How the new Congress can improve drug pricing reform

Few aspects of U.S. health care arouse passions more than out-of-pocket prices for prescription drugs. Americans pay more for the same drugs than do patients in other countries, and we pay a higher share of GDP on prescription drugs. As the federal government moves forward with reforms set in motion in recent years, the new Congress should refocus on a more specific problem: too few incentives to sell generic or other lower-cost drugs and the role of pharmacy benefit managers.

While a few drugs are very expensive, the truth is that through a combination of effective policies, rules and more reliance on insurance, Americans’ average out-of-pocket expenditure for drugs has been falling. Additionally, the use of prescription drugs continues to increase because of the availability of drugs and treatments for common conditions.

The most expensive drugs have no generic equivalents or biosimilars or treat chronic or rare conditions, which sometimes require lifetime use. Out-of-pocket costs for variations of some life-saving drugs, such as insulin for type 1 diabetes, have risen in the past. This has rightly attracted the attention of lawmakers.

Enter the prescription drug negotiations component of the Inflation Reduction Act — the culmination of years of efforts by Congress and state policymakers, and an idea that bound the late, venerated Rep. John Lewis (D-Ga.) with President Trump. The premise is that drug companies overcharge Americans and, by extension, the government. Drug manufacturers make most of their profit from the U.S. market, so there could be some truth to the idea that Americans subsidize other countries that impose price controls.

However, forced negotiations with drug manufacturers will have unintended consequences, many of which have already began to show — including a reduction in the number of drugs in development.

The complexity of drug pricing is a uniquely American phenomenon, much like our complex health care system. Post-sales drug reimbursements, mandated by law, create perverse incentives. Perhaps the most reviled middleman in the distribution chain is the pharmacy benefits manager (PBM). Created by health insurers in the 1980s, PBMs play a vital role in the final price that patients pay and the profit margins of drug manufacturers.

Patients and plans rarely pay the list price of drugs. Instead, PBMs negotiate with manufacturers to obtain discounts or rebates. Laws mandate that PBMs share these with insurance plans, including Medicare and Medicaid. PBMs primarily make money on rebates from brand-name drugs. They also decide which drugs are on the formulary for most insurance plans. This means they have an incentive to work with drug manufacturers that want their products included.

It’s only rational that manufacturers factor this song-and-dance into their decisions about the listed price of drugs. They have every reason to begin negotiations with high list prices. In fact, research has shown that for every $1 increase in rebates, the list price of a drug increases by $1.17.

The story of insulin deserves special mention. According to researchers, the share of net drug expenditures (the price of the drug after rebates and discounts) that goes to manufacturers has been decreasing while that which goes to the middlemen (primarily PBMs) has increased.

Manufacturers may not be popular, but if they don’t make enough return on their drugs, it imperils not just the sustainability of the drugs but also the entire drug pipeline. While the rebate processes evolved from the need for insurance plans to negotiate prices, congressional and state mandates have strengthened PBMs, which have every incentive to include only the drugs with high list prices and therefore the most rebate money.

Congress should zero in on these price-inflating mandates in the Medicaid and Medicare Part D programs, and then move forward with these kinds of incentives in mind. Drug manufacturers’ contributions to a healthy society are hard to overstate, and like all economic agents, these companies respond to incentives.

One such policy, and a hallmark of successful policymaking, is the Hatch-Waxman Act, which incentivizes getting the generic equivalents of brand-name drugs onto the market. As a result, about 90 percent of all drugs in the United States now have generic equivalents.

In fact, PBMs do not make any money on generics. Another effective law, despite some problems, is the Orphan Drugs Act, which incentivizes making drugs for rare diseases available. Eliminating some abuses (such as the “evergreening” that happens under Hatch-Waxman, where manufacturers obtain extended exclusivity through miniscule changes in brand-name drugs) could help improve these policies.

The key to fairer drug prices is the growth and availability of generic equivalents and biosimilars. Instead of obsessing over rebates and price transparency, Congress should focus on this idea.

Kofi Ampaabeng is a health economist, senior research fellow and data scientist with the Mercatus Center at George Mason University.