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The Pharma Conundrum: Pharmaceutical Spending Increase Drivers and Policy Solutions

March 23, 2017

National spending on pharmaceutical drugs, while not the largest component of national health expenditures, has come under scrutiny from politicians on both sides of the political spectrum. Several high-profile controversies over drug pricing hikes have been the subject of public ire, and fingers are often pointed toward pricing as the culprit for increased spending on drugs. Yet pricing is not the only culprit: examined here are possible explanations for increasing pharmaceutical spending, along with an evaluation of several policy proposals.

Pharmaceutical spending in the United States comprises approximately ten percent of national health expenditures, and its share is expected to increase [1].

Increasing pharmaceutical spending is often a hot topic in political and policy discourse, and likely draws attention because copayments for drugs reflect a very tangible component of cost-sharing for patients [2]. Often, the discussion on national drug spending is prompted because of specific instances of drastic drug pricing increases, such as the acquisition and subsequent price hike of Daraprim by Martin Shkreli-led Turing Pharmaceuticals, or of Isuprel and Nitropress by Valeant [3].

These pricing hikes can result from acquisitions of older drugs, or from the traditional pharmaceutical pipeline for developing new drugs. This process can take over 11 years, and is estimated to cost anywhere from $800 million in 2003 [4] to $2.6 billion in 2016 [5]. The drug pipeline involves discovery, research and development, clinical trials, FDA approval [6], and then a patent-protected or exclusivity period in which the drug is protected from generic entry. The manufacturer can exercise more discretion over pricing during this “monopoly” period. If a drug is successful, this pricing strategy often serves to cover a manufacturer’s failed ventures (as less than one in ten drugs that enter clinical trials make it to market [20]); profits from successful drugs are often directed back toward research and development.

(Image: Percent of national health expenditures going toward prescription drugs Source: Kaiser F...

(Image: Percent of national health expenditures going toward prescription drugs Source: Kaiser Family Foundation)

The publicized political discourse around pharmaceutical spending often focuses on drug pricing. The executive branch has expressed a vague desire to bring down drug costs by fostering more competition [7]. Other high-profile proposals to drive down prices include plans to increase drug importations [8]. Yet multiple factors, beyond only pricing, are contributing to increases in pharmaceutical expenditures.

(Image: Average annual growth rate of prescription drug spending per capita Source: Kaiser Famil...

(Image: Average annual growth rate of prescription drug spending per capita Source: Kaiser Family Foundation)


Drivers Behind Spending Increase

Increasing List Prices

Increases in the invoice (list) prices of drugs are a modest culprit contributing toward increased spending, with invoice prices increasing 12.4% in 2015. However, the effect of increasing list prices is tempered by rebates that drug manufacturers provide to insurers – for example, accounting for rebates, drug prices increased on net only by a modest 2.8% in the same year. This reflects a shift in market practices from previous years – negotiations with manufacturers are becoming more effective at slowing net price increases [9].

Manufacturers, however, are still averse to slowing down increases in list prices – they cite concerns about such practice hampering research and development. In addition, even if rebates are offered, this practice allows them to negotiate higher prices with payers each year [10].

Decreasing Number of Patent Expiries

A drug patent expiry ends a manufacturer’s “monopoly” pricing period and allows generics to enter the market, which drives down the price of the drug. However, in recent years, the number of expiries have fallen; in turn, it has not decreased spending as much as in past years, thus contributing to the spending rise [1].

Specialty Medicines

The significant driver of the spending increases originates from spending on specialty medicines, which are used to treat complex, chronic, or rare conditions, including cancer, HIV, hepatitis, and autoimmune diseases. These specialty medicines drove over 70% of the increases in overall drug spending between 2010 and 2015, and comprise quite a large portion of yearly drug expenditures (36% in 2015) [11]. The utilization of specialty drugs is increasing, and is expected to reach $400 billion by 2020 [21].

Spending on specialty medicines can present an ethical policy dilemma, as a responsible balance must be achieved between innovation and cost containment.

