Accusations that pharmaceuticals are driving the problem of health care affordability abound. But, political misdiagnoses are just as problematic as medical misdiagnoses. Policies based on the wrong political diagnosis will not solve the health care affordability problem, and could cause irreparable harm to medical innovation.
The misnomer that drug prices are a primary cause of the health care affordability problem persists, in part, due to the overly complex pricing system for pharmaceuticals. Pharmacy intermediaries, known as pharmacy benefit managers (or PBMs), play a large role in perpetuating this overly-complex pricing system.
Much of the news coverage discussing rising pharmaceutical prices focuses on the list price. For most markets, this makes sense because the list price accurately portrays the typical transaction price. However, the list price for pharmaceuticals varies, often significantly, from the drug’s typical transaction price.
The transaction price is the price including the large discounts, negotiated payments, and retrospective price rebates that, relative to total expenditures, are quite sizable – nearly one third of all expenditures on branded drugs in 2015 were eventually rebated back. And, most of these rebates directly benefited the PBM.
As a consequence, PBMs’ earnings are enhanced when manufacturers charge high list prices, but then pay large rebates and discounts to lower the actual transaction prices, creating a strong financial incentive for PBMs to support the current opaque pricing system.
Ultimately, the complicated pricing structure for pharmaceuticals is problematic and diminishes the beneficial role prices typically play in a market economy. Therefore, pricing reforms are necessary to establish a simpler, transparent, pricing model for pharmaceuticals. The goal of such reforms should be to enable list prices that more accurately reflect actual transaction prices.
Patients, pharmacists, and doctors will benefit from better pricing information. Further, the PBMs that add value by creating purchasing efficiencies for their clients will still have an opportunity thrive under a less complicated pricing structure. But, their profits will be solely based on providing value-added services.
While PBM reform is important, this reform will not address the broader affordability problems that afflict the health care sector. The prices of pharmaceuticals, like the prices of most economic goods, reflect the value of the product to consumers. This value is dependent upon the costs of the alternatives, which in the case of pharmaceuticals will include the costs of other treatment options. These alternative treatment options are broadly represented by the growth in overall health care prices.
It should, consequently, be expected that the growth in pharmaceutical prices roughly match the growth in overall health care prices. And, this is what the data show. Relying on government pricing data, over the long-term, pharmaceutical price increases match the growth in overall health care prices – in fact pharmaceutical prices have grown slightly less.
While periods of accelerated pharmaceutical prices occur, such as the accelerated price increases over the past several years, these periods are typically associated with increases in new medical innovations, and then followed by periods of slower than average price increases.
Pharmaceuticals are not unique either. What holds for pharmaceutical prices also holds for the prices of other sub-components of the health care system. The prices for health care products and services are interdependent and cannot be viewed in a vacuum.
With respect to the broader health care affordability problem, the inter dependencies of all health care prices indicate that sustainably addressing the affordability problem requires systemic reforms that improve the efficiency and competitiveness of the entire U.S. health care system.
These reforms should focus the health care system on patients, not insurance companies, by: moving away from the current fee for service payment model, empowering greater competition for doctors and other health care providers, addressing tort abuse that raises medical costs, enabling high-risk pools to address the problems of pre-existing conditions, selling insurance across state lines to enable greater competition, and expanding health savings accounts to empower patients to better afford health insurance.
Reforms such as these will help address the broader affordability problem that plagues the health care system. And, fixing the broader health care affordability problem is the most effective way to ensure that pharmaceuticals are both available and affordable.
Wayne Winegarden, Ph.D. is Managing Editor for EconoSTATS. and a Sr. Fellow in Business and Economics at the Pacific Research Institute