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.

Conclusion

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.

How Much Will Insurance Cost Under Obamacare?

May 28, 2013 Update: California’s just-released prices for ACA coverage are close to my 2012 estimates, with an unsubsidized bronze plan (for a 25 year-old) available for $142/month in Los Angeles.

Health insurance premiums for minimum coverage will likely be around $150/month for 27 year-olds under the ACA, since the ACA includes relatively high-deductible plans under the Bronze plan option.

Now that the dust has settled on the Supreme Court ruling, let’s attempt to answer a simpler question – how much will health insurance cost under the ACA (Obamacare)? Individuals purchasing health insurance via the new health insurance exchanges will be able to select from four plan levels: bronze, silver, gold, and platinum. The law dictates that plans falling into these categories must have 60%, 70%, 80%, and 90% “actuarial value”, respectively. The concept of “actuarial value” dictates that the plan must cover the specified percentage of health care costs for enrolled individuals. Individuals enrolled in a bronze plan can expect their insurance to cover 60% of their health costs, for instance [1].

The Kaiser Family Foundation commissioned a study to determine the structure of plans that might meet the 60% actuarial value standard for the Bronze plan.  The study found that the following individual health care plans might qualify (all plans have a cap of around $6350):

  • A plan with a $6350 deductible and 0% coinsurance
  • A $4350 deductible with 20% coinsurance
  • A $2750 deductible with 30% coinsurance

How much would plans like these cost in 2014? We will focus on adults aged 27 in this example, since young adults more frequently go without insurance, and since young adults can now stay on their parents’ plans until 26. We can shop online for similar plans and get some results for comparison [2]:

  • $67.26 for a $2750 deductible / 30% coinsurance plan in Atlanta for a 27 year-old male
  • $98.21 for a $2750 deductible / 30% coinsurance plan in Atlanta for a 27 year-old female [3]
  • $129 for a $2750 deductible / 30% coinsurance plan in Silicon Valley for 27 year-old men and women
  • $73.22 and $95.07 for a $2500 deductible / 20% coinsurance plan in Chicagoland for a 27 year-old man and woman, respectively
  • $95 for a $2750 deductible / 20% coinsurance plan in Houston, TX for a 27 year-old man
  • $132 for a $2500 deductible / 10% coinsurance plan in Houston, TX for a 27 year-old woman
  • $70.75 and $90.46 for $2500 deductible / 20% coinsurance plan in Hartford, CT for a 27 year-old man and woman, respectively

Here are two market quotes for 63-year old females in relatively expensive markets:

  • $302 for $1200 deductible / 10% coinsurance HMO plan in New York, NY for a 63-year old woman
  • $516 for $3500 deductible / 10% coinsurance PPO plan in Santa Clara, CA for a 63-year old woman

The ACA stipulates that the most expensive policies for older individuals can be no more than 3 times the price of policies for younger adults. The data above show that a 27-year old can get a plan similar to the exchange bronze plan for around $100 per month today, but this is less than 1/3 the cost for older Americans. Using 1/3 of the cost of the plans for older women as a price floor, we get an estimate of $150 per month as the lower limit for plan prices [4].

This estimate is lower than the commonly-cited CBO estimate of $4500 per individual for bronze plans via the ACA exchanges. The CBO estimate is for 2016, and so it builds in two additional years of premium inflation (roughly 15%). The CBO number is also an average across all age groups – since young adults’ plans can cost 1/3 as much as the oldest (non Medicare-age) Americans, 27 year-olds’ plans will be much cheaper than the average. While the ACA should have allowed for more high deductible plans, it’s good to know that the bronze plans do provide for some affordable coverage options within the new health insurance exchanges.

[1] The 60% bronze plan threshold and other thresholds are applied to each plan considering the average expenditures for plan members. Given the deductible and copay structure of a particular plan, it’s possible that the plan spends a higher (or lower) percentage on a particular individual’s care. For instance, if you don’t use your plan at all in a given year, then your plan spent 0% on your care. At the other extreme, if you are diagnosed with cancer, and incur $100k in costs in a year, even a bronze plan would cover  perhaps 90% of that amount.

