Howard Deutsch, ZS Associates

Over the last few years, the pharmaceutical industry has faced a barrage of criticisms

 over the pricing of its prescription drugs in the United States. Public concern has generally been focused on two areas:

 new specialty drugs, such as for oncology and hepatitis.

 for particularly older, often already off-patent drugs, such as the frequently mentioned cases of Turing and Valeant.

Medical associations, media and politicians from both political parties have advocated more transparency around pricing and granting of authorization for price negotiation to the Centers for Medicare & Medicaid Services (CMS). In some cases, the high cost of drugs is directly affecting patients, who can’t afford their copayment as determined by health insurance companies. That is obviously a concern, which, certainly in combination with some excesses in pricing practices, is causing emotional responses and calls for government intervention. Finding acceptable solutions while maintaining a healthcare market that fosters innovation isn’t helped by the complexity of drug pricing.

It’s important for patients and for the industry that these issues are resolved. Hopefully, what we propose here can provide a contribution to some dearly needed real solutions.

Let’s be clear: Price increases as practiced by Turing’s Martin Shkreli for Daraprim are excessive and harmful to both patients and the industry. A valuable contrast to that stance can be found in Allergan CEO Brent Saunders and the “social contract with patients,” announced in September 2016. It includes the following commitments:

“We commit to these responsible pricing ideals for our branded therapeutics.

 in a way that is commensurate with, or lower than, the value they create.

 policy makers and payers to facilitate better access to our medicines.

 price gouging actions or predatory pricing.

 the practice of taking major price increases without corresponding cost increases as our products near patent expiration.

We commit to providing an aggregate view of the net impact of price on our business.”

Allergan’s social contract is a strong signal from an R&D-based drug company that it takes the issue seriously and that it believes that it has a societal responsibility to address it. It will be interesting to see whether other companies follow.

Some price increases for drugs that still have a valid patent have been criticized. We will get into those later. Many of the drugs under debate are off-patent drugs—that is, generically available products that would normally be inexpensive.

Most generic drugs cost pennies. For some drugs, particularly for very specific and rare patient conditions, the originator or subsequent acquirer of the brand ends up being the sole supplier even after patent expiration; limited market scale, manufacturing complexity and poor profitability make the commercial opportunity unattractive. While the large price increases may make it theoretically attractive for generics companies to re-launch a drug that has few or only one supplier left, in reality, this constitutes a risky investment of re-launch manufacturing capital. FDA backlogs in reviews of generic drug applications certainly add significantly to this problem.

In some cases, questionable distribution agreements have secured a form of market exclusivity for the manufacturer. Tightening regulatory rules to avoid exploitation of regulatory loopholes certainly seems justified. In the recent case of Mylan’s EpiPen, a combination of a recall of Sanofi’s competing Auvi-Q product, a delay in the approval of an EpiPen generic from Teva Pharmaceuticals and the niche character of the product category contribute to the issue.

Most initiatives to address excessive price increases involve transparency requirements. While intuitively helpful, transparency in itself is unlikely to address the issue. The fairness of a price is hard to calculate from the financials of one successful company, and even harder to subsequently try to control in an effective and responsible way. A much more reliable way is to ensure that there is a competitive, self-regulating market for investment in pharmaceutical innovation.

For off-patent drugs, there are a few options that come to mind in addressing excessive price increases:

Barriers and the cost of entry can impede active competition in otherwise well-functioning markets. Addressing these should be a first course of action in markets where competitiveness is impaired. One of the factors that drive this problem is the backlog in FDA reviews for generic drugs. It seems logical that the government would focus on fixing government agency problems, such as approval backlogs, first before it considers further interference with the market through pricing regulations. This may not entirely fix the issue, but it would be a good start.

Another way to address excessive price increases for off-patent drugs is to investigate why so many generics companies cease manufacturing them. This may reveal ways to maintain a competitive market with multiple manufacturers. Maintaining multiple supply options is a natural and highly effective way to avoid situations in which excessive price increases can occur.

