It Is The Policy Of The United States Government That We Do Not Negotiate With Prescription Drug Prices

First, I must apologize for the delay in posts in the last few weeks. I recently moved into a new house and things have been a bit hectic. Mea culpa.

The other day I received a comment to my post entitled Lisa Simpson and Prescription Drugs (if you have not read it yet I would recommend doing so be fore continuing).

It was well argued and used data to support its assertions, however, like so many other arguments of its nature, it fails under closer scrutiny. For this reason I'd like to take some time to respond. Please read the following comment:

July 24, 2008 3:30 PM

Anonymous said...

"Abroad, prescription drug companies are forced to contend and "negotiate" with socialized medical systems, which in turn impose price controls as the cost of access to their markets..."


...as opposed to in the US, where the PDIA legislation prohibits medicare for negotiating with drug companies for prices, which leads to massive profits for the companies and massive losses for the taxpayers.

...

"Dedicated to the idea that freedom, choice and COMPETITION represent the best prescription for healthcare reform."

Right.

The fact of the matter is that prescription drug companies enjoy some of the largest profit margins of any industry and do not plow as much of the profit back into R&D as some other industries, and not nearly as much as their PR campaigns would have you believe.

Consider Pfizer as an example. In 2008, this company reported 5-year average R&D expenses equivalent to less than 16% of revenues (and something like less than 40% of what they reported as net income.)

Their 5-year averaged profit margin is around 85%.

How much of that profit is drawn from non-negotiated prices charged to medicare (i.e., an opportunity cost to my bank account, and yours, and your neighbor's...)?

I'm sure you're aware that most other industries hover around 10 or 15% PM. (Other entities in healthcare, such as hospitals, operate on less than 5% PM, although they're frequently not responsible to shareholders.)

It seems that the high cost of R&D for prescription drugs is drastically overrated...

...just like your blog.

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This line of reasoning makes a number of fundamental errors in it's approach.

First and foremost, the author makes the assumption that there is some "appropriate" level of reinvestment that drug companies should put towards research and development (R&D). The author provides figures for the pharmaceutical industry versus others and determines that the former is far too stingy when it comes to R&D.

Unfortunately, this is not something that any outsider can adequately assess. The market for pharmaceuticals, like nearly every other sect of healthcare, is terribly convoluted. Given all the variables involved (patent law, foreign markets, FDA approval trials, etc.), it would be difficult if not impossible for anyone not directly involved in the process to determine the marginal utility of any increase in R&D. Drug companies want to make a profit, and the development of newer and better drugs at lower prices is a surefire way of getting there.

Similarly, and contrary to the author's assertion, the Medicare Modernization Act of 2003 (MMA) did not write a blank check to pharmaceutical companies as the price of refraining from "negotiating" prices.

First, it must be remembered that the government does not, and has never, "negotiated" a price, for anything. The government sets prices. This is apparent in the Medicare FFS program, in which prices are bureaucratically set by CMS via a statistical algorithm, the Resource Based Relative Value Scale (RBRVS). There is no negotiation involved with physicians or hospitals. Every year prices are set for more than 7,000 procedures and providers are given a simple choice: take it or leave it. Furthermore, every year these prices are under threat of being cut so that Medicare spending can keep in line with the Statistical Growth Rate (SGR). The problem has gotten so bad that more and more doctors are refusing to accept new Medicare patients, creating access problems for our nations elderly. Does the author suggest we do the same for drugs?

A fundamental rule of economics is that price controls lead to shortages. Price controls for Medicare FFS are leading to a shortage of physicians, would the author be shocked when "negotiated" prices for drugs led to a shortage of prescription medicine, or foregone innovation in the future?

MMA is far from perfect, but it did introduce a complex system based on a simple premise, one far superior to the methodology of Parts A and B, which are notoriously inept at controlling costs: competition, even if it is limited, works better than government control.

MMA allows private companies to compete to get the lowest prices, often lower than drug companies would give if they had to set a single price, meaning that it is likely that the government could not do any better even if it were given the authority to "negotiate" prices. This view is shared by both CMS actuaries and Sec. Leavitt.

Currently there are more than 30 million seniors enrolled in Part D, with over 80% satisfied with the plan they chose. Furthermore, premiums are almost 35% lower than Congress initially expected, with seniors saving up to 72% on their drugs compared to those without coverage.

Many individuals have the mistaken belief that the reason prescription drugs cost so much is simply because we do not set prices as is done in other countries. The truth is far different.

The unbridled demand for pharmaceuticals due to cost insulation stemming from either Medicare or employer based insurance has lead to massive cost increases over the years. Similarly, that Americans are footing the bill for those countries that set prices is another reason for our higher costs.

Is the latter fair to Americans? No, but giving the government the power to set prices for prescription drugs is not the answer.