[2] All plans were found on ehealthinsurance.com on 8/2/2012.

[3] The wide discrepancy between plan prices for men and women will be eliminated by the ACA. For these purposes, averaging men and women’s prices enables us to get closer to a representative price under the ACA.

[4] Since health insurance is more expensive for women, and more expensive for older Americans, we used a 63 year-old woman as the prototype for an expensive risk in the existing private health insurance market. At age 65 virtually all Americans gain entry into Medicare (or Medicaid for seniors), and so 63 is the oldest age for which insurance quotes can reliably be obtained (some insurers won’t write short-dated policies, and no insurer writes non-Medicare policies for 65+ Americans). The average price from the two expensive quotes thus obtained was $409. After adding in 10% in premium inflation between now and January 2014, we get a premium estimate right around $450 per month. By law, one-third of this is the minimum that the exchanges can charge for any adult – and this equals $150 per month.

A One-Line Fix For Medicare Spending

My one-line Medicare / Medicaid spending fix:

Medicare should continue to pay 80% of health care costs for recipients’ care below $40,000 per calendar year, but should pay only 50% of health care costs above $40,000 per calendar year.

With the ongoing debt-ceiling debate and political discussions over how to cut spending dominating discourse, I thought I’d chime in with a simple plan to fix America’s long term budget crisis. The majority of America’s future budget deficits are a result of runaway growth in health care spending, despite reductions in Medicare spending put in place with the recently passed health care reform. Paul Ryan and other conservatives propose to fix this by ending the Medicare program, and replacing it with an insurance-voucher scheme. President Obama proposes to control cost growth through the IPAB, a board with the power to control Medicare reimbursement policies.

My plan is far simpler than either, and will preserve Medicare as it exists today for 90% of recipients. How does this plan work? Kaiser Foundation research shows that 90% of Medicare recipients receive less than 40k per year in health care. The remaining 10% of recipients actually spend 60% of the Medicare budget. The proposed change would require these recipients to either shoulder more of the cost of expensive treatments, or to utilize less expensive treatments. Note that Medicare would not leave any recipient high-and-dry, but it would require even cost sharing for expensive treatments.

When faced with higher cost-sharing, many Medicare recipients would opt not to receive the newest cancer drugs, or the latest titanium hip replacement. It’s also quite likely that when faced with this two tier reimbursement structure, many health care providers would change treatments and pricing to stay competitive within the new structure – there’s evidence that today, health care providers charge Medicare what they do simply because Medicare will pay.

How much money would the proposed change save? Assuming that most spending above the $40k mark is eliminated [1], then Medicare and Medicaid might save $200B in the first year alone. This kind of change would also reduce health care cost inflation, since high-cost care would be curtailed significantly. It’s quite likely that this change would completely eliminate Medicare’s unfunded liability, without changing the program significantly for the majority of beneficiaries. But clearly this is too simple and non-ideological a change to stand a chance [2]!

[1] According to CMS, in 2011 total Medicare and Medicaid spending will total $1 Trillion. If my proposal to cut government cost sharing to 50% above 40k eliminated most spending above the 40k line (since many Medicare patients would not be able to pay their increased share above 40k), then the federal government would save half of the money expended above the 40k line. In 2006 the average expenditure for the high spenders in Medicare was $48k – in 2011 this would likely be over $60k per year with inflation and cost growth totaling 5% per year. Assume that the entire 20k per year above the 40 line were saved from using a resume builder online – that would mean that the high spenders’ health care expenditures would be reduced by 33%, reducing total government health care expenditure by 20% (one-third of the 60% spend on these expensive patients).

[2] I should note that this plan would leave some patients with expensive conditions to make difficult choices. By ending the endless spigot of government health care money, 10% of current beneficiaries would have to decide whether they could afford to have certain expensive procedures. But patients, not regulators, would be able to decide – the patients would simply be required to pay an even share for expensive treatment.

[3] In actual implementation, such a plan would have to be phased in. For instance, Medicare could initiate a 1 percentage point reduction in cost-sharing for each of the next thirty years, gradually moving from 80% to 50% for expenditures over the threshold.

