Drug price controls save the federal government money, but not necessarily consumers

[This piece has been published in Restoring America to highlight how a drug pricing proposal being considered by Congress might actually hurt consumers in the long run.]

While proponents of the prescription drug pricing proposal under consideration may position it as a benefit to consumers, the policy will not offer significant savings for many and may drive up costs to the coming. This encourages higher prices for new drugs and can crowd out private negotiation for lower co-payments. Moreover, it goes against other policies aimed at encouraging investment in medicines that can improve life at a lower cost compared to other types of health care. While not necessarily helping consumers, this policy will ensure government savings and a political victory.

First, consider how the federal government’s price “negotiation” compares to current price negotiation between drug companies and insurers offering coverage in Medicare Part D. Drug companies give insurers discounts in contracts forms for lower co-payments or fewer hurdles such as pre-authorization. Under the price controls under consideration, the federal government sets a price according to a formula that expands as the drug ages, there is no need to place the drug at a favorable level of the formulary.

So, consider drug A with a list price of $600 per month and the drug company offers a 30% discount, or $180, for the preferred form and the consumer pays $42 per month (the average preferred co-payment for PDPs). The pharmaceutical company is offering this discount as more people have affordable access to the drug and sales are increasing. The health plan uses discounts strategically, including reducing co-pay and premiums to attract more consumers to increase business.

In the proposed policy, the federal government can set a price for drug A of $300. If the pharmaceutical company chooses not to offer the $180 discount for the less valuable drug, the insurer facing the loss of this contract will move drug A to a non-preferred formulary where the patient pays 40% (the average coinsurance not preferred for PDPs) or $120. Consider that the policy also limits price increases. A new drug, drug B, which treats the same condition as A, can launch at $650 and offer a $350 discount and get Medicare formulary preferred placement for that big discount with a $42 copayment, but for the most expensive drug.

In addition, the policy diverts investment away from the drugs that generate the most savings. It places price controls among the top-selling drugs in Medicare after nine years in the market for chemical-based pills and 13 years for complex biologics, which are often injectable. Because it reduces revenue from small molecule drugs after a shorter period, the policy makes complex drugs a relatively more favorable investment. Small-molecule generics, which are typically launched about 12 years after the original, are the biggest generator of drug savings, other than better health. This is a unique feature of these pills, consider that although in the not too distant future there will be several generic pills that will cure over 90% of hepatitis C, there will never be generic liver transplant.

Not only do small molecule generics create billions in savings for insurers and funders like the federal government, but health insurers also often make them available to consumers for a few dollars. But this policy discourages the development of small molecules compared to biologics, which have a longer period without price controls, tend to be more expensive, and don’t experience the same degree of savings after patent expiration. In addition, by lowering the brand price for price-controlled drugs, this policy discourages entry of end-of-patent generics because it is difficult to compete with a low-priced brand, the gap between the brand price and the generic price is what creates this incentive for generics to enter the market, especially right after patent expiration, when there is a big financial price for early entrants.

Second, this policy discourages investment in new indications for existing drugs whose prices are likely to be controlled. Although some criticize expanding the use of a drug beyond an original intent, particularly when the drug has been granted orphan status, it is much faster and cheaper to develop an existing drug for a new indication rather than developing a completely new drug. But this policy discourages post-marketing study by reducing profitability near the life cycle.

Additionally, the policy excludes some smaller biopharmaceutical companies from price controls, meaning they may retain more value if they do not integrate with larger biopharmaceutical companies. This can increase costs for small businesses that would need to develop a commercialization infrastructure that typically focuses on research and discovery.

So, if this policy is implemented, consumers might see a significant change in what they spend on drugs today and tomorrow, but not in the direction they expect.

This article originally appeared in the AEIideas blog and is reproduced with the kind permission of the American Enterprise Institute.

James V. Hayes