This year has brought new treatments for osteoporosis, advanced bladder cancer, Ebola, tuberculosis, spinal muscular atrophy, and postpartum depression. And it’s only autumn — the season in which Congress and President Trump will decide to kill biomedical innovation with their proposals on drug prices just as we’re entering a new era of curative medicines.

The press is reporting on “bipartisan efforts to lower drug prices,” taking for granted that any debate about drug prices presumes that there are drugs to price.

House Speaker Nancy Pelosi finally released her three-part plan to lower drug prices last week. The first two parts would be terrible for patients. The third is exactly what we need.

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First bad idea: one price for the U.S., E.U., and Japan

Pelosi would peg U.S. drug prices to those paid by Japan and several European single-payer health care systems whose restrictive policies offer fewer innovative medicines to their citizens. This is similar to what President Trump has proposed before. But this well-intentioned price control would most likely push U.S. prices up, not down. Here’s why.

The pharmaceutical industry runs on profit margins of 10% to 20%, meaning there’s not much room to cut revenues before biotech becomes a giant nonprofit. The only logical response by companies would be to raise international prices to match those in the U.S., not to lower U.S. drug prices to match international ones. If other countries then cut back on their use of branded drugs, American companies will have to make up their losses by increasing prices.

Pelosi’s plan blocks price increases on existing drugs. To remain profitable, companies would have to launch new drugs at even higher prices than they would have otherwise, anticipating they wouldn’t be able to sell them in Europe and Japan and therefore would need to generate all their returns from U.S. sales. So over the longer term, the U.S. would shoulder even more of the cost of innovation than it does now.

With her focus on what other countries pay, Pelosi appears to miss the point that it serves American patients for drug companies to get other countries to contribute at least something to the development of novel medicines. Yes, patients in those countries get medicines for less. But what American politicians should focus on is making sure that American patients have access to today’s treatments and the ones we have yet to invent.

If America won’t let other countries pay less and then, later on, when those countries stop paying for drugs, won’t agree to make up the difference by paying more, then the funding for new drug development will dry up and there won’t be any novel drugs to fuel our debates about price and affordability.

Second bad idea: outright price setting

The second part of Pelosi’s plan calls for government price controls on 250 drugs under Medicare. This means U.S. companies would not be allowed to set their own drug prices — even if they were the same as what other countries paid. The bill summary referred to these controls as a “negotiation” to bring down costs under Medicare, but its reach extends well beyond Medicare and doesn’t actually call for negotiation. Drug companies that do not acquiesce to pricing demands from the Department of Health and Human Services would face punitive taxes until they came to heel.

The massive expense of drug development is borne almost exclusively by private investors, and there are not many of them. Fundamentally, Pelosi seems to believe that the U.S. government should decide how much reward to mete out to successful innovators. The premise of her proposal is that “innovation does not benefit Americans if they cannot afford it.” But when only 1 in 25 drug candidates makes it from preclinical studies through to FDA approval, no one is going to put money on the 25-to-1 longshot if the house can announce after the race is over that the actual payout will be 5-to-1.

What Pelosi has proposed is worse than the central planning ideology already debunked by the collapse of the Soviet Union, which at least paid inventors’ salaries while they worked for the state. If she believes the myth that the government already funds drug development, I can see how it would sound fair that the state should set the price for its own intellectual property. This belief is shared by other elected representatives, including Sens. Bernie Sanders (I-Vt.) and Rick Scott (R-Fla.), who have been spreading tales that U.S. taxpayers substantially fund the development of new medicines. But this isn’t true.

The average National Institute of Health grant to a university researcher is under $1 million. Drug companies then risk an average of $1 to $2 billion to convert that basic research into a single FDA-approved drug.

Although most drugs are invented by industry, there’s no question that government-funded university research germinates some promising seeds that can sprout into lifesaving medicines. When it’s time to bring their discoveries from the lab to the clinic, universities seek to partner with companies and receive both guaranteed payments and royalties if those drugs succeed.