The End of Government Subsidized Medical Innovation

Most Americans don’t realize it, but America’s status as the world’s primary source of medical innovation is heavily government-subsidized. During the healthcare reform debate, many pointed out that America spends over 17% of its GDP on health care, far higher than any other nation, and almost double the average for OECD nations. This high rate of spending on health care has fostered the growth of high technology health care, from pharmaceuticals to biotech, medical devices, imaging equipment and even surgical robots. What would happen if the government were no longer able to spend at such a rate?

Imagine for a moment that America had a purely free-market health care system, with no Medicare, Medicaid, and without tax breaks for health care. The government currently pays for 62% of all health care spending, and without this support, our healthcare system would be much smaller. If a free-market approach to healthcare brought spending down to the OECD average, the US would spend $1.2 Trillion (48%) less on healthcare than it does today [1]. Without Medicare to pay for costly end-of-life care, it’s doubtful that $200,000 per year chemotherapy drugs would find a market, or that anyone would pay full price for replacements on hips implants. In short, a free market health care system would deliver less health care technology to America – though it would still deliver technology that proved itself worthy and affordable to patients.

Of course in the real world government-subsidized innovation isn’t going away – or is it? America’s long term budget problems are driven chiefly by health care spending, as acknowledged by the trustees of Medicare. The Soviet Union eventually went bankrupt by spending 40% of its GDP on defense. The United States is on track to spend 40% of its GDP on healthcare by 2050 [2], with much of that on high tech gadgetry with low marginal benefit, and with virtually all of that money coming from taxpayers. This is obviously not sustainable.

The newly enacted healthcare reform law begins cutting Medicare in earnest, but deeper cuts will be needed to prevent Medicare’s insolvency. These cuts will inevitably mean less spending, and less revenue opportunities for big pharma, biotech, and medical equipment companies. While many other countries already have highly regulated healthcare markets with lower profit margins, pharmaceutical and medical equipment companies have been able to achieve consistent growth by tapping the US market and US taxpayers. Regardless of how healthcare reform plays out, America’s huge and growing debt mean that this situation will come to an end. The golden age of subsidized medical innovation is drawing to a close.

[1] CMS estimates that 2009 health care expenditures were $2.5 Trillion, or 17.3% of GDP. If this were reduced to 8.9%, the OECD average, health care expenditures would be $1.29 Trillion, almost half of what they are today. While we don’t know exactly what US health care spending would be without government subsidies and programs, we do know that government spending and subsidies would drop by roughly $1.3 Trillion ($1.1 Trillion in direct spending plus $200 Billion in subsidies), leaving a number very similar to the OECD average.

[2] See Figure 4 of this CBO Report for long term health care spending projections.

The End Of Employer-Based Health Care?

The employer penalties in the health care law are low enough that many businesses will drop health coverage. This is a blessing in disguise, as it will lower costs in the long run.

The fiery rhetoric on both sides of the health care debate obscured the details of the actual reform bill. Now that it has become law, policy analysts and journalists have been combing through the bill and issuing predictions on whether it will raise or lower premiums, help or hurt businesses, and generally bring or not bring the Apocalypse. The bill will definitely change how health care is paid for in the United States, but perhaps not in the ways many expect. The following analysis shows that it’s possible that the new law will end the system of employer-based health care entirely!

The Kaiser Foundation has produced a nice summary of the law, including employer requirements:

  • Employers with less than 50 employees face no penalties.
  • Employers with more than 50 employees that provide no health care coverage must pay a tax of $2000 per employee (with the first 30 employees being exempt)
  • Employers with more than 50 employees that do provide care may have to pay a tax 0f up to $2000 per employee if  their employees use the new health care exchange subsidies.

Given these requirements, what are an employer’s options?

