Picture this – your baby has infantile spasms (IS), a rare condition that could kill. Only one drug works, Acthor from Questcor Pharmaceuticals. The drug costs $1,650 a vial – until Questcor jumps the price to more than $23,000 a vial, putting the cost for a course of treatment at $80,000 to over $100,000, according to the company.
Or maybe your kid has a rare kidney cancer, and again there is one drug that works, Cosmegen from Ovation. And overnight the price jumps from $16.79 per dose to $593.75, more than 34 times as much.
Or suppose you have a more common disease, HIV/AIDS, and you are depending on an expensive, difficult, and ever-changing cocktail of retrovirals and other drugs to keep you alive – and one of the principal drugs, Abbott Laboratories' Norvir, suddenly quadruples in price to over $1,200 per prescription.
How do you feel? What do you do?
Okay, you might say, these people are insured or they have Medicaid. No one is paying these prices themselves. Maybe. And in fact, for "Orphan Drugs" for rare diseases, it is more likely that few, if any, patients or families are paying the price out of pocket. The companies making them establish programs to help patients find funding. And the companies claim that without these price increases they would have to stop making them, and then where would the patients be?
Questcor, for instance, is not a huge company. It bought the drug Acthor in 2001. In recent years it has not made the huge profits common to the pharmaceutical sector. Before the price change, it was losing about $10 million per year. So the price increase was the most rational action for the company to take, both to stay alive and to keep its patients alive.
But the problem remains. An estimated 64 drugs will more than double in price this year, up from 22 in 2004, according to researchers at the University of Minnesota. Some individuals and families do pay the cost (or a portion of it) out of their own pockets. Many make the choice to pay for rent, food, heating fuel, and gas to get to work, rather than refill the prescription. Here in the United States, where we spend more than anybody in history for healthcare, people actually die because they can't afford the drugs that would save them.
And the drug companies have no price pressure on them. Every other major economy in the world negotiates prices with drug companies, sets caps, mandates generics – they actively manage their economic relationship with the drug companies. The United States government, the largest buyer of drugs in the world, does not. By law and regulation, it is forbidden to. It must pay the price the drug company sets. So the price pressure on drug companies is, in fact, in the other direction. If you're an executive team at a drug firm, you want to push that official U.S. price as high as possible, to give you negotiating room with everyone else – private payers in the U.S. and other governments around the world.
The U.S. government not only offers the drug companies the shield of non-negotiable prices, it does this without even demanding that the company open its books to show its real costs. If the company says, "We need $14,000 a dose, because the drug costs us $12,000 a dose to produce," the government says, "Okay." How much of that cost is phantom, a product of creative bookkeeping, no one outside the company can know. One is reminded of Hollywood bookkeeping, which is notorious for producing no profit, even on blockbuster hits.
This is a condition of severe information asymmetry.
Even if the putative costs are real, are they irreducible? The situation also relieves you, as a drug company executive, of much of the pressure to improve your processes and bring down the cost of producing the drug. Are there efficiencies to be gained in manufacturing the drug? Who knows? Lowering your cost of production would increase your profit. But your profit on the drug is already comfortably high, so the Wall Street analysts are not coming at you with torches and pitchforks to get you to wise up. Could you "auto-genericize" your own drug, inventing a new formulation that would produce the same effect for less? Why would you do that when you can make a good profit for years to come on the drug that you have? Why spend research money to cannibalize your own product?
When most people pay for drugs out of their own pocket, it is very difficult for people to pay for them. Some people even die because they can't afford them. On the other hand, that awareness does serve as some brake on price increases. When most people are not paying out of pocket (and there is no other brake on prices), drug prices rise. If you look at any graph of price rises in drugs in the United States, you will see a sharp tick upwards starting in the early 1990s – just when many health plans began covering prescriptions. Now we are seeing a new uptick in the past several years since Medicare began to cover drugs as well.
So what these drug price increases tell us is not that pharmaceutical companies are evil. They are doing what we are paying them to do, playing the game according to the rules that we have set up. What they tell us is that here, as elsewhere in healthcare, there is no feedback loop forcing the pharmaceutical companies to compete to provide us the most effective drugs at the lowest price.
Economics 101: People do what you pay them to do, and they notice the shape of what you are paying them to do with great specificity. If we want to reform healthcare, we have to find ways to define just what it is that we want (in every part of the industry), measure what we get, let providers and producers compete to provide the best result at the lowest price, and only pay for what really works at the lowest possible price. If there is no competition (as there often is not for certain orphan drugs and vaccines), obviously the government must provide subsidies to the drug companies to produce the drug – but only if the companies truly become partners of the government, open their books and accept price caps. In no industry, in no situation, will you get efficiency and effectiveness if you don't demand it and pay for it.