Drug companies pay workers, vendors, and manufacturers, and issue dividends to investors — all transactions taxed by Uncle Sam. No one is exploiting taxpayers here: Biopharma innovators commercialize new medicines for society while generating revenue for both the U.S. Treasury and research universities.

The math behind drug development is often twisted by pharma’s critics to suggest that there is widespread price gouging in the industry. But the drug industry’s profit margin fluctuates between 10% and 20%, less than that for the software and oil and gas industries. And after all of the rebates that are already negotiated by insurers — which should be passed onto patients but aren’t — there is little room for further cuts. Shaving even 20% off net drug prices would render the industry profitless and wipe out most executive compensation. While that might please some, a 20% discount wouldn’t make an immuno-oncology treatment affordable to a patient with poor insurance coverage.

Generics were once novel drugs

Prices are generally set at levels the market requires to keep the innovation engine churning out new drugs, which are only temporarily expensive before going generic, remaining useful yet inexpensive in perpetuity. As long as drugs keep going generic, the industry must keep inventing to stay afloat, which is good for patients. That drugs go generic when patents expire is the natural price control that’s always ensured that drugs offer great value in the long run.

Our growing mountain of generic drugs is a national treasure. Like a mortgage that is eventually paid off, what we pay for branded drugs — 1.3% of GDP — is a worthy investment, not an expense. Nothing else about health care goes generic: Surgery costs, for example are an ever-increasing rent. Drugs going generic without undue delay, as most do, is the price control we have long had and the only price control we need.

Pelosi’s price controls are just another way of saying that the government — which still continues to invest in sugar subsidies — would prefer to stop investing in new medicines. That means our children’s and grandchildren’s health care will be no better than our own. America is better than that.

Third time’s a charm: capping out-of-pocket costs

Our creative drive to cure diseases should be the pride and joy of America, not a scapegoat for a broken health insurance system. Patients currently shoulder $61 billion of out-of-pocket drug costs. Some are financially ruined by what they are asked to pay, and many more give up on treatment. Their plight fuels outrage in the media and inflammatory rhetoric, leading many to blame innovators for the hardships insurance companies impose on patients.

This is why I applaud the third part of Pelosi’s bill, which proposes much-needed insurance reforms to cap what patients pay out of pocket for the medicines they need. That’s the real solution patients have been waiting for. It would upgrade today’s health care insurance from the tattered, complex web that fails to catch millions of sick people each year to proper coverage that allows patients to afford what their physicians prescribe. We need additional reforms to ensure that all people are similarly protected.

Only then will we have truly solved the affordability issue for patients.

Peter Kolchinsky is a founder and managing partner of RA Capital Management and writes on the Biotech Social Contract.

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  • It is ironic that 90% of the journalists don’t understand how drugs are priced. Pharma companies are not the culprit in high priced BRAND drugs. Culprit are the PBMs. They to facilitate distribution add to the brand pricing.

    WRT to generics, USA patients are being taken for a ride. A $0.005 per tablet is sold at Walmart and Rite Aid @$0.07. This will be discussed in an upcoming blog.

    Folks just put the blame on Pharma but don’t understand that there are others who are taking US population for a ride in the name of convenience.

  • This is one of the best commentaries I’ve read about pricing in a long time. It covers the issues in a compelling, readable way.

    I’m especially pleased to see someone noting that ANY sales outside of the US beyond the cost of production and distribution benefits people here.

    Few Americans understand that the US market is not big enough to support its biopharma sector. One of these days, I hope the number crunchers will run some scenarios, taking some drugs, looking at the value of those incremental returns, showing what would have happened either to price or availability if they drug could only be sold in the US.

    Hat’s off. This is a good one.

  • Good piece from someone in a part of the industry we don’t hear from enough — the investors and entrepreneurs at the early stage. Before the big companies and after the initial academic and NIH work. Waiting to see any substantive comments about the proposal discussed in the article.

    I agree that reference pricing simply won’t work to bring down prices for American consumers and will undoubtedly have unintended consequences that make it even worse. The price controls proposed are exactly the wrong direction for this conversation to take. It undermines the entire point of a market-based system. iPhones these days are effective medical gadgetry, so does that mean HHS should have authority to price a phone at $100?

