The debate around pharmaceutical pricing has become much more prominent in the past decade, predominantly with the emergence of the Patient Portability and Affordable Care Act (PPACA), otherwise known as Obamacare. As pressure grow from payers, and the election cycle winding up the past few years introducing a major transformation for America, drug pricing has become a top of mind issue for America, though few people really understand the many layers of complexity surrounding the topic.
Pharmaceutical drug pricing has been a contentious debate ever since the introduction of drug rebating and incentives. Pharmaceutical companies, under threat from the growing generics market, began offering competitive pricing discounts to pharmacy benefit managers (PBMs), as they jockeyed for dominant market position. This effect spiraled out of control between 1992 – 2002, as behind the scenes, the rebating and incentive programs created large financial arrangements between pharmaceutical companies and PBMs to market expensive brand name medications, under the guise of saving the healthcare system money. The added focus from certain bad actors within the industry of late, such as the price hikes from firms such as Turing Pharmaceuticals, Valeant, and Mylan, have only added fuel to the fire as of late. So much so that it became a key political issue for the Presidential Election of 2016, yet few understand the dynamics of why prices increase.
To start with, the costs of research & development of a drug has increased over the years, as scientific and technologic breakthroughs have allowed more targeted delivery vehicles, so have the costs incurred. In fact, from the 1970s until 2010, the costs of both the preclinical and clinical phases of drug development have increased more than 10-fold, as expressed in Figure 1.
Figure 1 – Cost to Develop New Pharmaceutical Drug
When combined with the fact that on average, only one out of 10,000 molecules ever makes it from the discovery phase to FDA approval (Figure 2), and the additive costs of all those failed molecules balloon to alarming proportions. In a study published March of 2016 by Tufts on the assessment of cost to develop and bring to market a new drug, a pharmaceutical company must spend on average $2.558 Billion. Couple that figure, with the ever growing threat from biosimilars, and the industry is fueled for even more aggressive spend into R&D to counter by scrambling to produce the next generation set of compounds.
Figure 2 – The Biopharmaceutical Research and Development Process
With the costs of R&D growing, another factor affecting the pricing equation is the amount of rebating towards the pharmacy benefit managers (PBMs). Since the establishment of drug rebating between pharmaceutical manufacturers and benefit managers, the percent rebate off of the gross price of a drug’s price has only grown. PBMs realized this was an additional revenue stream for them and quickly monopolized on this trend, while leaving their clients with the burden of the cost, leading up to the class action lawsuit against Caremark in 2011. To demonstrate further, in Figure 3, one can see that since 2010, while the overall invoice price of a drug has grown, the overall net brand price has decreased. This inverse relationship is largely attributed to the increased % of rebating. Going one step further, if you look at the rebate system of a PBM, they recoup a percentage off of a medications Average Wholesale Price, or AWP as known in the industry. If they were to push for decreased pricing, they would gain a smaller total sum of reimbursement, so it’s in fact in their best interest to keep drug pricing high, as they push the rest of the costs on to their member groups and inevitably their individual members.
A final factor that has attributed to the cost of increasing drug prices is the decrease of treatable patient populations for each specific drug. As technology and medical advancements progress, drug discovery has had both the delivery as well as the specificity increase. From the days of targeting HER2 receptors for women with breast cancer, we now are seeing medications targeting specific genetic mutations such as BRCA 1/2. We also are developing even more treatments with the advent of RAS/CRISPR technology, that can isolate specific genetic mutations within the human genome. This has resulted in drugs that went from a target treatable population of hundreds of millions with disease states such as high cholesterol and diabetes, to a treatable patient population of thousands, such as in the case of Pfizer’s Embraca (talazoparib).
In conclusion, between increasing R&D costs, increased pressure and rebating from payers, and diminishing target patient populations, it’s little wonder why the prices of medications keep increasing. What many do not seem to understand however, is that drug pricing is overall still only 10% of the total healthcare spend in the US, see in Figure 4. Yet there is still tremendous political focus on lowering drug prices when in reality, it’s not in the hands of the government, but in the hands of the payers. Without regulation of the payers, there can be no lowering of drug pricing. Biosimilars will likely have minimal effect on the long-term reduction in drug spend, as the overall industry will focus on pushing next generation, more specific compounds with higher prices to alleviate the burden of R&D and ever diminishing treatable patient populations. The focus should instead, be directed towards correcting the overspend in the hospital and provider side of the healthcare system, reducing fraud and abuse of CMS billing, and shifting the entire industry towards proactive, preventative health.
 Martinez, Barbara (August 14, 2002). “Pharmacy-Benefit Managers at Times Toil for Drug Firms”. The Wall Street Journal. Retrieved December 27, 2015.