How Should the Government Negotiate Medicare Drug Prices? A Guide for the Perplexed

Yves here. This post does the useful service of unpacking the new rules for Medicare drug pricing under the Inflation Reduction Act. It also describes an odd disconnect between parts of the process that are highly specified, and others that are left oddly vague and thus subject not just to industry pushback but conceivably also litigation. The piece stresses a long-standing sore point, that Big Pharma gets massive subsidies via government-funded basic and applied research, and that ought to be reflected in this price-arm-wrestling.

To be more pointed, the idea of negotiating a price that somehow provides drug companies with an “equitable return” in light of not just the huge public investment, but also the fact that the public is taking the highest risks by engaging this research, is something that seems utterly unlikely to be adequately performed by government negotiators or at least our government negotiators. The TGA then bargained hard for the best prices for these meds. And not surprisingly, even the very few, old prescriptions I took were markedly cheaper Down Under.

I lived for a time in Australia, and back then, the Therapeutic Goods Administration did a great job of reading the research on the medications for various ailments, picking the most effective ones (and regularly not buying the newest reformulation because they typically provided trivial extra benefits at much higher cost).

Similarly, now that I am in a high end third world country known for good medical care, the drug prices are way cheaper than in the US (admittedly, I have found an odd exception of drugs not bought directly but as part of a treatment being way more expensive than the price in the US).

So I am a loss to understand why the starting point is not a spreadsheet of the prices in foreign countries, with the Feds demanding discounts from that based both on R&D subsidies and the raw volume of the total purchases. It seems that the US bargaining position (not surprisingly) is starting from far too favorable a price point for the drug makers.

By Fred Ledley, Professor of Natural & Applied Sciences and Management, Bentley University, and Director, Center for Integration of Science and Industry, at Bentley University. Originally published at the Institute for New Economic Thinking website

The “maximum fair price” for a drug must not only be equitable to those with unmet medical needs who may benefit from the use of the drug but also provide equitable returns on both public and private sector investments.

Now, at last, thanks to the Inflation Reduction Act (IRA), the federal government will be allowed to negotiate a “maximum fair price” for drugs covered by Medicare Part D. This historical change, taking place in the face of intense industry opposition, incrementally reverses policies that have prohibited the government from engaging in price negotiations since Medicare Part D was first established in 2003. While only ten drugs will be subject to negotiation in the first year of the IRA and 90 over the first five years, negotiations are now ongoing.

The IRA creates a highly scripted process for identifying the drugs that will be subject to price negotiations each year and lists specific factors that may be considered in these negotiations, including the manufacturer’s research and development costs, the returns on these investments, federal financial support for discovery and development, and the extent to which the drug addresses unmet medical needs. However, the Act leaves unsettled how these factors will be weighed by the government in these negotiations.

It has been suggested that the government should negotiate for value-based pricing that would benchmark the Medicare Part D price measures of the health benefit provided to those using these drugs. This would be analogous to the approach currently used by most European countries for drug pricing. We believe this approach is inadequate and fails to provide the public with a return on the massive US government investments in biomedical research related to these drugs that enabled these products to be developed and commercialized in the first place.

Extensive research has demonstrated that the government plays a critical role as an early investor in innovation and that the risk embodied in these investments is not proportional to the public sector returns. For example, our previous studies show that government-funded biomedical research plays an essential role in enabling successful drug development and that investment by the US National Institutes of Health (NIH) in research related to drugs approved from 2010-2019 was comparable in scale to reported investment by industry.

In our new INET working paper, we extend these analyses to the ten drugs selected for Medicare price negotiation in the first year of the IRA. Our analysis reveals that the NIH spent $11.7 billion on basic or applied research related to the drugs selected for Medicare price negotiations, representing a median investment cost of $895.4 million per drug and, by making this research available to industry, saving industry a median of $1,485 million per drug. While data on industry investments in these ten drugs is not publicly available, this level of NIH investment is comparable to reported investment by industry in the drugs approved from 2010 to 2019.

Our analysis also assessed the health benefit (health value) provided to consumers through Medicare Part D spending on these drugs. This analysis involved a review of the published literature on the number of Quality-Adjusted Life Years (QALYs) accruing to individuals using these products and multiplying this measure of value by the number of Medicare Part D beneficiaries who received these products. This analysis showed that eight of the ten products selected for price negotiation (excluding products for diabetes) created a total health value of 650,940 QALYs or $67.7 billion based on estimates of US consumer’s willingness to pay (WTP) of $104,000 per QALY. Our analysis also showed that Medicare Part D spending on these eight drugs was $97.4 billion, resulting in a net negative residual health value (analogous to the consumer surplus) of -$29.6 billion before rebates. While manufacturer rebates on drug sales can be substantial (estimates range from 20-45% from 2017-2021), our conclusion was that there is a negative, or at best, a narrow, margin between the price currently being paid by Medicare Part D and the health value accruing to consumers from this spending.

