to meet the needs of patients.
PBMs and their affiliated insurance companies earn more revenue when drugs have high list prices because high list prices allow PBMs to negotiate bigger discounts. Since PBM reimbursement is based on the size of the deductible, the larger the deductibles, the more revenue they earn. Consequently, PBMs prefer drugs with artificially high list prices.
Current fees charged by PBMs to pharmacies, employers and manufacturers, now an even larger source of revenue, are also tied to drug list prices. This link between PBM fees and drug list prices creates another bias toward higher list prices.
The observed drug pricing effects have been consistent with these incentives for many years.
List prices for drugs were high and rising, but unknown discounts – negotiated discounts are strangely considered proprietary information – have risen even faster. Consequently, net prices, which are the relative prices from the point of view of the health care system, are increasing much more slowly and, in fact, have fallen last six years.
Another adverse effect of these misaligned incentives also arises because higher-cost drug brands often generate more rebates and higher PBM revenues compared to lower-cost competitors. Consequently, there may be strong disincentives against using lower-cost competing drugs that are equally effective.
Tragically, patients do not benefit from low net prices because their out-of-pocket costs are based on inflated gross prices. In other words, the current PBM controlled pricing system extracts excessive revenue from patients who need expensive drugs, which is then used either to subsidize other patients through lower premiums or to inflate the profits of PBMs or insurers. Each result is the exact opposite of how an efficient pharmaceutical market should work. And that’s why PBM reforms are necessary.
In response to these well-documented costs, Congress is considering reforms that would ensure “full and complete disclosure” of prescription drug costs, prices, and discounts. In addition, all fees, charges, and markups charged by PBMs to health plans and pharmacies should be disclosed. To address list price bias created by PBM-linked fees, the reforms would break the link between PBM reimbursement (fees and rebates/discounts) and list prices.
Ensuring that prices, fees, costs and discounts are disclosed effectively addresses the problem of price opacity which is a large factor in the current misalignment of interests. Combined with reforms that decouple PBM fees from list prices, out-of-pocket costs will more accurately reflect the true net prices of drugs and generate significant savings for patients.
Another major reform addresses the anti-competitive PBM practice known as “spread pricing,” which occurs when PBMs charge health plans and insurers more for a prescription drug than what they pay the pharmacy. The difference – the spread – is currently covered by the PBM. This practice, which is particularly harmful to smaller family pharmacies who often lose money on the sale of a drug as a result – is only possible because the current system has overpowered the middlemen. The reforms would prohibit this type of market exploitation.
The PBM legislation under consideration is not a silver bullet, but such expectations are unrealistic. The proposed reforms will improve the efficiency of the US pharmaceutical market and help improve the affordability of drugs for patients while reducing health care costs. More broadly, effective PBM reforms will demonstrate the broader potential benefits that could be gained by replacing the current third-party payment system with one that empowers patients and their physicians to manage their health care decisions.