(Image: Total yearly spending on specialty drugs (billions), and breakdown by type Source: IMS H...

(Image: Total yearly spending on specialty drugs (billions), and breakdown by type Source: IMS Health)

Proposed Policy Solutions

“Let Medicare negotiate drug prices” and Medicare Part D

One commonly cited proposal is to allow the Medicare program, America’s social insurance program for citizens over age 65, to bid with drug manufacturers for lower prices, closer to the way the Veterans Administration contracts with drug companies [16].

This could occur with a “bully pulpit” strategy, in which the Secretary of HHS would negotiate specifically with drug manufacturers for expensive drugs, pressuring them to lower their prices. One merit of this approach, making it an attractive target, would be to target and drive down the prices of the aforementioned expensive specialty drugs. However, this approach would have to be limited to a few specialty drugs, due to administrative difficulties (the Secretary can only negotiate with, and put pressure on, so many drugs in a given year). In addition, the Secretary would need specific leverage to pressure companies to decrease prices beyond a general power to negotiate, otherwise, savings would be modest [12].

What is often overlooked is that the private Prescription Drug Plans (PDPs) who provide the plans for Medicare Part D, Medicare’s drug coverage program, do in fact negotiate with drug manufacturers. They do this through formularies, which are lists of medications that the PDPs will cover. Drug manufacturers will drive down prices in order to be included on PDP formularies, so that they can gain access to the Medicare market of patients. PDPs are limited in their leverage, however, as Part D requires them to cover certain drugs in “protected classes” regardless of price [17].

Policy plans were made to remove these protected classes, but patients raised serious concerns about coverage being adversely affected [18]. However, other more nuanced proposals regarding Part D exist. One proposes that Medicare should require manufacturers to provide rebates for drugs covered under Part D for low-income patients, projected to save $137 billion over 10 years [19]. Another would be for Medicare to create a public Part D program to compete with PDPs, and create its own formulary, to hopefully generate savings [19].

Value-Based Pricing

A solution proposed by drug manufacturers as an alternative to further slowing invoice price increases, is “value-based pricing”, where manufacturers offer rebates to insurers if the drug is not effective [13]. The arrangement was proposed in earlier years but did not take off due to issues in tracking outcomes. Nonetheless, it has become popular in Canada and European countries with single-payer systems, for diseases such as cancer where reliable outcome metrics exist [23].

The solution has caught momentum in the US recently, fueled by the entries of new, expensive drugs designed to treat diseases for which older, cheaper generics already exist, and the increasing ability to reliably measure outcomes. Some difficulties would arise in adoption due to the patchwork nature of US health insurance, along with issues identifying appropriate drugs for value-based arrangements and how best to measure outcomes [23].

Importation – “It’s cheaper in Canada!”

This proposal, which suggests drugs approved for use in other countries such as Canada should be allowed to be imported into the United States, has a broad populist appeal. Proponents, including those in Congress, cite that often, list prices for protected drugs in the United States are much higher than in other countries, and that importation would foster competition and lower prices [14].

However, according to an HHS report, importation would only decrease total pharmaceutical spending negligibly, perhaps by 1%. There are three primary reasons for this: firstly, much of the savings from the list price would be captured by intermediaries who ship the drugs, secondly, many drugs are inappropriate for importation, and thirdly, the foreign supply of drugs would not insufficient to meet domestic demand [15]. As such, though the concept is attractive, the complexity of importation mitigates any savings from a quasi-free market, increased competition model.

Strengthening Generic Drug Presence

Still other policy proposals aim to increase generic drug presence, through a variety of means, including increasing the differential between copayments for generic drugs and brand drugs, with the idea of encouraging utilization of generic drugs. Others include decreasing brand drug exclusivity periods to bring generics to market faster (which might be an attractive option in line with the executive branch’s commitment to competition), or to ban “pay-for-delay” agreements, where brand drug manufacturers seek to extend their exclusivity period by paying generic manufacturers to keep the generic drugs off the market [19].

