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The High Cost of Pharmaceuticals

November 04, 2015

The United States pays more than any other country for both pharmaceuticals and healthcare in general. These treatments are undoubtedly helpful, and good for both the health of our nation and the economy as a whole. However, the skyrocketing price has made it difficult for many to afford the treatments that they need, and payers are increasingly shifting the costs to consumers. Pricing is not always consistent between payers, and the role of government-funded Medicaid and Medicare make the already congested healthcare market more complex and intricate. One potential solution is allowing Medicare to negotiate directly with pharmaceutical companies in order to lower prices. Doing so could allow the nearly 50 million people on medicare to pay more affordable prices, putting a dent in the amount that Americans pay for healthcare.

High Cost of Treatments

It is often helpful to consider the high costs of pharmaceuticals in context of their role in the larger economy and U.S. as a whole. Due in part to the development of new treatments and cures, in the last 100 years, the U.S. life expectancy has increased from 47 years to 78 years.[1] Additionally, in the past fifteen years, 5 year survival rates are up 39 percent across all cancers.[2] Death rates for HIV/AIDS has fallen 85% since its peak in 1995,[3] and therapies have cured more than 90% of hepatitis C cases.[4] However, to many people, the high cost of pharmaceuticals make treatments prohibitively expensive. Insurance companies handle most of the costs for most individuals, but those with lower coverage or no insurance are often faced with the brunt of the bill.

If development of pharmaceuticals slows, the United States faces huge problems in the massive cost of managing diseases with ineffective treatments. If the United States were to develop a treatment to delay the onset of Alzheimer’s by just five years, it is expected that the United States would save $367 billion by 2050.[5] Curing diseases with expensive therapies is usually still better than managing a chronic disease over a patient’s life. Chronic diseases account for most of the expenses in our healthcare industry, and 86% of all healthcare spending in 2010 was for people with one or more chronic condition.[6]


Health Affairs

The high cost of pharmaceuticals is due mostly to the rising cost of production and research/development activities. To every drug that makes it to market, consumers and payers are paying not only for the final product, but also every failed product along the way. While many tote that the drugs themselves often times cost $10 or less to manufacture, the cost to bring these drugs to markets is on average $2.6 billion.[7] In addition, it takes ten years to get to this stage. Pharmaceutical companies feel that they are forced to charge these extraordinary prices in order to stay afloat with the risky nature of their industry.

Pharmaceutical companies argue that the prices of their treatments are reasonable when considering the healthcare industry as a whole. Prescription drug retail pricing accounts for 10% of the total U.S. healthcare spending, the same relative amount spent in 1960.[8] However, this amount is far lower in many other countries. These countries, such as the United Kingdom, often have their own government-sponsored bulk purchasers. Pharma companies are forced to sell through these government corporations, many of whom don’t like to barter. Pharma companies in these areas exert less purchasing power when compared to the United States, in which individual insurance groups, hospitals, and plans buy for consumers.[9] Medicare, one of the largest buyers of prescription drugs, is not able to directly negotiate with sellers like German nonprofit insurers can. They are simply an idle player in the pricing market, taking the lowest price negotiated by independent insurance companies.


Drug Pricing by Payer

The prices for prescription drugs differ very significantly across insurers, government programs, and providers, even given the same exact product and the same manufacturer. There are many different ways to calculate drug costs, and each given purchaser of drugs pays a different price that is based upon how well they are able to negotiate a low price with the manufacturer. Often, the method for calculating these prices (especially among private insurance plans) is not very transparent.[10] Both Medicaid and Medicare, however, provide information and data sets describing how their prices are calculated, and many private insurers base their payment benchmarks and negotiations on these two government payors’ methods.[11]