The government also could ensure that distribution arrangements for multisource products can’t serve to circumvent market competition. Or FDA could accelerate the approval of additional generic suppliers to lower the cost of entry of multisource products. This would then increase the commercial risk of excessive price increases and therefore would create a natural protection against it.

 Incentivizing continued generic market presence or new generic entries:

 There could be government incentives to continue to manufacture important but financially unattractive drugs, or for new players to enter markets with few suppliers.

 Establishing government controls on price increases: 

Regulating price increases or setting a threshold price increase level over which sanctions (for example, reimportation) are triggered have also been suggested as solutions.

Elements of Option (1) can help to restore a competitive market in those cases where it now fails. They also avoid interfering with the largest sector of high-volume generics that’s functioning without any issues. Of course, regulating price increases is problematic. List and net prices are very different and will also differ from insurer to insurer, as a lot of active contracting and dealmaking take place between competitive private entities at various levels in the trade. Controlling list prices is meaningless and controlling net prices is practically impossible without destroying market competition in a generic market that’s generally functioning very well.

Moreover, any formal price increase cap that would trigger some government intervention may automatically become the default price increase for all drugs. Under this scenario, average prices across all generics could actually go up dramatically for some drug classes. This is exactly what happened in the Netherlands about 15 years ago, where a reimbursement limit, set to lower prices in a treatment category, resulted in dramatic cost increases for generics, as the lowest-priced product increased its price to the imposed limit in a previously competitive market.

Based on international experience, many pharmaceutical companies are concerned that government-instituted drug price controls never disappear. What’s more, since they often don’t reach the intended savings, they’re usually followed by more and more controls, thus further deteriorating the private market. Mechanisms that will restore a market for drugs for which the patent has expired are a great starting point.

US price increase discussions have been particularly emotional for off-patent drugs, such as Turing’s Daraprim. The arrogant responses of Turing’s former CEO Shkreli have seriously harmed the drug industry’s reputation. However, taking the Turings, Valeants and Mylans out of consideration, drug price increases for patented prescription drugs have also faced criticism. Some drugs in, for example, oncology and multiple sclerosis treatment have seen double-digit list price increases. Each situation may be different and needs to be judged on its own merits, but let’s examine this more closely.

What matters is net price, not list price. Managed care organizations (MCOs) and pharmacy benefit managers (PBMs) negotiate rebates or other discounts from manufacturers; better formulary placement or less-restrictive prescribing authorizations are one of the benefits manufacturers seek in this process. A recent analysis by IMS shows that prescription drug rebates in 2015 amounted to $115 billion over $425 billion in sales—that is, 27% of sales is paid back by drug companies to MCOs, PBMs and government agencies. As a result of rebate increases, net prices increased by only 2.8%.

Rebates are particularly high in therapy areas where individual drugs have a higher degree of similarity. As a result, rebate percentages are very different across drug companies, depending on the main therapy areas that they are operating in. For example, the diabetes and rheumatoid arthritis markets are highly competitive with many relatively similar options.

MCOs and particularly PBMs have gained substantial market power over the last five or so years. This is caused by a number of factors:

The top three PBMs (Express Scripts, CVS and recently merged OptumRx-Catamaran) handle 75% of all US prescriptions. If all recently announced mergers are completed, the top three MCOs (United, Aetna-Humana and Anthem-Cigna) will control close to 140 million lives. In any case, the level of consolidation is high, particularly for PBMs and in the Medicare Part D market.

PBMs in particular are increasingly using exclusion lists to negotiate high rebates with drug manufacturers. Initially in areas with multiple similar options (insulins, anti-TNFs, etc.), but more recently even with two options available (hepatitis C), PBMs have demanded high rebates to be even considered for reimbursement, rather than just differentiating the patient copay level as was customary previously.

Media and medical community criticism over drug pricing seems to have empowered payers to put tougher patient-access restrictions in place through such mechanisms as step edits, diagnostic testing requirements and prior authorizations. Particularly for PCSK9 drugs, initial access restrictions were extremely tough, putting physicians and patients through onerous qualification requirements.

