U.S. Healthcare Economics -- Why are Drugs Getting More Expensive and Why You Should Care
Written by Lok-Yee Lam
Edited by Sanjana Ahmed
One of the growing concerns that we’re seeing in the U.S. healthcare system is the pricing for brand-name drugs. Over the years, pharmaceutical companies have become notorious for marking up their brand-name drugs’ price tags. These copays and coinsurances can get fairly expensive even if a patient has health insurance. Even worse, for people who don’t have health insurance or a prescription drug coverage plan, they may be left to pay out-of-pocket for the retail price of the drug. Although one may think that the price is driven by the extensive costs undertaken for researching, developing, and marketing the drug, the reality could not be further from this.
What are the payer dynamics in healthcare?
Although the economics of U.S. healthcare are extremely complex and its entirety is beyond the scope of the present discussion, Drug Channels provides a detailed overview of how prescription drugs are distributed and payer reimbursements as summarized in the image above. In short, when a drug manufacturer produces a brand name drug and sells it to pharmacies, a patient receives the drug and pays a portion or all of the retail price listed while the insurance covers the rest. For reference, we can check these retail prices for drugs on websites like GoodRx. As we explore further behind the scenes, this transaction is only the tip of the iceberg.
It may seem logical that the bulk of the profits are split between the pharmacy that filled the drug and the manufacturing company, the truth is that the lion’s share is taken by the other players in the channel. Certainly, big pharma companies aren’t the only players who make money from that prescription fill. As we come to find out, there is a network of stakeholders involved in the pharmacy distribution channel and reimbursement system that are the main drivers behind why prices for pharmaceutical drugs have skyrocketed.
For starters, you are likely to already be familiar with co-pays and co-insurances, which represents the patients’ share of responsibility for paying the prescription. In the simplest of terms, insurance companies pay the remaining balance to the pharmacies to cover the costs of filling the prescription and the drug itself. This implies that the person is covered by an insurance plan that charges a premium and provides the benefit of covering the costs for the drug. However, insurance companies have a strict list of drugs that they cover under their formularies and the extent to which they may cover the drug. Brand name drugs typically fall under tier 2 or 3; either preferred brand name or not preferred brand name, respectively. These tiers differ in the amount an insurance is willing to cover for the prescription. Diving deeper into who pays for the drug that is going to be filled, we will soon see how this becomes an ethical issue in healthcare.
Although the cost of manufacturing the drug is a fractional amount of the listed retail price, insurance companies (also referred to as third-party payers in the diagram) and pharmacy benefit managers (PBM), which are essentially the middle men between the manufacturer, insurance companies, and the pharmacies, take a large cut. PBMs are the main players in negotiating discount rates, fees, and rebates to reduce the cost of the drug on behalf of the insurance companies and in theory, for their service, they also take a fee. Pharmaceutical manufacturers often discount upwards of 50% of the retail price back to PBMs which pass down the savings to insurance companies, but these savings do not benefit the beneficiary despite what they say on paper. On the other side of the distribution channel, wholesalers and pharmacies take a percentage of the sales price too in the form of discounts, fees, and chargebacks. To accommodate for all of these stakeholders and their profits, companies must price their brand name drugs higher every year (and provide even greater discounts) as it becomes more competitive for drugs to get on to formularies. Larger companies have more leveraging power to bundle discounts for PBMs and health insurers. As a result, even if there is an unmet need in a certain health concern, some brand name drugs won’t even be added on to formularies despite its efficacy and ability to address the gap in current treatments. And even if formularies included these newer branded agents, there is no guarantee that the price will be reasonably affordable to the patient (which sometimes can exceed the amount that insurers pay after rebates).
Ideally, the beneficiaries are supposed to benefit from these healthcare plans. The reality is that their formularies are limiting and big pharmaceutical manufacturing companies of brand name drugs are forced to inflate their prices to account for all the players in the distribution channel and stakeholders that seek to profit. In fact, as brand-name drugs’ list prices soar, so do the amount of discounts, rebates, fees, and reimbursements that they need to shell out to these stakeholders (wholesalers, pharmacy benefit managers, insurance companies, etc.). Taking into consideration how much of the responsibility falls on the patient, it is possible to argue that they pay a larger percentage of the net amount manufacturers receive than their insurers.
To gain a better understanding of how this all works, let us use the scenario of a patient with insurance filling their prescription, which is a brand name drug that is priced at $500. Let us assume that this patient has failed to see improvement after trying a generic and a preferred brand, and their doctor prescribed them a non-preferred brand which is a newer treatment option that may have promising results. When the patient goes to the pharmacy and gets dispensed the drug, they are likely responsible for a coinsurance which is usually a percentage of the listed price. For this example, let’s assume that the patient's coinsurance is 20% ($100). The PBM negotiates a 40% rebate from the manufacturer ($200), and passes down 30% ($170) to the health insurer and retains 10% as a fee ($30). The wholesalers and pharmacies retain 10% ($50) too in fees. So the pharmaceutical company receives a net of $250 of the $500 that was listed. Considering these steep discount rates, it is not surprising to see pharmaceutical companies increasing their prices year over year.
There were 30 million U.S. residents that did not have health insurance in the first half of 2020. Even those who are insured may not be able to afford the high prices reflected in their coinsurance or copay. Thus, these prices act as a barrier between them being able to get adequate healthcare. And because of the healthcare economics, we are beckoned to wonder how insurance companies claim to pass down the benefits of these savings to their beneficiaries who pay hefty premiums by providing better service. It also raises the concern on how doctors’ prescribing habits may be influenced by what these patients’ insurance coverage policies and budget are. Are doctors prescribing a drug because they think it will best treat the patient or because it is the only drug that is covered by the patient’s insurance? With these limitations, patients with unmet needs are left unaddressed and, in some cases, can exacerbate future health concerns.
The present discussion is, by no means, a comprehensive take on the issue, but it is a launching point for open dialogue and calls for more price transparency within the healthcare space.
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