Drugs, Pharmacy Benefit Managers, and Perverse Incentives to Raise Prices

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The United States spends more money on healthcare per capita than any other nation.  A little study leads to the conclusion that there is too much profit-taking in our system.  Who makes too much profit?  Everyone it seems.  The pricing of pharmaceutical medicines has received the most attention of late.  Just when one thinks the system of pricing can be explained by simple greed, one learns that nothing is simple in healthcare; it’s a collective system where components collaborate to ensure that profits get widely shared.

The most recent “stunning revelation” appeared in an article by Paul Barrett and Robert Langreth in Bloomberg Businessweek: The Crazy Math Behind Drug Prices.  The presumed new villains in this case are the pharmacy benefit managers (PBMs) who are hired to act as intermediaries between institutional healthcare providers and drug companies in order to negotiate lower drug prices and save the providers money.  These PBMs also have leverage over the drug companies by having control over the list of drugs that are considered “preferred medications.”  If a company’s product does not make that list, then it will lose sales revenue—perhaps a lot.  What the PBMs do is not negotiate the list price of a drug, but the discount price that a given provider will pay for the drug.  The PBMs take a percentage of the savings to the providers as their profit.  People not in one of the provider’s plans will end up paying the full list price.  The insightful reader will have already become suspicious about this system.

“David Hernandez, a 44-year-old restaurant worker and Type 1 diabetic, didn’t have insurance from 2011 through 2014 and often couldn’t afford insulin—a workhorse drug whose list price has risen more than 270 percent over the past decade. As a result of his skimping on dosages, Hernandez in 2011 suffered permanent blindness in his left eye, and three years later he experienced kidney failure. He’s since received a lifesaving kidney transplant covered by Medicare and has drug coverage under a New Jersey program for the disabled. But Hernandez’s eligibility expires next January, at which time he’ll have to pay about $300 a month out of pocket for insulin. ‘I don’t really have that kind of money,’ he says.”

“That Hernandez is struggling to deal with big price hikes for insulin, a century-old medicine that for most of its history cost $15 a month or less, speaks volumes about America’s failing battle to control drug prices.”

Legal action has been initiated in Hernandez’s name by Steven Berman claiming that the interactions between the PBMs and the drug companies are causing the price of drugs to increase rather than decrease—not just for insulin but for many other drugs as well.

“Other plaintiffs’ law firms have followed in Berman’s wake, all of them alleging conspiracies in which the dominant insulin makers—Eli Lilly, Novo Nordisk, and Sanofi—continually raise list prices to curry favor with the largest PBMs: Express Scripts Holding, CVS Health, and OptumRx, a unit of UnitedHealth Group. The four cases pending in New Jersey, which are likely to be consolidated, constitute a threat of massive damages for Big Pharma—and could topple the branded-drug pricing system used in the U.S.”

“Federal prosecutors are also investigating relationships between PBMs and large drug companies. The U.S. Attorney’s Office in Manhattan has ordered Lilly, Novo, and Sanofi to turn over documents regarding those relationships.”

The authors use the history of the drug Humalog to illustrate a pricing system that is out of control.

“When Lilly introduced its diabetes medicine Humalog in 1996, it cost $21 a vial. Today the same vial lists for $275. Patients often use two vials a month. Annual insulin sales worldwide exceed $20 billion.”

Consider the perverse set of incentives operating in the negotiation between PBMs and drug companies.  If two companies have equivalent drugs and one is cheaper than the other, the PBM can make more money from dealing with the more expensive product.  The cheaper drug company recognizes this factor and concludes that it is in its best interest to raise the price of its drug to match or even exceed that of the competitor.  This type of competition can easily lead to competitors frequently raising prices in lockstep.

The drug companies have admitted that this profit motive on the part of PBMs is a real consideration.

“Speaking at an investment conference in June 2016, Lilly’s then-CEO John Lechleiter referred to ‘the weird way the payment system can work in this country.’ He asserted that ‘higher rebates can be an incentive for a payer [PBM] to stick with essentially a higher-priced product’.”

“Lars Fruergaard Jorgensen, CEO of Novo Nordisk A/S, the world’s biggest maker of insulin drugs, says list prices are meant to be only the starting point for rebate negotiations with PBMs. ‘It was never the intention that individual patients should end up paying the list price,’ he says.”

The PBM can use the higher price to provide greater discounts to the healthcare providers.  Consequently, the providers may not be too much bothered by this scam, but this is far from a victimless crime.  We end up with two prices for drugs: the inflated list prices and the negotiated discount prices.  The problem that arises is that people like Hernandez end up being required to pay the artificially high list price.  People without medical coverage, the least likely to be able to pay, will face the list price.  People with a healthcare plan but with a high deductible will be required to pay the full list price until the deductible is met.  The Medicare system is not allowed to negotiate prices with drug companies so the taxpayers are getting gouged, as well as the elderly who use a lot of medications.

The drug companies make out like the bandits they are.  They make a decent profit from the discounted rates they negotiate and make an outrageous profit from the poor souls who must try to pay the list price.

Those bringing the lawsuits have a clear picture of what is going on here.

“All of the lawsuits describe the relationships between drug companies and PBMs as unlawful ‘enterprises’ operating in violation of the Racketeer Influenced and Corrupt Organizations Act.”

Who could argue with that?

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