Opinion

opinion | Sylvia Pagán Westphal

Drug pricing: A new prescription

leo acadia for the boston globe

What would happen if a company invented a drug that, taken once, cured a major disease like diabetes or Alzheimer’s, which affect millions of Americans? The answer: Our health care system could not afford it, even if the drug were priced extremely reasonably by today’s standards (say, $20,000).

That’s the sad realization from the ongoing controversy over who pays for Sovaldi, a hepatitis C drug launched this year by Gilead Sciences and priced at $1,000 per pill, or $84,000 for a 12-week course. The drug has been a budget-buster for health plans, with critics arguing that treating 3.5 million hepatitis C patients with it is unsustainable.

What’s more, Sovaldi is being labeled the canary in the coal mine of excessively priced drugs, with John Rother, CEO of the National Coalition on Health Care, warning of an upcoming “tsunami of expensive medicines that could literally bankrupt the health care system.”

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We definitely need a national dialogue about drug prices, but Sovaldi is not the right poster child for that campaign. The vast majority of the very expensive drugs in our medical arsenal are taken for life and cost thousands of dollars per month. Sovaldi is a one-time charge in the lifetime of a patient, and in almost every patient, it’s a cure.

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A full course of Sovaldi (12 weeks) costs about the same as the full course of the previous therapy (24 to 48 weeks), a fact that seldom gets mentioned. But the previous therapy didn’t work very well, so doctors were not prescribing it much. When Sovaldi came out, insurers were overwhelmed by the demand.

So what the Sovaldi story has crystallized is that our health care system is not well designed to handle cures that are needed for millions of people. Payers are thinking year-to-year, faced with the debacle of paying $84,000 today to cure patients who might leave them tomorrow. The misalignment of interests could not be clearer.

With an unprecedented number of game changers in the industry’s pipelines, we must address the dizzyingly complex issue of prescription-drug prices. Like other aspects of the health care system, this one defies a simple solution. But there are some reforms that should be on the agenda now, including:

 New ways to amortize the cost of treatment over a period of years, almost like a home mortgage, so that insurers can pay up front for the most promising cures.

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 Shifting, where possible, to a system that pays for drugs based on the value they bring. Many pharmaceutical firms would welcome a chance to be rewarded for their game changers while reducing the need to compete over drugs that offer only incremental improvements.

 A reform of Medicaid’s “best-price” rule, which gives the government very advantageous rates for drugs based on the lowest rate negotiated by private insurers. While well-intentioned, the rule is preventing companies from entering into creative arrangements to lower drug prices.

Change is needed right away, because innovative drugs are quickly emerging. There were 36 novel drugs launched in 2013, including 10 for cancer and 17 for rare diseases, the highest number in a decade.

These new treatments come with high price tags. Drugs for rare genetic disorders cost $300,000 to $400,000 per year. Therapies for cancer, multiple sclerosis, rheumatoid arthritis, and HIV, which belong to a category called “specialty medicines,” often cost north of $100,000 per year. These medicines accounted for 29 percent of the $329 billion spent on drugs in the United States in 2013, even though they comprised only about 1 percent of all prescriptions.

It’s easy to point the finger at the pharmaceutical industry for trapping us in a pricing straitjacket — after all, the industry plays the key role of setting the prices of drugs. But a fruitful dialogue can’t begin until all the players in the drug distribution ecosystem recognize how they have contributed to the status quo.

leo acadia for the boston globe
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Drug prices are high because manufacturers operate in a protected environment (via marketing exclusivity from patents), so they get to pick the price for their newly launched drugs. There is a deeply rooted, unspoken mantra that a new drug gets to charge more just because it’s new, and it’s a trend that continues to push prices upwards.

We have a system where the price of a drug has had little correlation with its value.

When challenged, the standard response from the industry is that companies must recoup the costs of drug research and development — a figure that stands at between $1.2 billion and $4 billion per drug. But as is quietly acknowledged behind the scenes, recouping the cost of R&D is hardly ever part of the pricing calculation. “It’s been a shorthand way of explaining to the public that this is a really costly business, but I think it doesn’t serve the industry well,” says Rena Conti, an assistant professor of health policy and economics at the University of Chicago. “R&D costs are sunk, so from an economic perspective they have nothing to do with prices. The truth is the pricing of a given drug is about profit maximization for the company. Some of that money goes into R&D for the next drugs being developed, but not all of it.”

In reality, manufacturers consider factors such as the patient population to be treated and the price of drugs in the same category to get to a price spread. They hire consultants that call insurers to “test the waters” for a drug in a blinded fashion, without revealing the name of the drug or discussing price figures. The goal is to get a sense of how much insurers might be willing to pay. Then it’s up to a top executive to pick a number.

Often, it’s not until the 11th hour before a drug launches that its price is set. Somewhere in that price spread is where fairness ends and excessive profits begin, and it’s not an easy call to make: A CEO’s duty not to leave money on the table is in direct conflict with the desire to make a drug affordable.

