Soaring drug prices? Here's how to control them

Life-saving drugs are getting more expensive
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Scott W. Atlas is the David and Joan Traitel Senior Fellow at Stanford University's Hoover Institution and the author of "Restoring Quality Health Care: A Six-Point Plan for Comprehensive Reform at Lower Cost" (Hoover Press, 2016). The views expressed in this commentary are his own.

(CNN)New Health and Human Services Secretary Alex Azar has identified his main priorities. At the top of his list is lowering prescription drug prices.

Even though prescription drugs constitute only 11% of US health expenditures, according to the Centers for Disease Control and Prevention and Centers for Medicare and Medicaid Services, and US drug spending ranks in the bottom one-third of comparison lists with other developed nations, prices continue to increase rapidly here, with a year-over-year rise of almost 10% for drug list prices, according to a 2017 Credit Suisse report.
Scott W. Atlas
Controlling drug prices through government action though is fraught with peril, because it could also slow the process of making new drugs available to Americans. A much smarter way to go is to make drug prices -- which can vary dramatically from one pharmacy to another -- readily apparent to patients and equip them with the incentives to shop around.
Drugs are the most significant reason behind the past half-century gains against both chronic and life-ending disease. Policies aimed at reducing drug costs must not restrict their supply, jeopardize their quality or inhibit essential drug innovation necessary for tomorrow's cures.
    American patients in particular have benefited more than others from drugs. For decades, the United States has been the most frequent country, by far, where new drugs are first available. Life-saving cancer drugs, as one critical example, are at least four times more likely to be made first available here compared with any country, including Germany, Japan, Switzerland, France, Canada, Italy or the UK, as reported in the Annals of Oncology in 2007.
    Similarly, two-thirds of the novel drugs OK'd in 2015 were approved in the United States before any other country. Most recently in a 2017 study, of 45 new cancer drugs approved by the Food and Drug Administration from 2009-2014, all of which were covered by Medicare in the United States, only 26 were approved and covered in the UK, only 19 in France, only 13 in Canada and only 11 in Australia.
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    This early and broad drug access is key to delivering America's better treatment results than nationalized systems elsewhere, where drug prices are strictly regulated by government, for virtually all serious diseases reliant on drugs, including cancer, heart disease, stroke and the most important chronic disorders, including high blood pressure and diabetes.

    Prices and profit margins

    Not surprisingly, prices and profit margins for prescription drugs in the United States dwarf those in foreign markets. It is obvious that economics represent a key incentive for the constant innovation and first access to life-saving drugs that Americans enjoy. Indeed, that is the conundrum: The same policies that are associated with the lower prices seen in other countries -- price regulation and weaker patent rights -- are also those that are typically associated with delayed launches and reduced access to drugs.
    In addressing legitimate public concern about drug prices, our politicians must avoid the temptation to impose top-heavy regulations. Price caps may seem intuitively attractive, yet price caps always restrict supply of the product, and drugs are no different. One study showed that price regulation strongly delayed drug launches of 642 new drugs in 76 countries. Another showed that price controls significantly diminish early-stage research and development.
    We also know that if a single buyer is as dominant as Medicare, it functions like a monopsony, where price "negotiation" ultimately leads to supply shortages and fewer new products, as economist Paul Krugman and others have noted in other industries. Empowering the government as price negotiator would also facilitate future restrictions based on political budgets, rather than on medical data.
    Case in point is Britain's National Health Service 2017 "budget impact test," which delays introducing any new drug -- even though it may already be proven cost-effective -- if the cost would exceed an arbitrary £20 million (about $28 million) per year, and even though all branded drugs are already price-regulated under the UK's Pharmaceutical Price Regulation Scheme.

