Prices of Prescription Drugs Are Complex and Opaque, and High Prices Drive Innovation

Michael D. Miller, MD


January 28, 2022

The price of prescription drugs is one of the most contentious and misunderstood issues in healthcare. Having worked on prescription drug issues for over 30 years in the federal government, US Congress, and healthcare industry, as a consultant, and with patient and clinician advocates, I've seen how the foundational misunderstanding and misrepresentation of prescription drug prices has stymied efforts to improve access and affordability.

The issue of prescription drug prices has such a high public profile because medicines are a very important component of care, and higher prices can translate into higher costs for patients, which means some patients can't afford their medicines.

Unfortunately, the resulting political rhetoric and proposals (supported by poll numbers) often conflicts with public policy that could improve lives — and even save money.

To shed some light onto this very complicated situation, below are short insights into 10 important and interconnected aspects of drug prices in the US. Some of these may be apparent to clinicians and patients, but others are rarely discussed.

1. There are no set prices for prescription drugs in the US. Specifically, while a company will set a list price, what insurance companies and government programs pay for prescription drugs is almost always a range of lower prices created by rebates and discounts that are either negotiated with private payers or required for government programs like Medicaid and the VA.

2. The "price" of a prescription drug is not the same as a patient's cost. The media and politicians often imply that "drug costs" for patients are the same thing as prices. But what patients pay (ie, their costs) is determined by their insurance plan's deductible, formulary structure, and cost-sharing within that formulary. Conversely, prices are the amount paid by the insurance company, and their net price may not be the basis for calculating patients' cost-sharing.

3. Determining both prices and patient costs for a medicine can be very complicated. Determining "net prices" paid for a medicine requires a lot of analysis and time because the rebates and discounts agreed to between insurance companies (and other payers) and biopharma companies can be paid months after a medicine is given to a patient.

The Congressional Budget Office (CBO) diagramed the complex flow of money and delivery of medicines across different type of organizations for retail medicines in a 2007 report (Figure). And as you can see, it was complicated – and has only gotten more complex. (The CBO did a similar report in 2017 for Medicare Part D and compared it with Medicaid, the VA, and DoD health programs.)

Figure. The complex flow of money and medicines across organizations.

An important part of this complexity is that most health insurance companies use a prescription benefit manager (PBM) to handle price and rebate negotiations, while also managing prior authorization and utilization management requirements that patients or clinicians need to navigate before a medicine will be dispensed/delivered. (See the box on the left side of of the Figure.)

A bit of good news is that there have been legislative and regulatory proposals to increase transparency about PBMs' activities and require some (or most) of the rebates to go to patients. However, those proposals have been pulled back several times after having advanced very far toward implementation — in large part because of political considerations — even though those proposals would make a complex situation simpler.

Simplifying the system of rebates and discounts would be better for patients and clinicians because determining a patient's cost for any particular medicine can be difficult. For example, my health insurance plan went from a four-tier formulary in 2021, with the highest cost-sharing being a $250 co-pay, to a six-tier formulary in 2022 with the addition of a specialty tier with 50% co-insurance (with either a $350 or $500 maximum). And of course, because a $400 unexpected expense has been shown to be a hardship for 37% of US households — and 12% don't believe they could find a way to afford such an emergency cost — clinicians face the challenge of recognizing the financial limitations of their patients to afford a prescription medicine.

4. Many policymakers (and pundits) claim to not understand how the initial list prices of prescription drugs are set by companies. Policymakers often claim not to understand how the prices for new prescription drugs are established, despite news articles describing the process and the book chapter I wrote about drug pricing principles in 2004 that discussed this topic. Because policymakers lack policy levers to effect "launch prices," proposals about prescription drug prices generally focus on trying to limit price increases of existing medicines, capping payments to what other countries pay, or restricting access to new medicines whose launch prices are deemed unreasonable based on the "value" they provide.

However, some proposal can still effect launch prices, such as the changes to Medicare Part D in the 2017 tax bill that created incentives for higher launch prices for some types of new medicines. (After I pointed this out to Congressional staffers at a Brookings Institution briefing, they admitted being completely unaware the law would have that effect.)

5. Having the price of drugs reflect value is a relatively new concept. Over the past 10 years or so, industry, policymakers, and advocates of different types have been gravitating toward the concept that prices (and patient costs) should reflect the value a drug provides. However, the definition of value — and how it is calculated — like beauty, is in the eye of the beholder. Specifically, depending on the organization, "value" can refer to clinical value or economic value, although most definitions and analytical-like frameworks try to meld the two (at least rhetorically), but usually strongly favor one over the other. Thus, quantifying the "value" of a prescription drug is very problematic and contentious.

A related new arrangement is connecting what an insurance company or health care system pays for a prescription drug to the clinical outcomes the drug produces. However, those arrangements are relatively new, limited in scope, and also dependent on what data points the two sides can agree upon as metrics of clinical outcomes, such as patients' lab values or rehospitalizations.

