Should the government regulate prescription prices: it works where it’s tried

The last two blog posts provided background for a discussion of whether the U.S. government should negotiate or regulate prescription drug prices and discussed why the market might not do such a good job of setting prices for prescription drugs.  This post looks at prices in programs that regulate them.

Comparison of U.S. Prices to Those of Other Countries

The United States is unique among high income nations in that it does not regulate prescription drug prices.  Most other high income nations have some mechanism in place to do so.  A 2010 study compared brand-name drug prices in the U.S. with those in other high income nations.  The results, shown below, indicated that prescription drug prices are higher in the U.S. than in any of the comparison countries.  The difference ranged from U.S. prices being twice those in the U.K. to U.S. prices being about 15% higher than those in Switzerland.  The comparison nations represented a range of types of negotiation and financing of prescription drugs.  According to Morgan, Canada has a mix of public and private payers for prescription drugs and a mix of statutory and voluntary price negotiations.  At the other end of the spectrum, the UK has a single payer system and government agencies that evaluate the cost-effectiveness of drugs and negotiate drug prices with the pharmaceutical industry.

Two other studies document substantially higher U.S. prices for brand-name drugs.  Danzon and Furukawa found that U.S. prices at the manufacturer level were 20-40% higher than prices in 11 other countries that included France, Germany, the UK, Canada and Australia.  The Canadian Patented Medicine Prices Review Board publishes an annual report that compares Canadian prices to those of other nations.  The 2015 report indicated that U.S. prices were at least twice as high as those in all other comparator nations – including France, Germany, the UK, Canada, Australia, and Switzerland.

Comparison of Medicare, Medicaid, and Veterans Administration Drug Prices

Medicaid requires drug makers to pay rebates as a condition of participation in the program.  The minimum rebate for brand-name drugs is currently 23.1%.  If drug makers increase a drug’s price at a rate greater than the increase in the CPI, the rebate increases.  Because of large price increases, many drugs have Medicaid rebates much larger than the 23.1% minimum.  In addition, if the pharma company provides a larger discount to a private purchaser, it must also give that discount to Medicaid.  Finally, many states negotiate additional supplemental rebates.  States induce manufacturers to pay additional rebates by threatening to require prior approval for drugs for which supplemental rebates are not paid.

The Part D Medicare drug program presents a much different situation.  The federal government is prohibited by law from negotiating drug prices in the Medicare program.  Instead, the private insurance companies that offer Part D drug plans, or the PBMs they use, negotiate rebates on drugs dispensed to Medicare patients.  This allows Medicare to take advantage of competition among pharma companies who use rebates to get favorable placement on private insurers’ formularies.  However, savings from competition are constrained by two features of the Part D program.  First, Part D formularies must have at least two drugs from every therapeutic class.  In classes with small numbers of competitors, this limits the size of rebates that plans can negotiate.  Second, in six important classes – anticonvulsants, antidepressants, antineoplastics, antipsychotics, antiretrovirals, and immunosuppressants – Part D formularies must include all or essentially all drugs in the class.  This requirement substantially reduces pharma companies’ incentives to provide rebates for drugs in these classes.  A 2014 CBO study of drugs in 53 therapeutic classes found that the average Part D rebate was about 15% while the average Medicaid rebate was 54%.

The federal government also regulates drug prices for the Veterans Administration.  Similar to Medicaid, the government requires that the VA get the lower of a discounted price (the government sets the discount) or the pharma company’s best price to any private purchaser.  (The details of pricing to the VA are explained in a 2005 CBO study.)  The VA negotiates additional discounts from pharma companies that wish to have their products on the VA’s limited formulary.  The CBO estimates that the VA pays about 42% of the AWP for brand-name, single source drugs.  By comparison, CBO estimates that Medicaid’s net prices average about 50% of AWP.

Why doesn’t the U.S. government negotiate prices?

These comparisons indicate that drug prices are lower when governments regulate prices.  So why doesn’t the U.S. government do so?  The 2014 CBO report provides several reasons to be cautious about government regulation of prices.  First, the CBO argues that drug manufacturers may respond to price controls by increasing the prices of new products.  To the extent this occurs, any savings from price controls would erode over time as new drugs come into the market.  A study by Duggan and Morton indicated that this is how pharma companies responded to the Medicaid rebate program.  The study also indicated that pharma companies were more likely to market new versions of existing products as a result of the Medicaid rebate program.  Second, pharma companies could respond to price controls in government markets (Medicaid, Medicare, VA, Tricare) by increasing prices in non-government markets.  Third, lowering drug prices could result in pharma companies reducing investment in research and development and, consequently, bringing fewer new products to market.  More on this later.