Prescription Drug Cost Control

(This has been updated from the original post from 2003. Since then, Medicare Part D and the Affordable Care Act have improved things a lot. However, many of the issues are unchanged.)

More than ever, physicians have the power to maintain their patients in good health using medications being developed by the pharmaceutical industry. But the expense of these drugs is high.

Prescription drug costs are a major factor pushing up the cost of health insurance, and it is no longer a reasonable option to have insurance that does not cover prescriptions. Drugs typically cost far more than it costs to see a doctor to get them, even more than the amount a hospital will be paid for an entire admission. Cash paying patients pay more for their drugs because they have no ability to negotiate discounts, and the doctors who care for them have to spend extra time trying to figure out treatments that are within their patients’ reach financially.

We’ve got a problem

Part of the expense of medications is undoubtedly justified: Quality drug research costs massive amounts of money, and drugs can save money in the long run by preventing premature death and disability. But we also see massive marketing budgets driving up costs:

  • Multiple sales representatives promote a single company’s products, competing for doctors’ limited office time
  • Free lunches are offered to entire office staffs in order to get to talk to the doctor while eating, putting physicians in the position of being the ones to refuse a free lunch for their overworked and underpaid employees. (However, the system has been reformed to make it illegal for pharmaceutical representatives to give out pens or other cheap toys with a drug name on them, as if that was the problem.)
  • Educational conferences, often at expensive restaurants, are sponsored with “unrestricted” funds — but only for topics involving diseases that can be treated with expensive new medications. Many of the speakers are working with audiovisual aids that are supplied free by the drug manufacturers.
  • Doctors who need to supply their uninsured patients with free samples must meet with a drug representative to sign for them, providing access to the doctors’ attention to market other drugs.
  • Television news is full of “medical reports” that are clearly based on corporate press packages.
  • Television and print media are glutted with direct-to-patient advertising for drugs and conditions supposedly so complex that prescribing the drugs is limited to those with medical degrees. Doctors find themselves in the position of having to argue with patients who want the overpriced drug they heard about on TV, instead of a more appropriate and less expensive older drug. (Ironically, in my experience it’s more common to find that patients refuse to take a medication that would benefit them because of the frightening list of side effects in the commercials.)
  • Some of the most reliable independent medical journals have found, after the fact, that they have published research papers tainted by authors’ ties to pharmaceutical companies.
  • Several new drugs have been pulled off the market for safety reasons after they had already become widely prescribed due to aggressive marketing. Often, the safety issues were well-known from the start, but the drugs were still given to patients who should not have received particular drugs/drug combinations. The information about risks was not communicated as efficiently as the rest of the sales pitch. In some cases, the drugs in question would still be the safest drugs for a specific subset of patients — but now no one can get them.
  • Foreign pharmacies can purchase the same drugs at far less cost than American ones can. American pharmacies are not allowed to re-import those drugs, even though it would be cheaper to American patients, even after the cost of those drugs’ brief foreign vacations.
  • Cash patients pay far more at the pharmacy counter than insurers do when paying their pharmacies to dispense those drugs, despite the added expense to pharmacists for billing the insurer.
  • Despite multiple brand-name “me-too” drugs within the same class, all are priced at the same stratospheric level, and even the promotional copay cards will offer identical discounts to their competitors. Supply is greater than demand, and competition is brisk, but it isn’t bringing down the price — only increasing the money spent on marketing.
  • Thanks to the Affordable Care Act, patients who have expensive diseases, like diabetes or HIV, are no longer excluded from insurance due to pre-existing conditions. But insurers have been artificially inflating the cost of the cheapest generic drugs for those diseases: They have been requiring patients with expensive diseases to pay more out of pocket for cheap drugs than patients with minor illnesses pay for expensive drugs. It’s a blatant attempt to try to encourage those patients to take their pre-existing conditions and go enroll in someone else’s insurance program, and it’s currently legal.