  1. Drop Employee Coverage: A company drops its health care plan, paying the $2k per head tax and leaving employees to buy their own plans. The company will save $10,000 per employee on average given the average cost of health insurance [1], and will also save by eliminating benefits administration expenses. The company could give each employee a $9000 raise and still increase profit by $500 or more per employee [2]. Employees will be mad about the loss of benefits, but not too mad as they can get coverage on the exchange using their new income and potentially subsidies.
  2. Keep Employee Coverage: The company will face the administrative burden of supplying vouchers to some employees who would like to opt out, of complying with minimum benefits requirements, and will potentially still have to pay $2000 in fines per employee if its health care plan is deemed insufficient. The company’s use of benefits as a recruiting tool will be diminished once benefits can be obtained on the health care exchange.

Looking at the alternatives, why wouldn’t a company drop its health care plan? Particularly for employers with middle-income employees (who may qualify for federal subsidies), it makes more sense to drop health care coverage and raise wages than it does to continue the status quo. While the employer-based health care tax deduction still exists, for many families its appeal will be neutralized by subsidies available in the new health care exchanges. And since all Americans will be guaranteed access to insurance starting in 2014, benefits will no longer be the employment draw that they are today.

The health care reform bill will thus reduce the share of employer-based healthcare in the US market. This is an excellent change for a couple of reasons: first, it breaks the link between employment and health care, providing more stability to all Americans; and second, it slowly weans Americans off the employer health care tax deduction, which contributes significantly to health care cost inflation. Ironically, the bill’s writers did not intend it to be the demise of employer-based health care. But if this trend does accelerate, the bill may be successful in controlling health care costs. [3]

[1] The average employer contribution for a family insurance plan was $9860 in 2009, according to Kaiser Foundation research. With health care inflation averaging above 4% in recent years, this will rise to roughly $12,000 by 2014. If an employer chooses to pay the $2000 penalty rather than buy insurance for an employee, it can thus save $10,000.

[2] An employer could cancel insurance, saving $10,000 per employee, and then give each employee a $9000 raise. Payroll taxes (7.65%) would add another $688 to this sum, leaving a net profit of $312 per employee if an employer took this approach. Benefits administration expenses would also be eliminated, however, and these savings could be significant. Eliminating a single $40,000 salary HR position at a 200 person company would save another $200 per employee, for instance. So a net profit of over $500 per employee is quite possible – the actual profitability of the move would depend on how much of the health care savings the company chose to pass on in the form of higher wages for its employees.

[3] Why will the shift from employer to direct purchased health care coverage lower costs? First, when you spend your own money, you are more likely to be judicious about it. Second, when tax deductions are replaced with tax credits, the cost inflation effect will drop, since a deduction rises with every additional dollar spent, while a credit does not.

What Percentage of US Healthcare Is Publicly Financed?

Public, taxpayer-funded health care spending will pay for for 53% of US health care in 2009. If health care tax breaks are included, this figure rises to 62%.

Of the $2.5 Trillion dollars expected to be spent in the United States on health care this year, what percentage is paid by taxpayers? The Kaiser Family Foundation calculates that 46% of health care spending was publicly financed in 2006, but this number seems to exclude health care for government employees. The Center for Medicare & Medicaid Services collects data on health care spending in its National Health Expenditure survey, which can be used to perform a direct calculation on the government share of health care financing. The following table summarizes the 2007 NHE data, the latest year for which a detailed breakdown is available:

Category Amount (2007 $ Billions)
Medicare [1] 418
Medicaid (Including State Funding) 340
Other Public Health Programs [2] 189
Federal, State, and Local Employee Health Care 134
NIH and FDA Budgets [3] 32
Total Public Spending 1113
All Private Health Spending 1018
2007 Total US Health Spending 2131

The 2007 data show that 52% of all health care in the United States is publicly financed. The NHE data also show that from 1987 to 2007, the government’s share of health care financing has risen by ten percentage points, or about half a percentage point per year. This means that in 2009, the public share of health care spending is likely at 53%, or perhaps higher as a result of rising unemployment due to the recession. If health care subsidies (primarily tax exemptions) are included as government financing of health care, they add another $200 Billion to the total, raising the government’s share of health care spending to 62%.

With the government already paying for the majority of US health care, one thing is clear about the current health care reform debate: The debate is not about whether the government will take control of the health care system, as that has quietly taken place over the last 40 years. The real debate is about how the government should distribute its health care spending, and on whether it will be able to rein in endless health care cost growth.

