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In October, the House Oversight Committee turned a magnifying glass on the rising cost of prescription drugs. With health care costs critical to voters on both sides of the aisle, lawmakers grilled drug company executives on practices from copay assistance to evergreening. Rep. Katie Porter (D-Cal.) and her whiteboard garnered viral attention after she interrogated Celgene CEO Mark Alles about price hikes to the cancer drug Revlimid.

And the White House recently stepped into the fray. A broad administration rule issued on Oct. 29 will require insurance companies to tell their customers in advance what their out-of-pocket cost will be for a drug and what the company actually paid for it. The rule applies only to private insurance, rather than Medicare and Medicaid, and it is likely to be bogged down quickly in litigation over issues such as proper rule-making procedures, freedom of speech, and trade secrets, but it represents a major attempt at providing information to patients.

But behind the outrage over pharmaceutical profiteering and the technical rule-making lies a pressing question: What, exactly, is the price of a drug?

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At first glance, that may seem like an obvious question. In the world of prescription drugs, however, price is a murky term. Drug companies are often maligned for the headline-grabbing list prices they charge. But they argue — and rightfully so — that the list price does not necessarily reflect the price of an individual drug purchase. Although patients may pay for a drug based on the list price, drug companies argue that the true price is lower because drug companies shell out rebates long after a patient has completed her purchase.

So what is the amount of that rebate? Drug companies won’t say — not even to auditors and regulators. In fact, researchers and regulators have struggled mightily to determine post-rebate prices. Drug companies refuse to disclose that information, arguing that rebates and post-rebate price information are trade secrets.

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Trying to reform the system — or even talk about it — is like shadow boxing.

The strange and shrouded notion of drug price

The “price” of a drug begins in a perfectly ordinary fashion. A drug company sells its product to wholesalers, and the company must report the wholesale price to the federal government. This figure, which must be confirmed by actual sales, is statutorily defined and reported to the Centers for Medicare and Medicaid Services.

The wholesale price, however, quickly sinks into an impressively obscure pool of industry terms: wholesale acquisitions cost, maximum allowable cost, average wholesale price, and more. Many of these terms lack consistent definitions, are not verified, or are not based on actual sales transactions.

In theory, a patient would pay the wholesale price with a small markup for the wholesaler’s profit. That would then be the list price. Yet in many circumstances, the list price is only the beginning. Drug companies offer substantial rebates — not to the patient, but to the patient’s health plan. These rebates are offered as a reward to the health plan if the plan’s patients buy a sufficient volume of the drug, and drug companies can demand to be favored in the health plan’s formulary as a way of ensuring a high volume.

Of course, the patient never sees any of these rebates, at least not directly. Instead, payments are made to middle players — the pharmacy benefit managers that work for the patient’s health plan — and are based on large groups of purchases. Pharmacy benefit managers generally get to keep all or part of the rebate, and any portion passed on to the health plan may be used to lower the plan’s premiums (what a patient pays to enroll in the plan) or for other expenditures. In other words, the actual post-rebate price of a particular drug at a particular moment is impossible to determine.

Even in the presence of rebates, drug prices are rising

This pricing system raises two big questions: How can the government tackle rising prices if no one really knows the extent to which prices are rising or how dollars are flowing through the system? And how can lawmakers respond when drug companies can defend against criticism of rising drug prices by noting that prices are lower than anyone realizes due to rebates — but then refuse to reveal any information about post-rebate prices?

My research has found a way through the impasse. As part of a broader review of the drug pricing system, I analyzed data from the Centers for Medicare and Medicaid Services, following 1 million Medicare Part D patients between 2006 and 2017. This work will be published shortly in the peer-reviewed Journal of Law and the Biosciences.

Since drugs are often dispensed in different dosages or quantities, my research team and I created an average dosage-unit cost for particular drugs in particular years, using data from tens of millions of claims. Consider an analogy from the beer industry: Imagine a 12-pack of Bud Light cans standing next to a single bottle of Heineken. To compare pricing between the two, you need to know the price of one ounce of Bud Light beer compared to one ounce of Heineken beer. We then used other information derived from Medicare data to determine post-rebate pricing.