In Medicare, most prescription drugs are purchased through the Part D drug benefit, under which the Medicare program and seniors pay a premium so that beneficiaries can shop and enroll in a private drug plan. Drugs in these plans may be priced in a variety of ways based on private market standards.[12] Drugs may also be provided in traditional Medicare (Part A and Part B)– in Part A, drugs are included in the diagnosis-related group (DRG) pricing system that Medicare uses for all hospital services.[13] For Part B, Medicare pays the average sales price, which is an average of the reported sale prices of a given drug, weighted by volume and calculated using data that is about six months old. The program adds a 6% flat markup onto the ASP for any given Medicare drug to account for differences in provider acquisition costs and handling costs for all drugs.[14] This current system was implemented in 2005, mandated by the Medicare Modernization Act of 2003, and was intended to create government reimbursements that more accurately reflect the actual purchase price of prescriptions drugs (which at the provider or insurer level often include manufacturer discounts and negotiations that are not seen in the sticker price).[15]

Number of State Medicaid Programs using Measures as Their Primary Drug Reimbursement Benchmarks 

Kaiser Family Foundation

Medicaid, like Medicare, has a variety of ways to pay for drugs. Many Medicaid beneficiaries are not in managed care plans, which means that the payment for those drugs is negotiated at the plan level and is not entirely transparent.[16] In fee-for-service Medicaid, most states reimburse for drugs based upon an “Estimated Acquisition Cost” which are created by a state Medicaid agency, and are based on the Wholesale Acquisition Cost (WAC) or Average Wholesale Price (AWP) which are typically the listed or sticker prices for drugs. The AWP is related to the WAC (it is roughly 1.2x the WAC for non-branded pharmaceuticals) and the EAC as calculated by the states is usually either a percent reduction to the AWP or a percentage increase to the WAC.[17] However, most states also collect rebates on the drugs that they purchase through the national Medicaid Drug Rebate Program, and those rebates are typically calculated as a percentage of the Average Manufacturer Price (AMP), which is the price available for drugs sold in the retail class of trade and includes most of the manufacturer discounts.[18] States are limited on the prices they can pay for drugs by the Federal Upper Limit (FUL) price, above which the federal government will not provide Medicaid matching funds for drugs. The FUL prices are created by CMS for multiple-source drugs and are historically about 150% of the lowest listed price for that drug in national pricing compendia.[19] The states also set their own limits, the maximum allowable costs (MAC) for multiple-source drugs, which are usually the lowest price amongst several different pricing formulas, including the FUL and the state’s EAC.[20]


A Possible Solution?

In order to counteract the skyrocketing costs of drugs, several reforms have been proposed. One reform that has recently gained traction is allowing Medicare to negotiate drug prices, so let’s explore it in detail. As talked about above, most Medicare prescription drugs are purchased through Part D. Medicare Part D prescription account for about 7% of sales in the global pharmaceutical market, giving them lots of leverage for negotiating drug prices[21]. However, Medicare is barred from negotiating drug prices with pharmaceutical companies for Part D prescriptions. This was one of the terms the Bush administration agreed to in exchange for support of the pharmaceutical industry’s support of the Part D program, which was created in 2003.[22] As a federal programs like Medicaid or the Veterans Benefit Administration[23]. In fact, Medicare Part result, prescription drugs covered under Medicare Part D are priced at much higher levels than in other D pays an average of 73% more than Medicaid and 80% more than the VBA for brand name drugs[24].

VHA vs Part D Drug Costs 

Studies estimate that Medicare’s drug tab could be lowered by somewhere between $15.2 billion and $16 billion a year if the federal government was allowed to directly negotiate prices with drug companies to secure the same prices that that Medicaid or VBA receive[25].

The Pharmaceutical Research & Manufacturers of America (the main lobbying group for the Pharmaceutical industry) usually has a two pronged response to allowing Medicare to negotiate prices. First they argue that the Part D program has been widely successful at keeping total costs low because it was $349 billion lower than initial CBO 10-year projections[26]. But the reason for that $349 billion shortfall wasn’t because of how good Part D was at cutting costs. It was because the number of new enrollments for Medicare were far below what the projections in the CBO report. Secondly, drug companies say that this move would decrease incentives for drug companies to invest in research and development[27]. That claim is just not supported by the evidence. Data shows that the introduction of rebates for Medicaid (as a result of negotiations) had no impact on research and development of antipsychotics, drugs which are disproportionately used by Medicaid recipients[28].