As a result of the above, MCOs and PBMs have significantly increased market power, as criticism over drug cost helped them to justify coverage denial options. PBMs are often criticized for their focus on rebates, while it’s not clear how much of those monies are passed on as savings to health insurance companies or, ultimately, patients. Illustrating the magnitude of the issue, a year ago, Anthem initiated a lawsuit against Express Scripts, claiming $15 billion in damages for not passing on negotiated rebates from pharmaceutical companies.

PBMs actually implicitly encourage a combination of high list prices and significant rebates because it provides them with significant income streams. This is further illustrated by the fact that, as of January 2017, the two largest PBMs, Express Scripts and CVS, haven’t adopted Merck’s new hepatitis C drug, Zepatier (grazoprevir and elbasvir), on formulary despite its significantly lower list price in comparison with Gilead’s Sovaldi and AbbVie’s Viekira Pak.

Also, patients often aren’t benefiting from rebates because coinsurance rates for drugs usually are based on the list price rather than on the actual cost to the insurer. In early October 2016, a class action suit was filed against United Healthcare over charging copays to patients that exceed the cost to the insurer, thus turning what is supposed to be a patient benefit for paid insurance into an additional income stream. The suit cites an example of a patient paying a $50 copayment for a contraceptive that cost the pharmacy only $11.65. After fulfillment, the pharmacy is paying United Healthcare the extra “hidden additional premium” of $38.35 per their agreement.

The high cost of new oncology and other specialty drugs is a contentious issue for insurers, physicians and patients. Physicians are becoming more engaged in the debate, as they are struggling to help their patients in light of the increasingly high copayments that patients are exposed to. Following the introduction of Medicare Part D, MCOs have gradually introduced significant coinsurance rates (the percentage of cost as copayment) for their employer-sponsored plans. Patient shares of drug costs have thus gone up substantially over the last five or so years, irrespective of the underlying drug cost.

There are a lot of misperceptions over how a drug company sets a price for a new drug. Also, prices are usually publicly analyzed and scrutinized after the launch of a breakthrough innovation. Focusing on the financials of companies that have just launched a blockbuster drug will distort the picture if one doesn’t also consider all the other companies that just lost the race. A more fundamental explanation on the early-stage decisionmaking processes and the competitive and risky nature of the drug development business is crucial to creating a better understanding.

The financial structure of the pharmaceutical industry is highly complex due to various factors that are unique to the industry, such as:

 A complex “dinner for three” decision process

 between the prescriber, patient and payer: As distinct from most other consumer products, prescription drugs aren’t usually purchased in a direct buyer-seller transaction but rather through the three-party relationship of decisionmaker, consumer and payer. This creates distortions in market mechanisms, especially when the payer is a government. The generally lower prices for brand drugs in single-payer systems outside the US are commonly recognized as being subsidized by the higher prices paid inside the US.

: The Tufts Center for the Study of Drug Development estimates an average cost of $2.6 billion per newly approved prescription drug. 

 simply divided reported R&D cost over the number of approved new agents from 1997 to 2011 and showed numbers ranging from $3.5 billion per approved drug for Amgen to almost $12 billion for AstraZeneca. Arguments regarding the high cost of R&D in defense of drug pricing have never resonated well, and they probably never will if the public can’t be convinced that drug pricing is under reasonable control through free-market mechanisms.

With an effective patent life of about 10 years (perhaps a bit longer for biologics), drug companies have a limited time period to recoup investments and make a profit. Most drugs provide substantial benefits to patients many years beyond patent expiration, although at that stage of the life cycle, they come at merely nominal cost. Novartis’ Gleevec increased the five-year survival rate for patients with chronic myeloid leukemia (CML) from 35% to above 90%, an inarguable breakthrough. Now it’s off-patent, with prices falling. Patients with CML will benefit from this innovation for decades and decades until a cure is found.

The essence of the points above is that there is a competitive market for drug development in which a large number of biotechnology and pharmaceutical companies are participating. Therapy areas with a high unmet need attract investment as premium pricing can be obtained. Where companies offer innovative new treatments, patients are well served. The best of those innovations can have a clear drug budget impact, but over time, it will attract new investments and competition. Also, higher drug costs can sometimes be offset by lower medical cost over time. The new hepatitis C drugs are a clear example of this.

