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Pills spilling out of a bottle of prescription medicine.

Drug prices, especially for brand names, are sky high and rising in the United States. According to a couple of University experts, the steep price of drugs depends on many factors--like the shielding of insured consumers from the true prices of drugs, patent laws, and the byzantine structure of an industry whose practices are all but impossible to track.

A hard pill to swallow: why U.S. drug prices are so high

Why U.S. drug prices are so high

by Deane Morrison

From M, spring 2004

The last thing Marie, a University employee, thinks about when she reaches for her asthma medication is its cost. Thanks to her Health Partners coverage, she pays only $20 for a three-month supply of Advair. If Marie paid cash at the Nicollet Mall Walgreen's in Minneapolis, she would pay $151.59 for a one-month supply. If she were buying online from Canada, the price would be about $99 a month, and if a generic form of the drug were on the market, the price would probably be slightly lower than the Canadian price. Marie is getting a good deal with her HMO coverage, but her situation illustrates one reason why drug prices, especially for brand names, are sky high and rising in the United States. According to a couple of University experts, the steep price of drugs depends on many factors--like the shielding of insured consumers from the true prices of drugs, patent laws, and the byzantine structure of an industry whose practices are all but impossible to track.

Consumer price insulation

One simple factor in high drug costs is that the doctor who chooses a drug doesn't pay for it and may have no idea of its price; therefore, he or she may pick a high-priced brand name over a generic version of the drug without a second thought. Doctors get much of their information about drugs from the manufacturers, who send "detail" people to doctors' offices--complete with free samples--to extol the virtues of the latest brand-name drugs. Ads aimed at consumers also tout brand names, increasing the demand for more expensive drugs. If an HMO or other health plan is paying, that's good for the consumer but not for prices. "Suppose each refill costs you a flat $10 to $20 co-pay, whether it's a $50 brand-name drug or a $30 generic," says Roger Feldman, a University professor of health services research and policy. "Demand for the drug would be insensitive to price." Such arrangements help insulate consumers like Marie from the true cost of their medications, so they have no incentive to shop around. But an insurance policy that requires the consumer to pay a certain percentage of all costs would introduce some price sensitivity, and encourage both consumer and insurer to seek better bargains.

Both Stephen Schondelmeyer and Roger Feldman scoff at companies' claims that anti-reimportation laws serve to ensure the safety of drugs from Canada. "Anti-reimportation laws have little to do with safety and everything to do with profit," says Feldman.

Oh, Canada

U.S. prices got so high in the first place partly because, in the 1970s and 1980s, companies began pricing according to a percentage of a country's median income, says Stephen Schondelmeyer, head of the University's PRIME Institute, which monitors the pharmaceutical industry. Drug prices in Canada run about 50 to 60 percent of the U.S. figure; in Europe it's about 40 to 50 percent. But the U.S. has huge income disparities; affluent people tend to have HMO or other coverage, and those who don't have any coverage tend to be the poor or elderly. "Many people paying cash are way below median U.S. income, but prices were set according to the median," says Schondelmeyer. "That's why seniors complain--many have only Medicare, which doesn't cover most drugs." U.S. law allows only the company that makes a drug to reimport it from Canada into the United States, says Schondelmeyer. The law is routinely ignored by U.S. consumers who order drugs from Canada or go there to buy them, and several states, including Minnesota, have challenged the law. But drug companies have threatened to limit sales to Canada if the law were repealed or if the flow of drugs southward over the border gets out of hand. "[If they did that], they would be acting like a cartel, which is illegal in the United States," says Schondelmeyer. Both Schondelmeyer and Feldman scoff at companies' claims that anti-reimportation laws serve to ensure the safety of drugs from Canada. "Anti-reimportation laws have little to do with safety and everything to do with profit," says Feldman. In effect, says Schondelmeyer, by paying high prices, Americans are subsidizing lower prices in Canada and Europe.

Patents

Laws governing the patenting of drugs also play a role in how they're priced. Drug patents give companies the exclusive right to manufacture a drug for 20 years; without patents, companies would be unable to protect their products long enough to recoup the huge costs of drug development, and new drug research would suffer. But loopholes like the one covering patent extension allow manufacturers to keep their patents--and the relatively high prices--longer, while keeping lower-priced generic equivalents off the market. Patent extension law gives a patent holder an automatic 30-month extension on the patent whenever a second party challenges the patent. A court decision could cut the 30-month extension, but companies know how to keep cases in court longer than 30 months, Schondelmeyer says. Drug companies can also ask Congress to extend patents, a company can patent something besides the actual drug chemical--such as a new process to make the drug, a new dosage form, or a new use, as happened with Prozac. "Prozac is off patent, but Eli Lilly found it could be used for PMS," says Schondelmeyer. The company now has a new patent on the same chemical it uses in Prozac, but it's called Serafem for PMS, he says. Thus, rival companies can't market the off-patent Prozac chemical as a drug for PMS.

The PBM labyrinth

During the last two decades--the PBM, or pharmacy benefit management company--has arisen to manage drug benefits for HMOs. PBMs contract with HMOs and other health plans to obtain discounts from drug makers and retail pharmacies. PBMs recommend certain drugs and try to get doctors to prescribe them and HMOs to include them in their formularies (lists of approved drugs). When a discount is negotiated, it appears as a rebate from the manufacturer, which the PBM passes on to the HMO. But, says Schondelmeyer, PBMs don't disclose to their HMO employers the total amount of the manufacturer's rebate or other payments, which might include administration fees, data acquisition fees, or other types of compensation for the PBMs. Also, PBMs get more rebate dollars from higher-priced drugs than from lower-priced drugs. "PBMs are paid by HMOs to get low prices, but they benefit by preferring higher-priced drugs in their recommendations to HMOs," says Schondelmeyer. "It's a huge conflict of interest. I think transparency is needed. If PBMs had to disclose their transactions, maybe somebody could referee them." Adding to the complexity and the conflicts of interest is the fact that some of the biggest PBMs have become affiliated with, or even owned outright, by some pharmaceutical companies.

What to do?

In Feldman's view, closing loopholes in patent laws and shortening the 20-year life of patents would be a good first step towards controlling prices. Schondelmeyer thinks the industry could benefit, at least in the long run, if some of the veils hiding its structure were swept away. "Companies argue that the United States is the only 'free market' for drugs because other countries, for example, in Western Europe, control prices," says Schondelmeyer. "But that should lead to competition and lower prices. Instead, the structure of the industry, hidden prices, and conflicts of interest prevent those from happening." Neither Feldman nor Schondelmeyer believes that the new Medicare prescription coverage will lead to lower drug prices. For one thing, the legislation stripped the federal government of any right to negotiate lower prices. What Schondelmeyer calls the drug industry's "broken market"--a market that doesn't have to play by the traditional rules of economics--may eventually work against it. The inscrutable nature of drug pricing makes the industry vulnerable to public anger, and the longer that resentment simmers, the larger the potential for a political showdown. Were that to occur, Congress may act in haste, and price controls--or other remedies for outraged consumers--may be used to treat the symptoms and little effort will go into investigating the underlying causes of the problem. For now, the best prescription may be to open up the closed and secretive world of the drug industry to the light of day.

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