Why are prescription meds getting more expensive?

The cost of prescription meds are notoriously confusing. Not only can the price of a drug cost different amounts across multiple health plans, but it’s not uncommon for life-saving medications to cost hundreds. So why is that?

Research and development of drugs can be a costly affair, and in recent years, pharmaceuticals have stepped up how much money they’re putting into the development of new drugs. Take this one study:

These figures likely exclude other situations where a larger pharmaceutical company may acquire another company or buy the rights to a drug, which even though it brings up concerns of market concentration, likely incurs a pricey up-front cost.

On one hand, it is reasonable to expect a drug manufacturer to not want to make a net loss on an investment of millions of dollars. Why would any manufacturer invest so much if the sales of said drug would not be able to at least break even? However, assuming that’s the full picture is taking the word of lobbyists too far.

There’s more to the world of drug pricing than corporate greed on the part of drug manufacturers, but addressing it is important to see the big picture.

During the 1980s, corporate leaders, and even many economists, adopted the idea that the sole purpose of a company is to maximize the earnings of shareholders, which for publicly traded companies equates to raising the share price.

The past several years have seen newer business leaders denounce this understanding of shareholder value maximization, however, this understanding of corporate thought explains some decisions made by large pharmaceuticals.

A House Oversight Committee in July 2021 found:

For those unsure of what those terms are, dividends are earnings distributed to shareholders by a company while buybacks are when a company buys its own shares on a public market. Both have the effect of raising share price. Higher dividend payouts serve as an incentive for investors to buy shares of a company while buybacks can serve as an upward demand-side push on the price of the stock.

In the context of such practices, it makes more sense why a drug manufacturer obsessed with the well-being of its shareholders may jack prices to rake in profits.

Shareholders over all else doesn’t really tell the full picture either. Jacking prices for manufacturer shareholders does not explain why pricing is so varied across health plans. Here’s the other thing. If your insurer is supposed to be helping cover the cost of these drugs, why are out-of-pocket costs rising? If the insurer takes on higher drug prices, then maybe the premiums should be increasing, but instead a lot of this is being off-loaded immediately onto patients in co-pays and co-insurance.

The part of drug pricing that most directly affects patients must be at some point after the manufacturer. It doesn’t excuse manufacturer greed, but instead conveys that financial incentives are worsening an already bad situation.

Behold, new health industry jargon!

Health insurers, like private plans, employer-insured plans, and even many federal and state-level health plans (including Medicare), have to come up with ways to offer coverage for drugs to their plan members. What drugs are covered? How much does insurance cover? How much is the out-of-pocket cost? Questions like that are typically answered in what is called a formulary.

Let’s slow down, what’s a formulary? A formulary is a tiered list of drugs that an insurer will cover. A higher tier drug is what the insurer prefers that a patient uses, and thus, insurance covers more of it. For lower-tier drugs, patients pay a higher co-pay or co-insurance to disincentivize getting these drugs, and for drugs not on the formulary, the patient has to face the full list price of the drug.

Health plans typically contract out pharmacy benefit managers (PBMs) to negotiate the contents of the formulary with drug manufacturers and even retail pharmacies. With retail pharmacies, the PBM may negotiate discounts on the list price of the drug. With the manufacturer, the drugs are placed on the tiers according to how much a manufacturer pays in a rebate to the PBM.

Why would the manufacturer pay to get their drug on a formulary? Well, if their drug is expensive to patients by either being low on the formulary tiers or not on it at all, then the sales of the drug will be low.

While PBMs claim to create large cost savings for patients and their clients (health plans), there are a number of conflicting pieces of information.

For one thing, pharmacies, manufacturers, and insurers are not allowed to disclose the difference between the list price and the final negotiated price on the formulary. So, there is no ability for the market to correct itself when PBMs price in a predatory manner, because no one really has an easy way of figuring out what other plans are paying. Then, we also have the great market concentration of the industry.

PBMs also get a good deal of their revenue from drug manufacturer rebates. Take this quote:

Especially in a market where price transparency is virtually non-existent, PBMs can demand higher rebates from manufacturers to get desired placement on the formulary. Pressures for higher rebates are supposedly a significant cause of increases in drug prices faced by patients.

In response to a question about rising insulin prices during a 2019 Congressional hearing, Eli Lilly SVP Mike Mason claimed

The same hearings where Mike Mason made the 75% claim about insulin costs were marked with bitter disagreement between PBM and pharmaceutical representatives. The two groups offered different policy proposals to address rising prescription drug costs and essentially went to playing the blame game on each other.

It may seem hopeless, but there are critical steps to be made that can help at least de-tangle the complexity of root causes for rising prices. For one thing, expanding transparency throughout the drug supply chain is crucial for informing the public and policymakers.

As with many other areas of the healthcare space, introducing simpler systems for drug pricing would likely drive down costs by itself. Why deal with middlemen when it would likely be cheaper for manufacturers to directly work with insurers or if manufacturers set prices that patients could more easily take on out-of-pocket.