[1] The detailed NHE data split up by source of payment can be found here:

In calculating the numbers in the above table, I used Table 1 in the pdf. I allocated all costs associated with Medicare to the public sector, unlike the table in the pdf, which counts Medicare premiums and contributions as private sector payments. From a standpoint of determining government involvement in the health care system, it makes more sense to count all Medicare dollars as public financing, particularly since paying Medicare taxes is precisely how most of the Medicare system is funded!

[2] According to the NHE pdf, other federal, state, and local health programs “Includes maternal and child health, vocational rehabilitation, Substance Abuse and Mental Health Services Administration, Indian Health Service, Office of Economic Opportunity (1965-74), Federal workers’ compensation, and other miscellaneous general hospital and medical programs, public health activities, Department of Defense, Department of Veterans Affairs, and State Children’s Health Program (SCHIP)” and “Includes other public and general assistance, maternal and child health, vocational rehabilitation, public health activities, hospital subsidies, and state phase-down payments.”

[3] The NIH budget is $30 Billion, and can be classified entirely as health care spending, though it’s often left uncounted. But isn’t research to cure disease health care spending? If it’s not, then what exactly is it? I have also included two-thirds of the FDA budget, as that is the portion related to drug and medical device supervision.

The Mystery of Health Care Pricing

Many economists, think tanks, and politicians have been agitating for more consumer-driven health care in the US. They argue that if consumers have to spend their own money for care, they will tend not to waste health care resources, and they will shop around for cost-effective care. The first part of this argument appears valid, as individuals will always spend their own money most carefully. Studies have validated this hypothesis, showing that individuals with high-deductible insurance and health savings accounts (HSAs) tend to spend less than those on traditional insurance.

But are individuals able to shop for health care in a competitive marketplace? Personal experience and numerous reports indicate otherwise. In the US, most health care providers can’t tell you the price of any particular health care service until after it’s been performed! I recently shopped around for a health care service, and called four doctors’ offices in total. One office told me that they “aren’t allowed to provide that sort of information.” Two more offices were flabbergasted, and attempted to ease their way out of the conversation. Only one office was able to answer with an actual price quote.

Why is this so difficult for medical providers? Virtually all chargeable medical services have associated CPT Codes, which are defined by the American Medical Association [1]. Hospitals, labs, and most medical practices have a chargemaster, which is essentially a price list. Even small practices without explicit chargemasters know the rate their doctor charges for his time. When insurers and medical providers negotiate payment structures, they negotiate using the chargemaster rates (and usually Medicare rates) as starting points for negotiation.

The currently proposed health care reform plans have missed this essential element: require all health care providers to publish standardized price lists, and market competition can begin [2]. For doctors, a simple hourly rate should be enough to satisfy this requirement. Hospitals and labs should be required to initially publish online price lists for their most common charges, with the list expanding over time. While this information is irrelevant to patients in emergency situations, the great majority of health care spending is pre-planned [3].

Put another way, why not include a mandate on medical price lists as part reform? The cost of the mandate to providers is extremely low, as the information is available, and publishing the information online eliminates distribution costs. While price transparency is making slow progress, Congress has an opportunity to make this happen, and should do so as part of the health care reform package.

[1] The AMA would likely be a primary opponent of free publishing of CPT code-based price lists, since it derives signicant ($70M per year) income from its copyright on CPT codes. If the government is to open up the pricing market, it may have to break this monopoly by buying the copyright at fair value and putting it in the public domain.

[2] Consider a scenario in which all doctors are required to provide price lists. Since most small practices would find this difficult, they might just quote a maximum hourly charge. One surgeon might quote $1000 per hour, and another $2000 per hour. And there you have it, competition on price can begin, just as it occurs for plastic surgery, Lasik, and other out-of-pocket services today!

[3] According to the Kaiser Family Foundation, roughly 70% of health care expenditures are non-hospital expenses. Since many hospital expenses are planned, it appears that significantly less than 30% of health care expenses are emergencies in which consumers have no choice of provider. According to ACEP, only 3% of health care costs are emergency-related.