New Marketplace 2015

Is Value-Based Drug Pricing Compatible with Pharma Innovation?

Article · June 14, 2016

Innovations in the life sciences industry have greatly improved patients’ lives in the past three decades. Hepatitis C was once virtually untreatable, and now people talk seriously of eradication. HIV/AIDS, now a manageable disease, used to be a death sentence. Early mortality from heart disease and cancer has fallen dramatically. By almost any measure, the United States is the most productive biotech innovation engine in the world (see the Scientific American 7th Annual Worldview Scorecard).

This innovation has occurred within the context of an implicit social contract. The U.S. government substantially subsidizes basic research and the provision of health care, and it waives its ability to negotiate directly with manufacturers about prices. In return, the biomedical industry is allowed to attempt to recoup its R&D investments during a limited post-approval period defined by the Drug Price Competition and Patent Term Restoration Act of 1984 (often called the Hatch–Waxman Act), with the expectation that drug prices will be set at a point that ensures a reasonable level of population access.

However, normal market dynamics (e.g., supply and demand) that might restrain pricing are severely disrupted because of both a lack of price transparency and many buyers’ inability to negotiate. It should therefore come as no surprise that per-capita spending on prescription drugs grew to $9,523 in 2014 and is projected to grow by 6.3% annually through 2024, far outpacing inflation and total health expenditures nationally. Legislators and consumers are seeking justifications for this rapid growth.

Although much of the growth in spending on prescription drugs stems from demographic changes, overprescribing behavior, and other variables, greater use of increasingly expensive treatments continues to play a major role. The industry stakeholders that develop novel therapies therefore have an incentive to work toward developing a sustainable innovation funding model. One widely discussed idea is whether to tie the price of drugs to their actual value to patients. But before that specific idea can be realized, a few fundamentals must be addressed.

Challenging the Fundamentals of Drug Pricing

Lack of transparency of drug prices complicates the task of sustaining innovation. The complex web of rebating structures and other gross-to-net adjustments in standard pricing rubrics so obscures the effective net price of drugs that even experienced industry professionals struggle with the data sets. Furthermore, these rebating schemes can inappropriately affect physician prescribing patterns and may well hinder competitive entry and, thus, innovation. In addition, the investment in people and processes to maintain the current complexity can be wasteful. For markets to function more effectively, we recommend taking these steps:

Publish the net price rather than the list price. The media often highlight the list (sticker) price of a drug. But the list price is nowhere near the actual price after discounts and rebates—up to 50%, or even 90% in highly competitive markets such as Managed Medicaid—have been negotiated with payers and distributors. An effectively functional market requires this net price information to be readily and publicly available. In addition to rebuilding public trust, that kind of drug pricing behavior may foster competition among both manufacturers and intermediary buyers and, thereby, benefit consumers.

Make pharmaceutical prices more predictable. When innovative drugs that address significant unmet medical needs (e.g., new hepatitis C therapies) are first approved, overall costs inevitably go up. But the price of medicines that are well into their commercial lifecycles may also rise dramatically, as happened in both 2013 and 2014. Mechanisms to limit rapid price inflation for existing drugs (thus stabilizing growth overall) could range from the draconian (e.g., requiring that for every dollar of price inflation 3 years before loss of exclusivity, an equal amount must be reinvested in R&D) to the more reasonable (e.g., increasing tax credits to offset R&D investments that match price adjustments).

Let buyers negotiate openly. Some people argue for regulation of drug pricing (e.g., a cap on the relative price growth for a drug through the life of its patent). It would be much more efficient to simply let the largest buyers negotiate transparently on the open market, where information about the actual market demand (net price) for pharmaceuticals is readily available.

Tying Drug Prices to Patient Value

Addressing the aforementioned fundamentals must go hand-in-hand with proposals to price drugs on the basis of their value to patients and, by extension, to payers and society at large. Peter Bach has explored some of the issues with value-based drug pricing, specifically with respect to cancer drugs. Stepping back to assess the landscape for drugs more broadly, we think that for treatments in many therapeutic segments, a value-based approach to pricing is amenable to a pilot proof of concept, using data on acute outcomes, hard clinical events, and surrogate endpoints in well-delineated treatment environments. Here’s how such a proof of concept would work in some of the more expensive therapeutic categories.

  1. Tie the number of dollars spent on a medication per quality-adjusted (or disability-adjusted) life-year saved to a rolling measure of average GDP per capita. When an innovative drug produces meaningful clinical outcomes, society becomes healthier and more productive. As GDP per capita increases, so does society’s ability to pay, creating a virtuous cycle. In addition, this system (a) would nudge profits and innovation away from diseases in older patients (e.g., blood cancers in the elderly) toward strategies for younger people (e.g., mutation-resistant antibiotics, gene therapy to treat pediatric neuromuscular conditions) and (b) would make regional and global price variance easier to decipher.
  2. Enable payers to migrate the costs of care when the patients themselves move. This type of approach would temper concerns about free riders. For example, no payer is willing to bear the burden of a lifetime’s worth of treatment in an instant (say, $1 million to cure a patient with hemophilia) — because it will never recoup that investment. High-cost therapies with long-term benefit can be amortized over time and must be transferable from one payer system to another, so that the liability effectively migrates with the health benefit. Current legislation already regulates coverage for preexisting conditions in this way.
  3. Align the information infrastructure. True value-based drug pricing is feasible only with good longitudinal data that are easy to share and access. Unfortunately, for more than two decades, attempts to link treatment and long-term clinical outcomes in the U.S. have been hampered by a messy array of patient- and case-tracking systems and by fragmented electronic medical record (EMR) architecture (witness how many physician offices still use fax machines). Although national-scale solutions remain elusive, pilot programs have become feasible in some high-cost therapeutic areas. Within oncology, for instance, increasing consolidation of integrated delivery networks (often running on Epic EMR systems), private practices (e.g., US Oncology), and the remaining private-practice EMR systems (e.g., Flatiron Health) puts the goal of measuring discrete patient outcomes largely within reach for entities that continue to invest in innovative cancer drugs.

The Way Forward in Defining Value

All of the elements of our outcomes- and value-based drug pricing solutions are contingent on having a way to define value. But that task may not be as complex as it first appears. That’s because pharmaceutical company boards (as a proxy for the larger investor community) operate in a predictable way:

They invest in innovation when they can foresee positive risk-adjusted returns, tied to specific clinical and health economic targets, in a pricing environment where innovative products have the potential to create their own markets. Those markets will be sustainable only if payers are able to forecast (1) long-term costs, using transparent pricing data and accounting for how patients move into, out of, and between private insurance plans; and (2) morbidity and mortality, using the power of well-integrated IT systems. Defining value in that kind of predictable environment will have economic multiplier effects that improve population health and, thus, short- and long-term productivity.

Innovation in the life sciences industry has already bettered the lives of millions of patients. The innovators themselves have the opportunity to lead the way in sustaining that progress by actively participating in efforts to define the true value of their contributions.


Disclosure: As consultants to the life sciences industry, David Gilman and Nathan Dowden are retained and/or contracted on an ad hoc basis by numerous drug development and commercial organizations.

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