The bizarre world of drug pricing

We also see that the bizarre system of drug pricing is distorting the market price for drugs. In the real world, you have a product to sell, you set a price low enough that people will feel it is worth the money but high enough to make a profit for your business. If your competitor is selling cheaper, you’d better provide more value in some other way, or you’ll lose your customers. But that’s not how it works with prescription medications.

To understand why, you have to understand “formularies.” A formulary is a limited list of drugs that are available for prescribing. In many cases, there are several drugs that all do the same job, but one will be a better choice because it is more effective, costs less, has more convenient dosing, has fewer side effects or drug interactions, etc. Basically, there are more drugs on the market than we really need.

To a certain degree, the medical profession as a whole creates a de facto formulary. For instance, no one told them they couldn’t prescribe propranolol to control blood pressure any more. But there are newer drugs that have fewer side effects and can be given once a day instead of four times a day. So doctors pretty much stopped using propranolol.

Institutions like hospitals have formularies, because it doesn’t make sense to have uncommonly used drugs on the shelf that will sit unused until they expire. If a patient normally takes a non-formulary drug at home, the doctors in the hospital will switch them to the formulary alternative (unless there is some reason it’s not a good idea in that particular patient).

However, restricting drugs’ formulary status can be used as an inducement to get better prices, too. Your hospital needs to provide medication for cholesterol, but it doesn’t need to have lovastatin, pravistatin, atorvastatin, simvastatin, rosuvastatin, fluvastatin, and pitavistatin on the shelf. If the hospital pharmacy stocked all those drugs, it would use fewer of each type, and it would not be able to negotiate any volume discounts. Their pharmacy committee will ask the manufacturers to submit bids, and they will choose one or two that are most useful and cost effective. The drug manufacturers will deeply discount the drugs to get them on the formulary.

Insurers also have formularies to get better prices. But here’s where it gets weird. They aren’t buying the medications directly from a wholesaler or manufacturer, the way hospitals do. They are reimbursing thousands of pharmacies and pharmacy chains. Those pharmacies still have to buy and stock all the medications, and all those drugs must be sitting there if a patient comes in needing one. Insurers limit their costs by having a fee schedule that pharmacies must agree to. However, insurers also control costs by by negotiating rebates from the manufacturers.  (A “rebate” is a retroactive payment they receive when one of their members fills a prescription for a manufacturer’s drug.)

Here’s a typical example to show you how complex it has become: Suppose your pharmacy buys Supermycicillin for $1o00/100 pills. You fill a script for 10 pills. The pharmacy charges  $105 as per the insurer fee schedule.  With your insurance plan, you pay the brand name copay of $30. Your insurer pays the pharmacist the other $75. The pharmacist earns a $5 prescribing fee and probably only makes a profit if you buy some shampoo and cosmetics while you’re waiting for your medications.

However, your insurer also has a contract with the manufacturer of Supermycicillin to get a rebate of $200 per 100 pills. So although the wholesale price for your 10 pills was $100, your insurer’s final cost was only $55.

Joe the Plumber standing behind you in line with no insurance couldn’t afford over $100 for a prescription of Supermycicillin, so his doctor prescribed penicillin VK generic.  He’ll have to take that 4 times a day instead of once a day, but he’s lucky he’s only got a tooth infection, and penicillin will work just fine for him. The wholesale price of that might be something like $20/1000 pills, but he had to pay $30 for his 40 pills because there’s no insurer negotiating any discounts for him.

Of course, your insurer would much rather you use the penicillin VK, too. So it has arranged the formulary into “tiers,” with lower copays for cheaper drugs. So Supermycicillin might cost you $30, but penicillin VK might cost you $5. They’re counting on your doctor knowing that the higher tier drug will cost you more money — and therefore choosing penicillin VK when it will suffice for your condition.

Another drug, Augmentimycicillin, is not on the formulary. It isn’t covered by your insurance at all unless your doctor calls them to give a very good reason why Supermycicillin won’t do the job. Since Augmentimycillin isn’t on the insurer’s formulary, the insurance company doesn’t get any rebate when your fill it.