While benchmarking the price paid by Medicare Part D to the health value created by this spending (i.e., value-based pricing) would rectify any deficit in the balance between price and value, it would not provide for a return on public investment in the discovery or development of these products. That return would require a surplus between the value received by the public and the price paid to producers. In this context, our new INET working paper argues that price negotiations under the IRA need to benchmark the margin between the price paid by Medicare Part D and the health value created – the residual (or net) health value – against the expected return on public sector investment in these products.

Consideration of investment costs, risks, and returns is central to the concept of a “fair price” that can be agreed upon by buyers and sellers. As such, the maximum fair price must be one that provides appropriate returns on both government and industry investment in drugs consistent with the scale and risk of these investments. Moreover, as argued by Lazonick, Mazzucato, and others, these negotiations should recognize the co-creating roles of the public and private sectors in innovation and assure that the returns on public sector investments are comparable to those investments made by the private sector. The empirical analysis of public sector investments and the health value created by the drugs selected for Medicare price negotiations provides a cost basis for such an assessment.

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  1. TomDority

    mention and review of the Bayh-Dole Act. Section 6 (a) of Pub. L. 96–517, Dec. 12, 1980, 94 Stat. 3018 would aide in back grounding for Fair Pricing for the public (we the people) types as opposed to consumers.
    Certainly the current pricing schemes are a bit ruthless — So you want to save your life with this med…. what do you think your life is worth… well we think you would spend every last cent to save yourself so we will price accordingly – thank you very much

  2. Catherin

    I favor no negotiations at all. Prices should be DICTATED by the people who financed the research and underwent the experimentation, i.e. the taxpayers and patients. The ROI (whose investment? not theirs!) to pharmas should not even be a consideration. They can get out of the business if they don’t like it. So tired of this shit. We don’t negotiate with terrorists and the pharmas are terrorists of the highest order.

    1. gcw919

      Amen. If the gvt. finances much of the research, why does Big Pharma get to keep the patents, ala the Moderna cartel? Five new billionnaires, on our dime. Another example of Socialism for the Rich.

  3. Gregory Etchason

    Contrary to Reagan “the government is NOT the problem. Oligarchic and private Corporate capture of the government IS and always has been the problem.🤨

  4. ciroc

    Selling drugs made with American tax dollars to the American people at inflated prices is almost done by psychopaths.

  5. Piotr Berman

    About dictating prices. My impression was that countries like Australia have universal health care of some kind, and a budget to fund it, and within the constrains of the budget, they want to cover various diseases and conditions in a cost effective way to maintain and improve health metrics of the population. So overly expensive drugs are simply not covered.

    That instantly prevents price gouging on off-patent drugs. “Your acyclovir is priced 300 USD per 5 g cream tube, but a producer in Hungary can provide it for 4 USD” (that happened to me, now it seems that mail order price of acyclovir dropped to 20)). Moreover, it removes a myriad of price negotiations for the same drug with health care plans with “full prices” for the uninsured and “discount prices” of various plans.

    About 300 USD for 5 g of a generic drug sold in central Europe over the counter. Actually it was higher, but 20 g, with drugstore discount (free membership) was 50. This absurdity had to be related to how insured prices operate, the provider gets seemingly large discount and 5 g purchase is covered for, say, 100 USD. With such a jungle, negotiating 5 or even 90 prices may scratch the surface.

    My second observation was on self-injected epinephrin. This is an “ancient” mass produced compound, ca. 1 USD per dose. Among many uses, it is recommended for people who got a very strong allergic reaction, typically to an wasp bite. I had a funny experience with a wasp bite and a “normal” swelling in my palm. Anyway, if your reaction was stronger, next time you could get an anaphylactic shock, potentially life threatening, especially if you travel or hike: you can be literally knocked out. To prevent the shock, you can inject yourself with a dose of epinephrin, and repeat if it does not help. So it is worthwhile to carry a pair of syringes with measured doses, but every year (or two?) you need to replace them. In Poland, the price of 16 USD per syringe, covered by insurance, or if your dexterity is lacking, you could buy an automatic syringe for 75 USD. In USA, the cheap product was not available, and the producer hiked the price from 150 to 300. Temporarily, it had national monopoly for the device. The cheap device is the same as for other prescription injection, like insulin or something for clot prevention. But here you have to inject a bit deeper, into a muscle, so the needle has to be a little longer, and the patient, a little braver. Long story, but the price hike was pure banditry of “only in USA” kind.

    In both cases, medications are purchased “just in case”, if you have herpes outbreak, you dab the affected place with Acyclovir, and if you have a wasp bite or something, you inject epinephrin, in both cases avoiding potentially nasty complications, so high prices combined with bad insurance make you do without it.

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