What Can Be Done About Skyrocketing Drug Prices?

The American government and even major insurers actually have a lot of levers they can pull to lower drug costs – but do politicians, insurers, and employers have the courage to try?

The drumbeat of overpriced-drug stories has been continuous in America of late, from Martin Shkreli’s 5400% price hike last year, to the recent price hike and subsequent backpedaling of Mylan with respect to the EpiPen. With growing outrage over skyrocketing drug prices, it’s worth asking – what can be done about it? Drug pricing is not subject to typical market forces since a new drug often has exactly 0 direct competitors – enabling a drug company to set virtually any price. New cancer drugs often start list pricing at $300,000 per year, while groundbreaking new Hepatitis-C treatments like Gilead’s Sovaldi started out at $84,000 for a short term (curative) course of treatment. Insurance companies (and major employers) have been unwilling to say no, swallowing each hike and passing it on in higher premiums. Medicare, Medicaid, the VA, and other public entities have been banned from negotiating prices, leaving them powerless to get a better deal for those receiving care through their programs. Here are a few ideas on how to break the logjam, in order of increasing potential savings:

1. The Anti-Monopoly Approach

Making drugs, and in particular so-called small molecule drugs, is actually both inexpensive and easy. The primary protection that drug makers use to enforce their monopoly position on new drugs is the patent system. While this arguably makes sense for new drugs, what about long-generic drugs? In recent years certain drug companies (e.g. Valeant) began specializing in buying up the manufacturers of old drugs and immediately hiking prices. After gaining a monopoly position it became easy to hike prices by 50-100% per year and extract huge profits, while new entrants were stymied by
the FDA approval process required to certify the efficacy of their drug version. Why not streamline the FDA approval rules for generic drug manufacture? If a drug is tested and shown to be chemically identical, how much further testing is really necessary?

Alternately, the Department of Justice or FTC could bring suit to halt acquisitions which would leave zero competitors in the market for a generic drug. Special pharmacies called compounding pharmacies are also capable of making many drug compounds. Why not
allow compounding pharmacies to compete across all generic drugs, or specifically contract with them to make generic equivalents for the VA system or Medicaid system?

2. The “Title IX” Approach

Private American colleges and universities are not actually required by law to provide equity in women’s sports, or to follow any of a wide range of Department of Education edicts. The catch? In order to receive federal funding, institutions of higher education must comply with these rules. Since virtually all colleges make use of varying forms of federal assistance, they fall into line.

The American pharmaceutical industry does very little original research – most innovations originate in the university system, and most of the research funding (over $21B per year) comes from the National Institutes of Health [1]. The American government could utilize this lever to strongly influence drug pricing. Pharmaceutical companies might be required to adhere to certain pricing guidelines if they wished to license research originating from NIH funding.

Those guidelines might require drug makers to release drugs into the generic market on an accelerated timeline, for instance. Or the rules might require that drug makers adhere to a value-based pricing approach, as described further below. Drug makers could be required to pay a tiered tax on drug sales to fund NIH research – a tax of 25% on prices above $1000/patient/month and 50% above $4000/patient/month could simultaneously fund future research and encourage drug makers to keep pricing down. The advantage of the “Title IX” approach is that it preserves the liberty of drug companies – if they don’t want to conform with the rules, they can simply do their own basic research. Fiscal conservatives might find this approach palatable as it directly charges users (drug companies) for the government programs they use, and lowers the deficit in the process.

3. The Value-Based Approach

If insurers and government buyers (Medicare/Medicaid/VA) all insisted on paying for value, pharmaceutical companies might be compelled to go along. How do you define value? The UK’s NICE measures the efficacy of medical treatments by attempting to measure the number of “quality-adjusted life years” provided by that treatment. If a cancer drug postpones death by 2 years on average, and has mild side effects, then it can be said to provide 2 years of QALY. The NIH takes this a step further by quantifying how much it will pay per QALY (currently around 25,000 pounds per year), and it sets prices
on drugs using this approach.

American buyers could emulate this approach by offering to pay for measured improvements in outcomes. If a new cancer drug extends life by 2 years, but existing cancer drugs extend life by 1.5 years, then the value of the new drug is an additional half-year of life. Drug buyers could offer to pay a premium for the new drug based on this degree of improvement, and no more. Buyers could also use this as a way to foster competition between older and newer generations of drugs. The older drug is 75% as effective, so it can be placed into competition with the new drug, but at a discount. Express Scripts took this approach in the Hepatitis-C market and was among the first buyers to find a way to push back against Gilead’s $1000 per-pill asking price for Sovaldi.


As long insurers are happy to pass rising costs along in the form of higher premiums, and American politicians remain beholden to the pharmaceutical lobby, nothing will change. But the ideas outlined above show that America doesn’t need European style price controls to break the drug price spiral – a combination of relatively small policy changes and insurers’ willingness to negotiate are all that is required.


[1] This article investigates the breakdown of basic pharmaceutical research in detail, and concludes that big pharma companies contribute less than 25% of research dollars in the US, with most of the balance coming from the NIH.

Fix Healthcare.gov by turning it into Turbotax

Go to www.irs.gov. Look for the File Now button to file your taxes. You’ll find a list of options for filing, including software companies providing tax filing web sites and software. The IRS makes fillable online tax forms, and the instructions for completing them – so why not cut out the middleman and deliver a free irs.gov tax filing portal? Healthcare.gov is just the latest answer to that question – the government has a poor track record of delivering technology solutions, with IRS, FBI, and DHS systems as just a few examples of failure [1].

The department (Health & Human Services) managing the Obamacare rollout should take a lesson from the IRS: if you set the rules, and let the private market deliver the software, you can offload the expense and risk of technology development while still receiving the benefits of automation. Turbotax and its competitors receive not one dime from the IRS, and yet have taken a huge share in the multi-billion dollar tax filing preparation market. In addition, these companies have agreed to give their software away for free to low-income individuals, eliminating any criticism on fairness or access grounds.