The actual amounts of the rebates are secret. Drug companies don’t want to have to give Yellow Cross the same rebate amount they gave Blue Cross if they can negotiate a better deal, so the agreements have confidentiality clauses. In the example above, the wholesale price of Augmentimycicillin might be only $950/1000 pills to the pharmacist. The manufacturer has priced their drug lower than their competitor. But without the rebate, your insurer would be paying $60 for the Augmentimycicillin and $55 for the Supermycicillin, and with thousands of subscribers, that starts to add up. Joe the Plumber paying cash could get the Augmentimycicllin cheaper — but your insurance only covers the Supermycicillin.

A company with a “blockbuster” drug — a drug that is so much better than alternatives that an insurance company would lose business if they didn’t cover it — will use that as a wedge to get all their other products on a formulary, too, even if they aren’t particularly attractive choices on their own merits.

And if you’re going to a chain pharmacy, they’ve probably negotiated their own price discounts with wholesalers and manufacturers. So they have probably mailed you or your doctor cheery letters suggesting you switch to drugs that are more profitable for them.

All of this means that your doctor has no friggin’ idea what the actual cost of your medication will be. There is no logic governing which drug is covered by which insurance company.  The formularies they post on their websites are typically out-of-date, and they are not required to honor them. You only find out the drug you were presribed is more expensive — or that it’s nonformulary — when you get to the pharmacy counter.


The failure of the free market

What’s going on? What happened to supply and demand?

In fact, those principles don’t work here because of the disconnect between who selects, who consumes, and who pays for a product. There are no fixed prices for drugs, so physicians can’t learn which drugs are most cost effective. The wholesale price is set very high, but then pharmaceutical companies offer rebates to insurers and discounts to institutions like hospitals to induce them to put the drug on their formularies. The higher the make-believe wholesale price, the sweeter the rebates/discounts look.

But the independent pharmacist who dispenses the drugs must pay the full wholesale price – he/she doesn’t see any of that rebate and is paid a paltry profit to stock and dispense all these medicines. And cash patients have to pay enough to cover the pharmacist’s actual costs – so they pay the highest price, even though they pay up front, saving the pharmacist considerable cost.

Patients who do have prescription coverage, on the other hand, usually pay a fixed co-payment. It may be higher for brand name or non-formulary drugs, but it has no actual relationship to the cost of the drug to the pharmacist or a cash patient. So if a company wanted to sell its new drug at a dramatically affordable price, most patients would still pay the higher “brand name” co-pay, and the drug might even be excluded from formularies if competitors offered rebates that overcame the cost differential to the insurer. And again, formulary tiers are being manipulated based on the cost of insuring the patient who needs particular drugs, not the cost of the drugs themselves. Not surprisingly, even drugs that advertise they are lower-priced are only a few dollars cheaper for comparable potency. It makes no economic sense to set prices aggressively low.

Since the wholesale price has little effect on physician prescribing, drug companies feel the need to pump huge sums into marketing. Doctors like to think of themselves as skeptical and not susceptible to marketing — so it takes even more money to drum in the message.

How can physicians be sucked into this? Medical education is being squeezed by pressures on medical schools and physician practices to be more cost effective, to have their doctors generating more income seeing patients or doing corporate-sponsored research. (Ironically, some of that pressure comes from health insurers — who can’t control the price of patent-protected drugs as easily as they can the cost of hospital and physician reimbursement.) The time that used to be available for informal teaching of students and residents is gone. The result is that physicians hear again and again about the new products from marketing efforts. But they hear very little about the older drugs, with lower prices and established safety profiles, which the senior physicians are familiar with.


