The American government and even major insurers actually have a lot of levers they can pull to lower drug costs – but do politicians, insurers, and employers have the courage to try?

The drumbeat of overpriced-Drug stories has been continuous in America of late, from Martin Shkreli’s 5400% price hike last year, to the recent price hike and subsequent backpedaling of Mylan with respect to the EpiPen. With growing outrage over skyrocketing drug prices, it’s worth asking – what can be done about it? Drug pricing is not subject to typical market forces since a new drug often has exactly 0 direct competitors – enabling a drug company to set virtually any price. New cancer drugs often start list pricing at $300,000 per year, while groundbreaking new Hepatitis-C treatments like Gilead’s Sovaldi started out at $84,000 for a short term (curative) course of treatment. Insurance companies (and major employers) have been unwilling to say no, swallowing each hike and passing it on in higher premiums. Medicare, Medicaid, the VA, and other public entities have been banned from negotiating prices, leaving them powerless to get a better deal for those receiving care through their programs. Here are a few ideas on how to break the logjam, in order of increasing potential savings:

1. The Anti-Monopoly Approach

Making drugs, and in particular so-called small molecule drugs, is actually both inexpensive and easy. The primary protection that Drug Makers use to enforce their monopoly position on new drugs is the patent system. While this arguably makes sense for new drugs, what about long-generic drugs? In recent years certain drug companies (e.g. Valeant) began specializing in buying up the manufacturers of old drugs and immediately hiking prices. After gaining a monopoly position it became easy to hike prices by 50-100% per year and extract huge profits, while new entrants were stymied by
the FDA approval process required to certify the efficacy of their drug version. Why not streamline the FDA approval rules for generic drug manufacture? If a drug is tested and shown to be chemically identical, how much further testing is really necessary?

Alternately, the Department of Justice or FTC could bring suit to halt acquisitions which would leave zero competitors in the market for a generic drug. Special pharmacies called compounding pharmacies are also capable of making many drug compounds. Why not
allow compounding pharmacies to compete across all generic drugs, or specifically contract with them to make generic equivalents for the VA system or Medicaid system?

2. The “Title IX” Approach

Private American colleges and universities are not actually required by law to provide equity in women’s sports, or to follow any of a wide range of Department of Education edicts. The catch? In order to receive federal funding, institutions of higher education must comply with these rules. Since virtually all colleges make use of varying forms of federal assistance, they fall into line.

The American pharmaceutical industry does very little original research – most innovations originate in the university system, and most of the research funding (over $21B per year) comes from the National Institutes of Health [1]. The American government could utilize this lever to strongly influence drug pricing. Pharmaceutical companies might be required to adhere to certain pricing guidelines if they wished to license research originating from NIH funding.

Those guidelines might require drug makers to release drugs into the generic market on an accelerated timeline, for instance. Or the rules might require that drug makers adhere to a value-based pricing approach, as described further below. Drug makers could be required to pay a tiered tax on drug sales to fund NIH research – a tax of 25% on prices above $1000/patient/month and 50% above $4000/patient/month could simultaneously fund future research and encourage drug makers to keep pricing down. The advantage of the “Title IX” approach is that it preserves the liberty of drug companies – if they don’t want to conform with the rules, they can simply do their own basic research. Fiscal conservatives might find this approach palatable as it directly charges users (drug companies) for the government programs they use, and lowers the deficit in the process.

3. The Value-Based Approach

If insurers and government buyers (Medicare/Medicaid/VA) all insisted on paying for value, pharmaceutical companies might be compelled to go along. How do you define value? The UK’s NICE measures the efficacy of medical treatments by attempting to measure the number of “quality-adjusted life years” provided by that treatment. If a cancer drug postpones death by 2 years on average, and has mild side effects, then it can be said to provide 2 years of QALY. The NIH takes this a step further by quantifying how much it will pay per QALY (currently around 25,000 pounds per year), and it sets prices
on drugs using this approach.

American buyers could emulate this approach by offering to pay for measured improvements in outcomes. If a new cancer drug extends life by 2 years, but existing cancer drugs extend life by 1.5 years, then the value of the new drug is an additional half-year of life. Drug buyers could offer to pay a premium for the new drug based on this degree of improvement, and no more. Buyers could also use this as a way to foster competition between older and newer generations of drugs. The older drug is 75% as effective, so it can be placed into competition with the new drug, but at a discount. Express Scripts took this approach in the Hepatitis-C market and was among the first buyers to find a way to push back against Gilead’s $1000 per-pill asking price for Sovaldi.

Conclusion

As long insurers are happy to pass rising costs along in the form of higher premiums, and American politicians remain beholden to the pharmaceutical lobby, nothing will change. But the ideas outlined above show that America doesn’t need European style price controls to break the drug price spiral – a combination of relatively small policy changes and insurers’ willingness to negotiate are all that is required.

[1] This article investigates the breakdown of basic pharmaceutical research in detail, and concludes that big pharma companies contribute less than 25% of research dollars in the US, with most of the balance coming from the NIH.