    Many of the proposals being circulated these days pay no mind to tomorrow’s cures and drugs. Americans will want access to those (so don’t set price controls) and American companies should be the ones invented them (strong IP, investment/innovation incentivized environment).

    P.S. To fellow commenters, referencing the world’s largest selling drug as your only example is hardly high-minded debate. Yes, Humira sells in Europe, though several competitors are coming to market. People complained similarly about Sovaldi and now there are several competitor drugs and the price has come down significantly.

    What are some good ideas that should be discussed by policymakers in DC? Because this plan did not hit the mark.

  • I don’t see much difference among all of those proposals. They each are a form of Price Control. Plan 3, which you advocate, shoulders the cost of expenses incurred by those who use the most, to those who consume much less. The latter group essentially subsidizes the former. There needs to be a Plan 4: where patients pay for Plans which will cover their needs. Get Govt out of the equation.

  • I’m no pal of insurance companies. But Medicare and many state insurance departments have mandated loss ratios. So who’s gonna pay for these caps on out-of-pocket drug costs? The same people who always pay!

  • Making up for ‘losses’ is a fascinating turn of phrase. Less profit, but still unparalleled profit is seen as a loss that must be compensated. Industry will stop making drugs even when their revenue might be exactly the same because more people can afford to buy the previously financially toxic product? Really? The goal is not lower prices — the goal is making drugs accessible for patients — more sales. More sales requires lower prices. Not sure why pharma can’t understand this and why more sales would cause the industry to close up shop.
    We are pharma’s largest country market and we pay the highest prices. What functional economic market works like that?
    Also, let’s be clear: high patient out of pocket costs are a symptom of the affordability problem, not a cause of the affordability problem. When every new drug costs millions of dollars, it’s hard to manage premium costs to keep people in the insurance pool — which is essence of the insurance business. Hence the balance between managing the insurance cost driver — drug benefits — and the impact on premiums and patients. It’s not a good place to be, for anyone.
    Industry creates the problem (as in out of control rebates and high out of pocket costs) and then complains about it.

  • Last time I checked, Humira, Enbrel, and other blockbuster biologics were also bringing in BILLIONS of dollars in revenue. So it’s possible to have the same price across regions of the world and make tons of money. And at this point of their development cycles, the profit margins on these medications is quite high.

  • From public health Care standpoint, I agree that pharma investors should be rewarded for investments and cost but in reading this article it’s easy to pick out the numbers versus the ideology perhaps flawed at times.

    It’s not appropriate for pharma to force the public to afford the innovation it thinks is necessary. If there are worse outcomes due to affordability (including Medicare) then the role of innovation is completely undermined. While I agree with pelosi’s third principle as well, this on its own only cost shifts and to where? This does nothing to combat a flawed reward system.

    Surgery centers among other areas of medicine have cost inflation but this is being tied to services of value. So as the author states there should be consistency in medicine, pharmacy based contracts should also be tied to value based agreements! Innovation must equal outcomes and cost, not just cost. Inflation for price increases of generic medications should be tied to value based agreements within Medicare as opposed to a “we promise to use this for R&D, we swear”.

    I very much agree with Seema Verma, If providers (myself) and pharma doesn’t start to take on more value based risk, the only other option is price control.

  • This article is bull. Industry average is plenty high to cut profit margins. You referring it to bring lower than oil in gas? In what universe? Without government assistance the oil and gas industry would average a net profit margin of -7.6%. Take this crap down.

    • I absolutely agree. And there should be capped price consequences from the start of a drug’s development if any public money is used even at the basic research stage. Moreover, if later studies show that it is the fault of big “medicine/ big pharma” for charging us for “medical advise” and putting us on “drugs to alleviate symptoms, like hormone replacement drugs for women suffering menopause that are later proven to dramatically increase rates of breast cancer, all treatment for that breast cancer should be FREE of charge-then BINGO! We would suddenly have cures for cancer rather than treatment.

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