6. High prices selectively drive innovation. Net prices are signals to industry and others as to where they should invest in developing future medicines. Specifically, expected revenue from a new medicine (based on net reimbursements for existing treatments for the same or similar conditions) is a key component for economic modeling to determine what R&D investments a company should prioritize. That is, a biopharma company is likely to spend more for R&D to develop new treatments in diseases areas where the existing treatments have better reimbursement and access. (This is one reason why the development of new treatments for mental and behavioral health have historically not been as robust as other areas.)

Thus, there is a policy tension between financial access now and better treatments in the future. This means that individuals should want very inexpensive treatments for any health conditions they currently have, and high prices for treatments for the illnesses they will have in the future. Of course, it is very difficult to know what illnesses someone will have in the future.

7. Drugs and biologics are not the same thing. "Drugs" may be the catch-all general term, but the FDA regulates drugs and biologics differently. In most situations, biologics are injected or infused, while most medicines that come in an oral form are small-molecule drugs. There are some biologics that patients can give themselves, often coming in an autoinjector type of device. This matters because most (but not all) of the debate about drug prices focuses on medicines that people give to themselves and thus are covered under the drug benefit of an insurance plan. Conversely, medicines that a clinician gives to a patient (like in an infusion or injection) are covered under the medical benefit of the patient's insurance plan. Since biologics account for a very significant part of expensive new medicines, how they are given to patients — and how insurance pays for them — has implications for patient costs.

And while biosimilars are being made available to compete with biologics, because of rebates, discounts, and the structure of patients' co-insurance, in some cases the biosimilar is more expensive for the insurance company even though it may have a lower list price. This creates a situation where the insurance plan does not encourage the use of the biosimilar, resulting in higher patient costs.

8. Paying for a drug is different from buying insurance for drugs. This is the crux of the difference between Medicare Part B (which pays for medicines a clinician gives to a patient outside of an inpatient hospital setting) and Medicare Part D, which pays for medicines that patients takes themselves (ie, medicines they typically have gotten from their local or mail-order pharmacy). In Part B, the Medicare program pays for each individual medicine (and its administration). Conversely in Part D, people pay a monthly premium for insurance (that is supplemented by Medicare), and that insurance (not Medicare) then pays for each medicine. Thus, the proposals for Medicare to "negotiate the price of drugs" is a disconnected misrepresentation of how the Medicare Part D program operates.

9. A few people use most of the medicines and healthcare. About 5% of the people in the US (or any large group) represent about half of the healthcare spending. And retail prescription drugs represent about 9% of all US healthcare spending, with another 4%-5% being spent on medicines given to patients in hospitals, clinics, and doctors' offices.

10. There is good news about prescription drug costs. One piece of good news for patients is that as of January 2014 (because of the 2010 Affordable Care Act), most people in the US with health insurance have a limit as to what they have to spend out of pocket (OOP) for healthcare. This annual OOP cap is still substantial for many people (for 2022, the maximum annual OOP limit is $8700 for an individual and $17,400 for a family), but it is better than the unlimited amount that people could be facing before the ACA. (Note: People with Medicare — who are not in a Medicare Advantage plan or do not have supplemental Medigap or retiree insurance — likely do not have an annual OOP cap. And if a medicine is off-formulary, it probably will not count towards the annual OOP cap.)

Patients may also be able to lower their costs by not using their insurance, but instead using discounts or coupons through companies such as GoodRx. There are also local community, state-run, and industry programs that may be able to help patients afford their medicines — particularly if they are uninsured.

And more help for prescription drug costs is on the horizon. First, there is bipartisan support for limiting the annual OOP limit for Medicare Part D plans, as opposed to requiring patients to continuing paying 5% of costs after reaching a certain "catastrophic" amount. This change was included in the Build Back Better (BBB) bill, which has hit major roadblocks to passage, so it is uncertain when (or if) that change to Medicare Part D will happen. The BBB bill also has provisions to limit patient costs for insulin to $35 per month for both private insurance and Medicare (although not for all insulin products ) and expand ACA marketplace plan affordability to those with incomes below 100% of the federal poverty level in states that haven't expanded Medicaid. But again, the prospects for when (or if) those changes will become law is very uncertain.

I know that's a lot. And for each of those 10 items, there are many other layers of complexity and nuance. My reason for presenting all these issues about prescription drug prices is so that you — the reader — will have some appreciation that these are a complex set of interconnected problems for which simple answers almost never work and politically driven solutions frequently are unsuccessful at fixing healthcare policy problems.

I sincerely hope that the proposals to cap costs for people with Medicare, limit monthly costs for insulin, expand affordability for marketplace plans, require more transparency about PBMs, and have rebates reduce patient costs become reality, since each of those changes would make a complex system somewhat simpler and help patients at the same time.

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About Dr Michael D. Miller
For more than 30 years, Michael D. Miller, MD has been working with large and small companies, government organizations, and patient advocates to improve access and affordability for treatments and innovations. His work has spanned many clinical, scientific, and policy areas, including autoimmune diseases, behavioral health, cancer, cell/gene therapies, diabetes, patents, reimbursements, and vaccines. He graduated from Williams College and Yale Medical School, has served on several nonprofit boards, and has spoken across the country on critical healthcare issues.

Connect with him on Twitter @HealthPolCom and on his website.


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