Healthcare.gov could easily move to the same model, and here’s the crazy part – several companies, including eHealthInsurance.com and GetInsured.com, already have healthcare exchanges certified to sell ACA plans WITH subsidies! While any licensed insurance agent (including websites) can sell ACA-compliant policies, a handful have built out their technology to work with the federal government and provide access to subsidized ACA insurance. Rather than competing with these firms, Healthcare.gov could terminate many of its bloated IT contracts and simply list certified private exchanges on its site. These exchanges would provide a free shopping experience for consumers, and earn a commission on policies sold in a manner similar to the financing system for healthcare.gov itself [2]. Let HHS & CMS employees set and administer the rules of the ACA, and leave the exchanges themselves to the private sector – leading to benefits for taxpayers and health insurance shoppers alike.

[1] This paper found that 70% of government-run software projects failed to meet stated objectives. Government contract reform has become a hot topic as a result of healthcare.gov’s failure, but these problems have been going on for years.

[2] The ACA exchanges will charge insurers 3.5% of each policy premium sold on exchanges to finance the marketplace. While this “user fee” is lower than the commissions many private insurance brokers receive, many would likely still jump at the opportunity given the size of the new market on offer (perhaps 7 million individual policies through 2014).

Lowering Healthcare Costs: Supply and Demand

Most discussions around healthcare these days focus on covering all Americans, and on lowering healthcare costs. President Obama has recently focused on the second issue, noting that ballooning healthcare costs could cripple the federal government’s finances and kill economic growth. But how can healthcare costs be reined in? In the partially private US healthcare system, prices are still somewhat subject to the law of supply and demand. Healthcare prices (and therefore costs) can thus be lowered by either reducing demand or increasing supply. Here’s a quick list of ideas:

Increasing Supply:

1. Increase the number of medical professionals. Unemployment among healthcare professionals remains near 1%, far lower than any other field. Increasing the number of medical, dental, and nursing school seats in the US will increase supply over time, creating more balance in the healthcare work force and driving down wage increases.

2. Shorten the length of medical school. Doctors in the UK and other countries finish their medical education in six years or less before going on to training programs (residency), while US doctors spend eight years between college and medical school. Accelerated six year medical programs exist in the US, and there is no evidence that their doctors’ education suffers as a result. Shortening medical, dental, and pharmaceutical programs to six years will increase the supply of practitioners, and decrease the starting salaries they demand since their schooling and debt burden are lower.

3. Doctors aren’t needed for routine healthcare. Nurse practicioners, midwives, pharmacists, and other medical providers can provide much of the routine care needed. National laws (or at least guidelines) making it easier for these practitioners to do their jobs will further increase the supply of qualified medical professionals, driving down prices.

4. Warranties on Medical Care. While pay for quality has been heavily discussed, it is quite difficult to measure and implement in practice. It’s far easier to require warranties on procedures, so that medical providers must provide care free of charge when issues as a result of mistakes during a procedure. Medicare could put this in place, incentivizing the industry to move towards higher quality.

Decreasing Demand:

1. Measure cost effectiveness of treatments within Medicare. As long as Medicare pays for healthcare by quantity, without any regard for cost-effectiveness, expensive and marginally effective treatments will continue to drive health care inflation. Patients should be given the option to pay for treatments that are not cost-effective, should they desire.

2. End employer health care tax deduction. As I’ve previously discussed, this $250B+ subsidy inflates demand, causing price increases for all, including those without insurance. Removing this subsidy would decrease health care spending by up to 10% [1], and could provide funding for other initiatives including universal health care or deficit reduction.

3. End tax breaks on medical goods and services. Sales taxes are generally not levied on healthcare products like the $285B pharmaceutical industry, providing them with a $20B subsidy relative to other goods [2]. Property taxes and income taxes are not collected on many not-for-profit hospitals, though some generate significant income and serve very few uninsured patients. Ending these subsidies would further reduce demand and prices.

4. Enact consistent end-of-life guidelines for Medicare. 27% of Medicare spending (almost $100B) is incurred for patients in their last year of life. While higher costs towards the end of life are expected, there are wide variations in spending in different regions of the US. Enacting a consistent set of guidelines which emphasizes palliative care would help decrease end-of-life healthcare demand.

Why doesn’t this list mention the approaches typically touted like electronic medical records, administrative efficiencies, and the like? Unfortunately, while efficiency improvements would result in one-time reductions in cost, they would not change the supply-demand fundamentals of the US healthcare delivery system. The solutions mentioned above would address these issues, creating permanent decreases in healthcare costs while potentially expanding availability.

[1] $250B is slightly more than 10% of healthcare spending in the US today, so eliminating this subsidy would reduce spending by that amount at most. In practice, the reduction would be somewhat less, since falling prices would cause some offsetting increase in healthcare consumption.

[2] Assuming a 7% sales tax (most states’ sales tax is higher), 7% of $285B is roughly $20B.

US Healthcare – Where does all the money go?

The Census Bureau recently released the results of its 2006 Services Industry Survey, which shed light in particular on where US healthcare dollars are spent:

Census Bureau Press Release: “Doctors and Dentists Account for 27 Percent of $1.6 Trillion in Health Care Revenue”

Full tabular data on US healthcare spending in 2006

The second link provides some detail on where US health care spending goes. It’s worthwhile to note that $117 Billion in Social Assistance is included, with line items like children’s daycare, community housing assistance, and other rolled into the overall Health Care and Social Assistance category. Without Social Assistance, health care spending is actually 1.45 trillion, or 11% of US GDP.
Read the full entry (500 words) …