Targeting Utilization of Specialty Drugs

HHS negotiations on specialty drugs remains only an idea, but current strategies do exist - payers have been using a number of strategies to attempt to manage and decrease utilization of specialty drugs by patients, though management proves difficult. Strategies include placing specialty drugs on the plan’s highest formulary tier (where out-of-pocket costs are largest for patients), step therapy (where patients are required to try and fail with lower-cost drugs before the plan will allow a specialty drug) and prior authorization (where a physician must document the patient’s need for the specialty drug) [21].

Other policies proposed to target specialty drugs in particular mirror aforementioned plans, and look to implement value-based pricing structures where appropriate, shorten exclusivity periods and limit patent abuse, and increasing clinical data transparency so providers can make informed decisions when prescribing [22]. Increased pricing transparency has also been suggested but not extensively researched, and the CBO only suggests modest effects [12].

Concluding Remarks

The pharmaceutical space is complex, with a variety of manufacturers and payers. Spending increases are being driven by a multitude of factors, and policy going forward will likely involve a more nuanced, piecemeal approach.


   [1] http://kff.org/slideshow/what-are-the-recent-and-forecasted-trends-in-prescription-drug-spending/

  [2] https://meps.ahrq.gov/data_files/publications/st413/stat413.pdf

  [3] https://www.nytimes.com/2015/09/21/business/a-huge-overnight-increase-in-a-drugs-price-raises-protests.html

  [4] https://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/76xx/doc7615/10-02-drugr-d.pdf

  [5] http://csdd.tufts.edu/news/complete_story/tufts_csdd_rd_cost_study_now_published

  [6] https://www.fda.gov/drugs/resourcesforyou/consumers/ucm143534.htm

  [7] https://www.washingtonpost.com/news/wonk/wp/2017/02/03/what-ceos-say-happened-in-trumps-closed-door-meeting-with-big-pharma/?utm_term=.e54c3183846e

  [8] https://www.washingtonpost.com/news/wonk/wp/2017/02/28/bernie-sanders-takes-another-swing-at-big-pharma-with-bill-to-allow-drug-imports/?utm_term=.c191684f9aa1

  [9] http://www.imshealth.com/en/about-us/news/ims-health-study-us-drug-spending-growth-reaches-8.5-percent-in-2015

  [10] https://www.nytimes.com/2016/04/27/business/drug-prices-keep-rising-despite-intense-criticism.html

  [11] http://www.imshealth.com/en/thought-leadership/quintilesims-institute/reports/medicines-use-and-spending-in-the-us-a-review-of-2015-and-outlook-to-2020

  [12] https://www.cbo.gov/sites/default/files/110th-congress-2007-2008/reports/06-05-pricetransparency.pdf

  [13] https://www.bloomberg.com/news/articles/2017-02-06/big-pharma-s-offer-to-trump-discounts-when-drugs-don-t-work

  [14] http://www.businessinsider.com/members-of-house-and-senate-introduce-drug-importation-bill-2017-2

  [15] https://archive.hhs.gov/importtaskforce/Report1220.pdf   [16] http://www.commonwealthfund.org/publications/blog/2016/may/drug-price-control-how-some-government-programs-do-it

  [17] http://kff.org/medicare/fact-sheet/the-medicare-prescription-drug-benefit-fact-sheet/

  [18] http://www.latimes.com/business/hiltzik/la-fi-hiltzik-medicaire-negotiate-20170111-story.html

  [19] http://kff.org/report-section/section-2-medicare-payments-to-plans-and-providers/#PrescriptionDrugs

  [20] https://www.fda.gov/ScienceResearch/SpecialTopics/CriticalPathInitiative/CriticalPathOpportunitiesReports/ucm077262.htm

  [21] http://www.pewtrusts.org/~/media/assets/2015/11/specialty-drugs-and-health-care-costs_artfinal.pdf

  [22] https://www.ahip.org/wp-content/uploads/2015/07/IssueBrief_SpecialtyDrugs_7.9.15.pdf

  [23] http://knowledge.wharton.upenn.edu/article/value-based-drug-pricing/ 

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