Our willful ignorance on drug prices

Our willful ignorance on drug prices
© Getty Images

This week, Sen. Claire McCaskillClaire Conner McCaskillEx-CIA chief worries campaigns falling short on cybersecurity Ocasio-Cortez blasts NYT editor for suggesting Tlaib, Omar aren't representative of Midwest Trump nominees meet fiercest opposition from Warren, Sanders, Gillibrand MORE (D-Mo.) released a report that sent another shot across the bow of the pharmaceutical industry. List prices for the most common Medicare drugs were found to have risen at nearly 10 times the inflation rate over the last five years. But as usual, we are all fixated on the wrong price.

This type of finding is not unique or surprising. It comes on the heels of a similar study showing pharmaceutical prices rose faster than that of all health-care sectors, with a nearly 25 percent increase in merely four years. All for what? A pill that appears to cost nearly nothing to make on the margin. It is no wonder a Kaiser Family Foundation poll finds that lowering prescription drug prices is the public’s top policy priority.

If only these prices really represented what many claim they do. As with other aspects of health care, the true “price” of a pharmaceutical is not always clear. Pharmaceutical manufacturers and wholesalers maintain official list prices for all of their products, akin to the manufacturer’s suggested retail price on new clothes, cars and other goods. These prices are regularly published and serve as the basis for “price gouging” accusations by McCaskill and others.

But the report ignores the fact that pharmaceuticals are nearly always “on sale.” List prices rarely represent what drug manufacturers are actually paid. Pharmaceutical companies negotiate with health insurers or pharmacy benefit managers about a number of issues. How much will insurers make their customers pay for a drug? Will the insurer even allow their enrollees to buy it?

The answers to these, and other questions, ultimately lead to a rebate from the manufacturer, a percentage reduction off of the list price. In general, the market conditions for a drug dictate the size of the rebate. An insurer that sells a high volume of a particular drug, for example, may receive a larger rebate.

The size of this rebate drives a wedge between publicly reported list prices and the true purchase price. The problem is that the size of these rebates has typically been considered proprietary. Manufactures and purchasers are reluctant to reveal the details of their contracts.

The U.S. Department of Veterans Affairs, a payer for about nine million veterans and their dependents, is a rare exception which publishes its payment schedule. A 2005 report from the Congressional Budget Office found that Veterans Affairs paid only about 42 percent of list price. It is possible these rates, which are often thought to be among the lowest payment rates, are an even smaller percent of list price today.

Large rebates are not constrained to Veterans Affairs. Disclosure reports from three large manufacturers — Eli Lilly, Merck and Janssen, the pharmaceutical arm of Johnson & Johnson — for example, indicate that the average discount off list price for their products was 44 percent in 2016. While list prices increased by 10 percent that year, the actual price paid grew by just over 1 percent.

These reports are consistent with what we already know, which is that pharmaceutical list prices have increasingly diverged from actual payment rates. Indeed, we have seen a similar story play out with hospital list prices. That U.S. health care has developed a strong tradition of opaque and bewildering pricing is nothing to celebrate, but it must at least be acknowledged.

This is more than a simple quest for accurate data. Normalizing the use of a wildly misleading measure of pharmaceutical spending has the potential to distort policymaking. Assuming that list prices represent what we currently pay for drugs could lead us, for example, to vastly overstate savings from proposed drug cost controls. Surely, the prospect of doing so would be tempting for, say, a creative political campaign. Who knows what we could fund with all the “savings”?

None of this is to suggest that all is well in drug pricing. Indeed, a host of issues remain. Are we appropriately balancing incentives to encourage the development of path-breaking drugs against the costs of patent exclusivity? How can we foster a market that increases competition and avoids the next Martin Shkreli? The list goes on.

McCaskill, many of her colleagues, and even President TrumpDonald John TrumpTrump conversation with foreign leader part of complaint that led to standoff between intel chief, Congress: report Pelosi: Lewandowski should have been held in contempt 'right then and there' Trump to withdraw FEMA chief nominee: report MORE seem convinced that pharmaceutical prices are a problem, a view that resonates among many voters. But if we are going to have this discussion, let’s at least start from the basis of reality.

Benedic Ippolito is a research fellow in economic policy studies at the American Enterprise Institute.