A proposed solution

I propose a measure to try to get market forces back on our side to regulate these prices: uniform wholesale drug pricing. If a company sells a product to Rite Aid or CVS or Tenet Hospitals for $X/unit, it must sell to small pharmacies for the same price for the same unit. (Shipping and handling costs of course, could vary for large vs. small orders, but would have to be within a fixed percentage of the actual shipping costs). No rebates – the price is the price. Publish the price on the internet so everyone knows what it is and whether it changes. Pharmacies would compete on the basis of the dispensing fee they tack on, not the overall price of the drug, and the dispensing fee at a particular pharmacy would have to be uniform — either a flat fee or a fixed percentage of the wholesale cost — for all the drugs they sell. No jacking up the price on generic antibiotics to allow lower prices for advertised maintenance drugs. If a manufacturer wants to get the business of the big payers by competing on price, the price must also be the lowest to the cash patient.

In addition, all prescription plans would reimburse a percentage of the wholesale cost of a product, not a fixed dollar amount.  If a brand name drug costs less than a generic competitor, the patient cost is also less, not perversely greater. As with the ACA marketplace plans, there would be an out-of-pocket maximum to protect patients with catastrophic illnesses.

The lower cost of foreign drugs is to some extent unavoidable given the lower tort costs in other countries. But perhaps some type of tort reform would be available to companies who sold a product in all countries at the same price and observed certain marketing restrictions. There might also be some type of prescription drug surcharge for Americans who wanted a “full-tort” option, just as there is for car insurance.

These controls would have to be set by federal law, since these pricing practices cross state lines.  They don’t have to set the prices; they just have to set the ground rules for pricing.  I predict that if such measures were instituted, the market would quickly control drug prices, as price wars between me-too drugs ensued. Patients would keep track of prescription drug costs better than any pharmacy committee at an insurance company could, eliminating a lot of overhead for insurers. (Believe me, patients will pay more attention to whether a prescription costs them $10 or $11 than whether it costs their insurer $10 or $100.)

If price were a consideration when doctors wrote prescriptions, marketing abuses would control themselves to some extent – they would effectively communicate to doctors and patients that the drug was overpriced. Even so, restrictions on doctors accepting gifts would be appropriate. Currently, there is a website listing the amount of benefit physicians have received.  Requiring pharmaceutical firms to issue doctors a 1099 form at the end of the year enumerating the taxable value of those gifts would begin to stop the flow pretty quickly, I would bet.

Who loses under this plan? Who is going to scream and try to convince people it is a threat to their health?

  • Drug companies may think they will lose out, because everyone fears change. But we’re just changing the incentive system in a way that is fair to all companies. There is no reason they should make less profits; they’ll just have lesser marketing expenses competing with each other.
  • Pharmaceutical benefit managers will also fear change, since their business includes negotiating these secret rebate deals for insurers. (PBM’s are the managed care companies subcontracted by health insurers to fill their prescription claims.) But since many of them are paid a flat capitation rate for paying prescription claims for a plans’ enrollees, something that controls overall prescription costs is in their long term best interests, too. It’s no accident that these firms are becoming less profitable as drug costs are rising.
  • Entertainment industry firms who provide meals and facilities for pharmaceutical company marketing activities will lose business. I know this is a bad time for them, but it’s a bad time for everyone else, too. Sorry.
  • Media outlets will be running fewer prescription drug ads. The market won’t dry up completely, however, as ads to promote drugs that are lower priced will fill some of the void. But expect their news services to scream total, bloody murder over anything that would reduce the amount of drug advertising.
  • There are too many pharmaceutical sales representatives, though there is quite a bit of turnover among reps. A program to retrain them for more productive roles (such as research jobs or clinical care positions) would benefit everyone. Many of them start out in fields like nursing and could return.
  • Medical training programs have come to depend on pharmaceutical companies to pay guest lecturers. If we want our doctors looking out for the best interests of patients, we’d better find a different way of paying for this, anyway.
  • Doctors and their staffs have been well-fed. We’ll get over it. And we’ll be gaining income seeing the patients who currently don’t come to the doctor because they can’t afford the medications.


© 2003-2015 Eileen K. Carpenter

Leave a Reply

Your email address will not be published. Required fields are marked *