New Marketplace
Navigating Payment Reform

Who Has the Power to Cut Drug Prices?

Article · November 20, 2017

Why do medications cost so much, particularly specialty drugs that treat the most serious conditions? Mostly because U.S. drug companies can price them however they want. Some of their justifications are reasonable — for instance, high prices fund research. Others, like the notion that drug treatment lowers total medical costs, are far from proven.

But pharmaceutical companies don’t deserve all of the blame for high drug prices. Lots of other actors in purchasing, distribution, and brokerage have greater incentives to keep prices high than to lower prices or choose drugs that reduce longer-term medical and business costs, like absenteeism.

We believe that employers have the greatest potential to influence some of those actors and, ultimately, to chip away at high drug prices. To appreciate the power that employers have in this area, you must first understand how competing incentives work in the world of drug pricing.

Competing Incentives

Hospitals, for example, can take advantage of the 340B pricing program, which allows them to buy drugs at 30% to 50% of the retail price but then bill at full price for patients with insurance. And even organizations that, theoretically, are paid to help hold down drug costs sometimes have incentives to do the opposite. Take insurers and pharmacy benefit managers (PBMs), which are hired to manage drug costs for employer-based health plans.

Indeed, it’s smart for employers like GE, IBM, and Google to contract with these specialist entities and have them decide which drug among several competitors their employees should get first, at what cost, and which medical policies should govern the use of that drug. After all, insurers and PBMs can spread the costs for research, negotiation, and decision making about drug-reimbursement policies across all of their clients.

However, PBMs and insurers may have business objectives that differ from those of their clients. For one, they’re not always at risk for the cost of drugs — the clients are. Also, a PBM or a pharmacy department of an insurer gets a substantial portion of its drug-related profit from rebates.  These are payments negotiated with manufacturers that return, via the PBM or payer intermediary, a percentage of the drug’s price to the payer — for example, to an employer that contracts with a PBM or an insurer.

Here’s a simplified version of how these rebates work:

To get the business, the PBM or plan typically guarantees a minimum rebate on every prescription, say $60. On a $300 script, that’s a 20% net reduction in the cost to the employer (final price: $240). As an incentive for the PBM or plan to negotiate even harder — maybe get a 30% rebate (in this case, another $30) — it often takes home 30% to 50% of anything above the guaranteed rebate. In this example, if the split were 50/50, the employer would pay $225, net, for the prescription and the PBM would get $15. Not a bad deal.

In the old days — maybe five years ago, when most prescriptions ranged from $200 to $400 — rebates worked to the employer’s advantage. But for a specialty drug, costing say $50,000, a rebate of 20% means that the employer pays a net $40,000 and the PBM pockets $10,000 (plus other fees for processing and, sometimes, for handling the prescription through a specialty pharmacy division). Meanwhile, the $60 guarantee becomes meaningless.

Now let’s assume both a smaller rebate (10%) and a lower price ($25,000) for the same drug. The $60 rebate is still meaningless, but now the net cost to the employer is $22,500 (much better than $40,000) and the PBM’s profit is just $2,500. If you’re the PBM, do you want the manufacturer to price the drug at $50,000 or $25,000?

It’s also true that very large employers sometimes get virtually the whole rebate, not a 50/50 split. But don’t cry for the plans and PBMs, which know how to tack on various fees, often including a specialty pharmacy fee of about 2%. That cost covers the overhead and profit margin of a necessary part of the distribution system. But 2% on a $500 drug is $10; on a $50,000 drug, it’s $1,000. Again, a higher drug price means a more profitable supply chain.

(Insurance companies would argue, by the way, that they shouldn’t be lumped in completely with PBMs, because most insurers manage their pass-through and full-risk businesses with the same pharmacy policies. For the full-risk business, insurers care about drug prices, at least to the extent that they can’t just raise premiums for employers.)

Options for Lowering Prices

The easiest way to lower drug prices would be with a single-payer system, which most European countries have. That payer would be on the hook for all medical costs and would therefore have the incentives — and the clout — to negotiate lower prices. But we can’t envision that in the U.S., where some political players would cry “socialism.” So we’re left looking to employers and the Centers for Medicare and Medicaid Services (CMS), which runs Medicare.

Changing CMS reimbursement practices is a Sisyphean task, given the congressional and lobbyist opponents. Even a relatively small proposal last year — narrowing the “protected classes” rules that, in essence, require reimbursement for all drugs in six therapeutic areas — was shot down decisively by drug companies, patient advocacy groups, and legislators.

Employers’ weak-kneed behavior is more baffling — no other group has a greater stake in buying smarter. But employers have always been reluctant actors in the health care system, as they feel out of their depth. Some companies, like Honeywell and Nielsen, have taken tough steps to control costs, with no loss in employee satisfaction. But don’t count on a sea change in employer buying behavior — when push comes to shove, they can always shift costs to their employees.