On top of that, there are outside pressures that promote high drug prices. A key one is the rest of the world, where most governments place strict price controls on drugs, causing companies to compensate by pricing high in the United States. Then, the many players along the drug distribution chain (wholesalers, pharmacies, pharmacy benefit managers, health plans) also benefit from the status quo.

Drug list prices, says Conti, are like the sticker prices for cars: Nobody really pays them. Wholesalers pay drug makers about 80 percent of a drug’s list price. But once a drug is paid for at the pharmacy counter, the manufacturers often rebate quite a bit of money back to payers.

It’s in these behind-the-scenes negotiations that the biggest downward pressure on drug prices occurs. Rebates negotiated by payers (which are extremely secretive and occur when there are several drugs competing in the same category) bring down the net price of branded drugs to about 73 percent of the list price. By law, Medicaid gets further discounts from what payers get, bringing prices down to between 60 and 67 percent of the list price. A little-known but increasingly common government program called Section 340b can bring the price of key drugs (including some of the most expensive cancer drugs) to about 49 percent of the list price. The US Department of Veterans Affairs gets the best deal of all: It purchases drugs at about 35 percent of their list price.

It’s a system that not only lacks transparency but has evolved to encourage high list prices: Manufacturers keep raising their prices because they know they’re getting squeezed, the middle men (pharmacies, hospitals) make money off the spread between list prices and true acquisition prices, and the payers have generally gone along because rebates eventually bring money back.

Unfortunately, it’s the patient who benefits the least from high list prices. A recent analysis by the consulting firm Avalere Health of more than 600 exchange plans across 19 states found that a large proportion (38 percent of platinum plans, 56 percent of gold, 59 percent of silver, and 75 percent of bronze) are asking patients to pay at least 30 percent of the list price of expensive drugs.

We’ve gotten to this point because we have a system where the price of a drug has had little correlation with its value. Many drugs, including some of the priciest ones to treat very rare diseases, represent an excellent value if avoided hospitalizations and complications are considered. Conversely, too many of the expensive drugs in our medical arsenal offer a barely incremental medical benefit, but they have been getting paid for without much fanfare.

The fix is not to lower prices across the board, but to find ways of not paying for drugs that don’t work, while continuing to incentivize the creation of those that do.

Some experts have proposed “pay-for-performance” programs, where drugs get reimbursed only if they work. Johnson & Johnson has had such a program in the United Kingdom since 2008, for the cancer drug Velcade. Patients are treated and if an effect is seen, the tab is picked up by the government. If a patient does not respond, J&J rebates the cost.

I have informally asked a number of biotech CEOs if they would be willing to do a pay-for-performance program for their upcoming drugs, and the answer has overwhelmingly been yes. Unfortunately, it is unlikely that such a program could work in the United States, at least not at the moment, due to the law used to determine Medicaid rebates.

Medicaid’s “best price rule” stipulates that a drug manufacturer has to match the lowest price it negotiates with any commercial payer. In a pay-for-performance program, the price of a drug is fully rebated back to the health plan if it doesn’t work, so it’s technically given away for free. Under the law, Medicaid would be entitled to obtain that drug at no cost.

According to Avalere’s Mendelson, the best-price rule is preventing manufacturers from engaging in creative pricing arrangements with payers, such as offering steep discounts to a health plan in exchange for preferred formulary placement. “You would not believe how much innovation is being squelched as a result of that provision,” Mendelson said at a discussion on drug pricing that took place this July at the American Enterprise Institute.

A possible solution is to allow safe harbors from the Medicaid provision, where a pharma company that works out a novel contract with an insurer could be exempt from the Medicaid best price rule if the contract adheres to certain criteria. The federal government should be looking for ways to encourage these types of creative arrangements.

The ultimate goal of any reform should be for every new drug to be much better than the previous one. Once we hold the industry to that high standard, more game changers will come our way. Some are already in development in the form of gene therapies and cell therapies that will be given just once to a patient and are expected to cure their disease.

Because cures are a one-time treatment, they will be priced much higher, because that’s the only payment a manufacturer will ever get per patient. We should stop questioning whether to pay for those incredibly valuable drugs, and concentrate on how.

AEI’s Scott Gottlieb proposes new vehicles to amortize the up-front costs of expensive cures. The drug company or a third party could “extend financing terms that would allow the payer to book the costs of the curative treatment in annual increments,” Gottlieb writes. University of Chicago health economist Tomas Philipson and former FDA commissioner Andrew von Eschenbach similarly argue for better credit mechanisms, akin to mortgages or student loans, to ease the burden on payers.

It won’t be easy to find the perfect balance. Pushing for sustainable drug pricing will have an effect on the pace of innovation, and critics should be mindful of that. The solution will have to include a lot of analysis and number crunching, but also, on the part of everyone involved, a little bit of heart.

Sylvia Pagán Westphal is a regular contributor to the Globe’s opinion pages. She is also content editor for Boston Biotechnology Conferences.