The conclusion is stark. Although rebates rose, prices rose faster, far outstripping the effects of the rebates. In fact, the average dosage-unit price of branded drugs after rebates rose a shocking 313% across the 12-year study period, from $38 to $157. During that period, the corresponding price for generic drugs barely budged — from $3 to $4 — creating an ever-widening gap. In fact, the difference between generic and after-rebate brand prices rose from $35 in 2006 to $153 in 2017.

Patrick Skerrett / STAT Source: Robin Feldman

Although generics are far less expensive than brand-name drugs, the study found that they are they are increasingly disadvantaged in health plan formularies. Formularies determine which drugs a patient’s insurance plan covers and at what copay or co-insurance cost. In theory, cheaper drugs should be placed on lower tiers, where patient costs are lower.

Between 2010 and 2015, however, my study found that the percentage of generics on the lowest tier of formularies fell substantially. The shift to higher tiers creates a considerable burden for patients, given that the average copay triples when a drug moves even from the first tier to the second.

Although understanding the true price of a drug is essential for any reform discussion, understanding the price before rebates is also important. Many people do pay the full, pre-rebate list price, at least at certain times, and some have payments tied to the list price. Specifically, some patients pay full price until reaching a deductible; others pay coinsurance as a percentage of the list price rather than a flat co-pay.

My study also examined pre-rebate prices to understand the trajectory from the perspective of these patients. The trajectory for pre-rebate prices was even worse than for after-rebate prices. Between 2006 and 2017, the average dosage-unit price increased 426%, rising from $42 to $221, as the price of generics remained essentially the same.

It’s important to note that the study did not examine how rebate dollars that are returned to the health plan — as opposed to those retained by pharmacy benefit managers — might flow back into overall costs in the system. There is some evidence that rebates help defray patients’ premium costs (their cost of enrolling in a health plan). Fully understanding the flow to health plans would require determining how much money goes toward premium reduction as opposed to executive pay or other expenditures, and how these flows affect premium payments among different types of patients.

For example, to the extent rebates reduce premiums, scholars have pointed out that they may actually shift cost burdens away from healthy patients and onto sick patients. Insurance is supposed to operate in the opposite manner, spreading the impact of a burden away from the party experiencing the burden and across a larger group, to soften the blow.

Embracing true price information

An unruly problem demands a disruptive solution, and therein lies the startling recommendation arising from this research. Knowing the true net price isn’t necessary for restoring sanity to drug pricing. The solution is to make list price the touchstone reference for drug pricing throughout the supply chain.

Focusing on the list price eliminates the need to ferret out and decipher complex deals. It also avoids the practical problem of navigating around parties’ claims that trade secret law protects net price information. Using the list price also has the beneficial side effect of removing incentives for the rebate and quasi-kickback games that drug companies use and pharmacy benefit managers demand.

Despite widespread recognition of the problems related to drug pricing and access, complex legislative and regulatory reform attempts have failed. In contrast, a simple congressional, regulatory, or even presidential mandate that government programs use list prices for formularies would sweep aside the incentive for playing the rebate game. By doing that, the price — and its implications — are already set, and the information is fully available. The price is the price.

Robin Feldman is professor of law and director of the Center for Innovation at UC Hastings Law in San Francisco and author of “Drugs, Money, and Secret Handshakes” (Cambridge University Press, March 2019).

  • Excellent article. All physicians need to get involved in efforts to reduce prescription drug costs as these prices affect all patients. What is being done by Medical Specialty Organizations and the AMA? It is essential that we all get involved in this dialogue.

  • PBM’s, which should arguably be afforded a far less permissive regulation than they currently enjoy, add nothing to the healthcare delivery chain but cost. They exist solely to get insurers a 30 point rebate, and pass a fraction of the savings to patients (I believe the author refers to these as ‘flows’, which would be more aptly regarded as ‘trickles’). It’s a matter of where you want the profits to go: Innovators that work to make treatments safer and more effective (biotechs/manufacturers) or PBM’s/payors, who realize profit from how frequently and consistently they can denying access to physicians and treatments. Advances in efficacy and tolerability are worth the additional cost, while indirectly paying and receiving no tangible benefit from a middleman are not.

    Also, in a vacuum it’s a bit gauche to refer to a recommendation arising from research as ‘startling,’ especially when that conclusion is really nothing new nor one that respectably admits to its own limitations.

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