Health Action In Depth

April 2004

Prescription Drug Pricing: Untying Medicare's Hands

The world of health care policy is rife with disagreements. One point on which people of all stripes do agree, however, is that the U.S. has the highest drug prices in the world, and those prices keep going up year after year after year. But not everyone pays the same price for the same drug. Insured by an HMO or PPO? Your health plan negotiates the drug prices it pays. Covered under Medicaid? Each state Medicaid program determines its own drug acquisition costs, and your state may negotiate additional rebates or discounts from drug manufacturers to lower prices further. Did you serve in the military? If you meet program requirements, the Veterans Administration (VA) negotiates drug prices for you.

What happens if you have no drug coverage? In a cruel twist of fate, you have to pay the highest drug prices of all. Because there is no middleman to negotiate lower drug prices on your behalf, you go it alone. Of course you can shop around -- prices vary tremendously from one drug or grocery store to another. And you may even be able to get your drugs for free or at low cost through programs maintained by drug companies themselves or through state-subsidized programs.

With so many parties involved in drug price negotiations, how can prices best be controlled, and who should be charged with controlling them? Conservatives often argue that government negotiations over drug prices will not work and that this task should be left to private industry. The Medicare drug law actually codifies this notion, forcing the federal government to maintain a strict "hands-off" policy when it comes to drug prices for Medicare's 41 million+ beneficiaries, effectively signing away the possibility of achieving significant drug cost containment.

But negotiating volume discounts is a well-established business practice, and the larger the purchaser, the stronger its negotiating position. State Medicaid programs are some of the largest purchasers of prescription drugs in the country, but the Medicare program -- if its hands weren't tied behind its back -- could be the single largest purchaser. As it turns out, there is another program where the feds have successfully negotiated significantly lower drug prices for years, clearly demonstrating that expanding the federal government's negotiating powers could help rein in the incredibly high drug costs that consumers end up paying for one way or another.

This article explores the lessons that can be learned from one government-based drug coverage program -- lessons with implications for the Medicare program and its future.

The Department of  Veterans Affairs (VA): Successful Track Record on Drug Prices
Critics point to countries such as Canada, Australia, France, and, basically, every other developed nation in the world and ask why the U.S. can't control prices the way those countries do. But we don't have to look to other countries, which have very different health care systems. We have a perfectly good model right in our own back yard: The VA's Pharmacy Benefits Management Program negotiates with drug manufacturers to get much lower prices on the drugs it gives to military veterans. And the agency has been doing this for over a decade.

How does the VA do it? The process starts with drug selection: The agency's doctors and pharmacists review drugs for effectiveness and cost. The program relies heavily on generics-these lower-cost alternatives constitute about two-thirds of the program's prescriptions. Where generics aren't available, the VA seeks competitive bids for "therapeutically equivalent" brand-name drugs (different drugs that treat the same condition in the same way -- say, different brands of cholesterol-lowering drugs). The key to the agency's cost containment is that it leverages the purchasing power of its beneficiaries - about 7 million members-to negotiate steep discounts from drug manufacturers. And it sticks to a tight formulary.

As one of the largest purchasers of prescription drugs in the U.S., the VA has created a program that enables millions of veterans to pay just $7 for a 30-day supply of drugs. In 2000, a National Academy of Sciences report found that the VA's purchasing methods had saved nearly $100 million over the previous two years. A 2001 investigation by the Inspector General of the Department of Health and Human Services (HHS) found that the VA paid, on average, 52 percent less for a list of 24 drugs than did Medicare.
What gives the VA the ability to do all this? A law passed by Congress in 1992 mandates that the program negotiate lower prescription drug prices. So, there is a precedent for a federal law that requires leveraged negotiations, and there's a successful federal program in place that could serve as a role model for other federal programs ... such as Medicare.

I Have Good Drug Coverage, So Why Should I Care about High Drug Prices?
Total U.S. prescription drug expenditures were expected to reach $184.1. billion in 2003, an increase of 13.4 percent over the previous year. By 2013, this number is predicted to nearly triple, reaching $519.8 billion. And while recent massive increases in prescription drug spending are expected to moderate over the coming years (falling from a peak increase of 19.7 percent from 1998 to 1999 to a "mere" 9.2 percent increase from 2012 to 2013), spending on prescription drugs is still predicted to be the fastest growing sector in health care. Furthermore, prescription drugs make up the largest component of health care spending that comes directly out of consumers' pockets-rising from 18.4 percent in 1993 to 22.9 percent in 2002 and a whopping 32.5 percent in 2013.

Even if you've got great drug coverage, high drug prices still affect how much money you pay out of your own pocket for your prescriptions. Employer-sponsored health plans have seen huge increases in the prices they pay for drugs. And while they may currently pick up the tab for most of these drug costs for their beneficiaries, as those prices rise higher, it will get harder and harder for them to cover drug costs. Employers can't afford to absorb these increased costs indefinitely, which means that, more than likely, employee drug coverage will erode over time, and employees will be forced to pay more and more out-of-pocket even if they can keep their drug coverage.