What Employers Can Do

Employers must recognize that, like it or not, the buck stops with them. Patients can hardly negotiate for themselves, but employers can be much more aggressive in getting PBMs and payers to have skin in the drug-pricing game.

Our sense is that PBMs, at least, are willing to listen. Express Scripts, for example, recently proposed capping its customers’ total exposure to the PCSK9-inhibitor class of cholesterol-lowering drugs. If their customers spend more than a pre-set amount, Express Scripts eats the overage. Certainly, Express wouldn’t do this without a clear idea of how much its clients would be spending. Notably, those clients must agree to follow Express’s rules about who gets the expensive drugs — and must use Express’s specialty pharmacy. But it’s a very good start.

We certainly don’t expect employers to start writing drug-coverage policies and doing their own contracting. But, as seasoned buyers, they know how to negotiate with suppliers, such as insurers and PBMs — and they should not be afraid to do it. It’s now easier to understand the tradeoffs among competitive drugs, thanks to tools like the Institute for Clinical and Economic Review’s new assessment reports, RealEndpoints’ RxScorecard, and the National Comprehensive Cancer Network’s evidence blocks. Combine these tools with contracting that does not focus entirely on rebates, and employers may begin to change the rules of a game they will otherwise continue to lose.

This article originally appeared in NEJM Catalyst on January 13, 2016.

New Call for Submissions ­to NEJM Catalyst

Connect

A weekly email newsletter featuring the latest actionable ideas and practical innovations from NEJM Catalyst.

Learn More »

More From New Marketplace
Conceptual Framework for Evaluating Specialty Care Partnerships

How to Engage Specialists in Accountable Care Organizations

Should an ACO insource or outsource specialty care? Here’s a framework to help leadership decide.

Illustrative Examples of Health Policies, Possible Goals, and Relevant Evidence Base

Evidence-Based Health Policy

Having a clear framework for characterizing what is, and isn’t, evidence-based health policy is a prerequisite for a rational approach to making policy choices.

U.S. and Canadian Prices of Some Generic Drugs with U.S. Prices That Recently Increased by 1000% or More

The Price of Crossing the Border for Medications

The health and safety risks faced by the many Americans who cannot afford medications necessitate consideration of alternative strategies to provide less expensive medications.

Economic Investment and the Journey to Health Care Value — Part III: Health Care Purchasers

Early successes suggest that value-based purchasing programs can both transform employer-based health care and have a powerful and lasting impact on the economic strength of U.S. businesses.

Single-Payer Health Care Is the Favored Outcome of Future Payment Reform

Survey Snapshot: Deep Frustration with the Current Payment System

Many NEJM Catalyst Insights Council members are frustrated with the pace of value-based payments and expect single-payer health care to gain traction — though maybe not soon enough.

Value-Based Payment Models Payer-Provider Contracts Value-Based Arrangements

Economic Investment and the Journey to Health Care Value — Part II: Health Care Payers

Payers’ broad scale of investment in value-based arrangements makes a compelling case for the importance of sustained efforts to identify effective value-based payment models.

Four Principles for Navigating Payment Reform

The changes needed in health care are happening way too slowly. Health care stakeholders must insist on value in what they pay.

Economic Investment and the Journey to Health Care Value — Part I: Health Care Providers

Early evidence suggests that value-based payment and care delivery can transform our health care system, but providers must increase the momentum for this positive change.

Shift Toward Value-Based Payments in the Industry and at Organizations Is Accelerating

New Marketplace Survey: What’s Next for Payment Reform?

As health care reform struggles to gain traction legislatively, health care professionals report that payment reforms continue to move forward at a moderate pace, and indeed are essential to achieving the Triple Aim.

Patrick Conway and David Cutler head shots

The Highest Quality at a Lower Cost? We Don’t Have That Yet

David Cutler asks Patrick Conway what worked and what didn’t at CMS, advice he’d give to the Trump administration, and his predictions on Medicare and Medicaid.

Connect

A weekly email newsletter featuring the latest actionable ideas and practical innovations from NEJM Catalyst.

Learn More »

Topics

Value Based Care

157 Articles

Improving Patient Involvement in Care

The CEO of Virginia Mason on facilitating and enhancing patient participation in care.

Primary Care ACO Models: Way of…

Evidence shows that primary care–led, risk-bearing, ACO-like practices and independent physician group models generate more…

Amazon and CVS: Short-Lived Unicorns in…

Will Amazon–Berkshire Hathaway–JP Morgan and CVS-Aetna change the health care game? To one health care…

Insights Council

Have a voice. Join other health care leaders effecting change, shaping tomorrow.

Apply Now