    Competition

    One major problem is that patients are neither positioned nor incentivized to exert pressure on drug prices directly. In the United States, many different parties pay directly for drugs -- employers, government and insurers -- but the true end-user, the patient, is not one of them. Patients are sheltered from any incentive to shop for lower prices by insurance that minimizes out-of-pocket costs.
    Adding to that is an extraordinary lack of price transparency, fueled by complex behind-the-scenes rebates totaling $179 billion (in 2016) from companies to pharmacy benefit managers, the government and insurers that pervert incentives and prevent any possible price consideration by patients.
    Worse, many pharmacy benefit managers contractually prohibit pharmacists from volunteering that a medication may be less expensive if purchased at the "cash price" with contractual "gag clauses," according to a 2016 survey of more than 600 community pharmacies. And newly published data revealed that well over 20% of patient co-pays using insurance actually exceeded actual total drug costs if patients paid by cash.
    Some have proposed that Medicare provide even more coverage for drugs, but further reducing out-of-pocket payment would only prop up prices. It would eliminate incentives for patients to consider price and prevent the very competition necessary to lower prices while enhancing quality.
    Instead, patients should be positioned to pay directly for more of their drugs with cheaper, higher deductible drug coverage, coupled with larger, liberalized health savings accounts, including specifically for seniors, the biggest consumers.
    Senior citizens make up about 12% of the population but account for more than 34% of medication use. More than 15 million seniors take five or more medications, and that number has tripled from 1988 to 2010, according to a study by Charlesworth in 2015. Health savings accounts are prohibited for seniors, but gains in life spans necessitating medical care for decades after Medicare eligibility and the recognition of the massive market power of the elderly argue for permitting Medicare beneficiaries to hold such accounts.
    Eliminating excess regulatory barriers to the supply of new drugs and generics is also needed, because it would leverage the power of competition. Under Scott Gottlieb, the FDA has dramatically reversed the downward trend in drug approvals, with 68 new drugs and biologics approved in 2017 (including those by the FDA's Center for Biologics Evaluation and Research), the highest in decades. Gottlieb's FDA also increased generic drug approvals by 60% in 2017 over the previous year. More work is needed, including considering selective importation of generics, an idea that is less complex because generics do not have unique intellectual property.

    Price-conscious patients could save money

    The hidden truth is that prices vary tremendously between drugstores for the same exact drug, yet patients are not sufficiently incentivized to alter buying patterns. In a December 2017 Consumer Reports study, the national average price between different retailers for a one-month supply of five common generics ranged by up to a factor of 20; for example, the generic version of cholesterol-reducing Lipitor ranged from $12 or $13 at HealthWarehouse.com or Sam's Club to $242 at Kmart.
    Even in a single city, the 30-day supply price showed a tenfold to 17-fold variation per drug. For the nearly 40 million senior citizens taking five or more medications daily, the savings would be many hundreds of dollars per month.
    Prices for medical care actually do respond to competition -- when patients have incentives to save money, as long as prices are transparent.
    Prices have plummeted for medical procedures that relied on direct patient payment because they were not covered by insurance, such as head-to-toe screening by CT and MRI, or LASIK surgery for vision correction. In models incorporating price transparency with defined benefits, prices for MRI and outpatient surgery were quickly forced down by nearly 20% due to the leverage of value-seeking patients.
    Congress and this administration are poised to propose policies on prescription drug prices, an issue that has heightened in visibility in the wake of widely covered price gouging as well as inflammatory comments by some pharma CEOs, most notably by now-jailed Martin Shkreli.
    Americans have noticed. A September Politico/Harvard School of Public Health poll indicated that from 76% to 88% of voters, depending on party, said it "should be a priority" for this Congress to address prescription drug prices.
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    But instead of replicating the same misguided policies that ultimately contribute to worse disease outcomes in socialized systems, the Trump administration should unleash competition for price-conscious patients.
    Eliminating excess regulatory barriers to the supply of drugs, coupled with empowering patients incentivized to compare prices, would reduce prices by competition, a pathway to help optimize value without harming the unique access to drug treatment enjoyed by American patients. And for those who argue against leveraging market forces in health care, we are reminded of what Milton Friedman observed -- that underlying most arguments against the free market is a lack of belief in freedom itself.