Many consumers with employer-based coverage are already experiencing this phenomenon. While their drug coverage used to consist of two tiers (generics and brand-name drugs), it may now consist of three or four tiers (generics; preferred brand-name drugs; non-preferred brand names; and those drugs that are simply not covered). In 2003, 63 percent of workers with employer-sponsored drug coverage had three-tiered copay plans, up from 27 percent in 2000.

The New Medicare Drug Benefit: No Insulation from Steep Drug Prices
The pricing spiral that affects those covered under employer-based plans obviously has an impact on the coverage provided by public programs as well. State Medicaid programs are cutting back coverage to limit the number of drugs or refills covered per month. And before the Medicare drug law was passed, some Medicare HMOs stopped providing coverage for anything but generics, while many others dropped drug coverage entirely.

Think the new Medicare drug law eliminates the impact that spiraling prices will have on those who'll rely on the program for drug coverage? Don't bet on it. Even under the new law, beneficiaries will still have to pay a considerable portion of their drug costs, and rising drug prices will affect those out-of-pocket costs. There will also be substantial gaps in coverage, and formularies (lists of covered drugs) are likely to get more and more restrictive over time.

How much beneficiaries end up paying out-of-pocket will depend in part on how good a job their HMOs or freestanding Prescription Drug Plans (PDPs) do in negotiating drug prices. If they do a lousy job, beneficiaries may end up paying much more out-of-pocket than if their drug plans have enough clout to negotiate lower drug prices. Lousy negotiating could also mean beneficiaries get to the "doughnut hole" (gap where there is no drug coverage but beneficiaries continue to pay premiums) sooner and that they'll get less for the money they spend while in the "doughnut hole."

And let's not forget price inflation. What the Medicare program will pay every year -- and what beneficiaries will have to pay out of their own wallets -- will go up at a rate much higher than the rate of inflation. As drug costs continue to climb, the prices Medicare pays for drugs will also go up, and the benefit will change to make up for Medicare's increased costs:

• the annual premium, currently estimated to be $420 when the program starts in 2006, is predicted to rise to $696 in 2013.

During that same period:

• the annual deductible will rise from $250 to $445;
• the initial coverage limit -- where coverage stops and beneficiaries will have to pay 100  percent of drug costs -- will grow from $2,250 to $4,000, so participants will get more coverage before they fall into the doughnut hole. However, the doughnut hole itself will be bigger-the out-of-pocket expenses beneficiaries will incur while in the doughnut hole will increase from $3,600 to $6,400.

Because drug prices are predicted to escalate much faster than seniors' incomes, seniors with median incomes and average prescription drug expenses will see an increasing proportion of their incomes consumed by drug costs, from 8.8 percent in 2006 to 12.3 percent in 2013 (despite the new drug benefit).

Unfortunately, there won't be much good information out there on how well different drug plans are doing in negotiating drug prices. Those who choose to participate in the new program will be paying prices based on how well their PDP or Medicare HMO negotiates drug prices -- and those companies, representing just a portion of the overall Medicare drug market, will not have the clout the Medicare program would have had as a whole.

Conclusion
Ultimately, no meaningful progress will be made in expanding health coverage to the tens of millions of uninsured Americans unless we can get a handle on rising health care costs, and one big component of those costs is prescription drugs. An obvious place to start is with the Medicare law. With a few fixes, Congress could go a long way towards making a dent in moderating prescription drug prices for the program's 41 million or so beneficiaries. Congress could:

• Remove the law's prohibition on negotiating drug prices. This would enable the federal government to buy medications for all beneficiaries the way it does for the VA, which would cut drug costs for the program nearly in half.
• Remove the provision in the law that prohibits the use of head-to-head testing of drugs that are therapeutically equivalent (that is, different drugs that function essentially the same way in the body) when making coverage decisions. This provision hamstrings not just the Medicare program, but also the overall effort to determine the comparative value of similar drugs-discouraging the kind of testing that we need more of, not less. According to experts at Consumers Union, "We need these studies to find out whether the most expensive and newest drug is really better than the tried-and-true drug." And the chief medical officer for Medicare said that "If Medicare is going to spend more on a new drug, we need to establish that it is going toward something that provides significantly improved care for seniors."
• At the very least, as an interim measure, allow the reimportation of prescription drugs with quality safeguards. If the U.S. government won't do much to control rising drug prices, Americans should be allowed to import less costly drugs that are the product of foreign cost containment systems.

By unshackling the Medicare program and allowing it to follow in the footsteps of the VA, the U.S. could make real progress in the pitched battle against soaring drug prices.