If only we have more problems like the ones caused by the hepatitis C oncology-immunology combination drugs, that would mean that we are well on our way toward solving some of the many very serious health problems that our society is facing. Each breakthrough will have some associated cost in a 10- to 15-year window, then it will literally serve for decades as an inexpensive and effective therapy.

Earlier, we discussed the issues in pharmaceutical pricing and price increases for innovative and multisource drugs. The issues have very different causes, but both cause significant public concern and need to be addressed. We propose the following:

1. Ensure a competitive market for multisource products.

Take measures to better address FDA review backlog for generic drug applications and create mechanisms to further accelerate approvals for off-patent drugs that have only a few US-approved manufacturers.

Investigate ways to sustain a competitive market for generic drugs for small patient populations and sufficient competition to drive cost down, while working to keep manufacturers from ceasing production.

Eliminate anti-competitive distribution arrangements that impede competition for multisource drugs.

2. Reform health insurance to put patients, rather than rebates, first.

Health insurance companies should make coverage decisions for new and existing drugs on the basis of the medical and patient needs while considering the impact on cost. PBMs are siloed and only responsible for drug cost (pharmacy benefits) and not for the much larger component of medical benefits. Irrespective of the medical improvements and medical cost offsets associated with these improvements, PBMs are incentivized to only adopt drugs on formulary that generate rebates or cut other drug cost. Long-term patient health, therefore, is easily compromised.

Drug coverage decisions should be made in the context of overall medical care rather than for a drug silo only. PBMs aren’t incentivized to work on long-term improvements to patient health outcomes because they are just concerned about short-term drug cost and margins over these drug purchases. PBMs should focus on, and be compensated for, handling administrative and logistical aspects of drug delivery while leaving medical trade-off decisions to integrated health plans. Patients, not rebates, should be the focus.

Medicare Advantage Plans should be prioritized over Medicare Part D options for the same reason. Medicare Advantage Plans offer a holistic medical perspective on patient needs with the appropriate trade-offs rather than making siloed drug coverage decisions that don’t put the treatment results front and center.

3. Encourage drug companies to show more restraint in price increases.

Brand drug companies should follow the example of Allergan and develop public policies with respect to net price increases. Doing so will allow the industry to be a more credible partner with the medical community, health insurance industry and Congress to address concerns over access to healthcare and the cost of care to individual patients.

4. Pursue payment models that reflect value.

In many cases, drug costs are incurred over a short period despite their long-term medical benefit. The new hepatitis C drugs are taken over a 12-week period, but they significantly impact the rest of a patient’s life. Some chemotherapies involve one to two years of treatment, then provide extended and improved lives for a number of years. New cell and gene therapies are single treatments that cure or provide improvements in a patient’s condition for many years. Particularly given the short-term focus of our health insurance industry, we need to think of better ways to match the time horizon of payment with the length of the health benefit provided. The drug and health insurance industries need to collaborate to seek some solutions. It will, however, require the government’s active participation, as many government-pricing rules, such as best price legislation, impair the implementation of new, more innovative payment models.

The healthcare dialogue in the US will have to reach beyond price increases, rebates and easy soundbites

to reach a resolution on some very complex issues. Hopefully, these thoughts can help to stimulate some much-needed dialogue.

Ed Schoonveld is a ZS Associates principal and global leader of the firm’s value and access solution area. As one of the world’s leading experts on pharmaceutical pricing and market access, Ed is the author of The Price of Global Health (second edition) and provides strategic consulting and research solutions to healthcare industry clients.

Bill Coyle is a ZS Associates principal and leader of the firm’s European region. He focuses on sales and marketing issues in the pharmaceutical and biotechnology industries. Bill’s areas of specialty include market access and pricing, key account management, commercial organization design, and sales effectiveness.

Howard Deutsch is a ZS Associates principal and global leader of the firm’s managed care strategy practice. He helped clients with a spectrum of sales force and marketing issues, with a particular focus on US managed-care and market access strategy.

Howard Deutsch, ZS Associates

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