Granted, Medicare negotiations aren’t a comprehensive solution to the problem of high drug prices. Medicare isn’t allowed to exclude overly expensive drugs from their coverage or maintain an approved drug list, so their leverage might be limited[29]. These negotiations also won’t do anything to curb rising drug prices for the millions of Americans on private insurance plans[30]. But even with all these pitfalls, Medicare negotiations would put a significant dent in the amount of money that Americans spend each year on prescription medications[31]. So even though it’s not perfect, Medicare negotiations seem like a sensible step forward.



  [1]Center for Disease Control and Prevention


  [2]American Cancer Society


  [3]Center for Disease Control, National Cancer Institute


  [4]Food and Drug Administration


  [5]Dall TM et al. The economic impact of Medicare part D on congestive heart failure. Am J Manag Care. 2013;19:S97-S100.; Alzheimer’s Association


  [6]Gerteis J, Izrael D, Deitz D, LeRoy L, Ricciardi R, Miller T, Basu J. Multiple Chronic Conditions Chartbook.[PDF - 10.62 MB]AHRQ Publications No, Q14-0038. Rockville, MD: Agency for Healthcare Research and Quality; 2014.


  [8]PhRMA analysis based of CMS data. National health expenditures by type of service and source of funds, CY 1960-2013.


  [10] “2013 AMCP Guide to Pharmaceutical Payment Methods: Executive Summary,” Academy of Managed Care Pharmacy, April 2013.








  [14] Angela Boothe, “Primer: Medicare Part B Drug Payment System”, January 21st, 2015.


  [15] Ibid.


  [16] “2013 AMCP Guide to Pharmaceutical Payment Methods: Executive Summary”, Academy of Managed Care Pharmacy, April 2013.


  [17] Brian Bruen and Katharine Young, “Paying for Prescribed Drugs in Medicaid: Current Policy and Upcoming Changes”, Kaiser Family Foundation, May 23rd, 2014.


  [18] “Medicaid Drug Rebate Program”, Medicaid.gov, March 24th, 2015.


  [19] Brian Bruen and Katharine Young, “Paying for Prescribed Drugs in Medicaid: Current Policy and Upcoming Changes”, Kaiser Family Foundation, May 23rd, 2014.


  [20] Ibid.


  [21] Gagnon, Marc-Andre and Wolfe, Sidney “Mirror, Mirror on the Wall: Medicare Part D pays needlessly high brand-name drug prices compared with other OECD countries and with U.S. government program” Policy Brief from the Carleton University School of Public Policy and Administration, July 23, 2015


  [22] Morgan, David. “Obama Administration Seeks to Negotiate Medicare Drug Prices.” Reuters. February 2, 2015. Accessed November 2, 2015.


  [23] Gretchen A. Jacobson, Sidath Viranga Panangala, and Jean Hearne. 2007. Pharmaceutical Costs: A Comparison of Department of Veterans Affairs (VA), Medicaid, and Medicare Policies. Congressional Research Office. January 2007


  [24] Gagnon, Marc-Andre and Wolfe, Sidney “Mirror, Mirror on the Wall: Medicare Part D pays needlessly high brand-name drug prices compared with other OECD countries and with U.S. government program” Policy Brief from the Carleton University School of Public Policy and Administration, July 23, 2015


  [25] Ibid


  [26] Silverman, Ed. “U.S. Could Save up to $16B If Medicare Part D Prices Are Negotiated.” The Wall Street Journal. July 23, 2015. Accessed November 2, 2015.


  [27] Silverman, Ed. “U.S. Could Save up to $16B If Medicare Part D Prices Are Negotiated.” The Wall Street Journal. July 23, 2015. Accessed November 2, 2015


  [28] Richard Frank. 2012. Prescription Drug Procurement and the Federal Budget, Henry J. Kaiser Family Foundation, March 2012.


  [29] Emanuel, Ezekiel. “The Solution to Drug Prices.” The New York Times. September 8, 2015. Accessed November 2, 2015.


  [30] Ibid


  [31] Gagnon, Marc-Andre and Wolfe, Sidney “Mirror, Mirror on the Wall: Medicare Part D pays needlessly high brand-name drug prices compared with other OECD countries and with U.S. government program” Policy Brief from the Carleton University School of Public Policy and Administration, July 23, 2015
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  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.


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