Drug pricing is having its moment. Thousand-dollar pills to treat Hepatitis C, eye-popping price hikes for common generics, and surging overall spending on pharmaceuticals have rung alarm bells from coast to coast. All the while, drugs continue to be up to twice as expensive in the U.S. as in other wealthy countries. Proposed treatments for the drug pricing epidemic are varied, but some call for government to do more.
While others resist the idea of government involvement, the federal government, in fact, already employs a number of effective tools for reducing the prices of drug purchased by certain public programs. These fall into two broad categories:
- Price controls, usually in the form of required discounts off of the average price paid by other purchasers.
- Negotiated pricing, in which the government wields its market power to bargain for favorable rates from pharmaceutical suppliers.
These strategies do not exhaust the available approaches, nor are they necessarily the most desirable. But as the current drug pricing discussion evolves, it’s worth reviewing the nature and track record of the government’s existing drug price reduction efforts.
Current Approaches to Rx Pricing in Government Health Programs
|Rx spending (billions)a||Discount/
rebate based on average price paid by other purchasers
rebate equal to lowest price offered to other purchasers
rebate if Rx price grows faster than inflation
|340B||$7.5||-23.1%||✔||✔||Via “prime vendor”|
|All public programs||$126|
Notes: Discounts/rebates refer to those applied for most brand-name drugs. The methods used to calculate the “average price” and “lowest price” vary among the four programs, but typically account for discounts negotiated by other drug purchasers.
a The Medicaid spending figure is for outpatient prescription drugs in 2014 (source: MACPAC). The VA spending figure is for nearly all drugs purchased through the program in 2012 (source: Government Accountability Office). The DOD spending figure is for drugs purchased directly by the DOD in 2012 (source: Government Accountability Office). The 340B spending figure is for outpatient drugs purchased through the program in 2013 (source: Apexus). The total public and total spending figures are for retail prescription drugs in 2014 (source: National Health Expenditure Accounts).
While the details differ by state, Medicaid’s drug pricing strategies are mostly based on discounts that drug manufacturers are required to give on retail drugs. In effect, these rebates lower the prices paid by Medicaid to whichever is lower: 23.1 percent less than the average price paid for the drug by other buyers, or the lowest price at which the drug is sold to other buyers. Medicaid gets an additional rebate if a drug’s price rises faster than inflation. In addition to these mandatory rebates, state Medicaid programs can negotiate further discounts.
The Veterans Health Administration (VA) and the Department of Defense (DOD)
The VA and DOD require that drug manufacturers offer them a discounted price—equal to 24 percent off of a drug’s average price or the lowest price paid by other (nonfederal) buyers—as well as further discounts if a drug’s price outstrips inflation. The two programs also directly negotiate lower prices with drug manufacturers. They may engage in these negotiations separately, or combine their substantial market share and negotiate together.
Both programs also use formularies to manage which drugs they cover. These formularies strengthen their negotiating stance. By threatening to offer only limited coverage for a drug, or to leave it off of the formulary entirely, the VA and DOD are able to extract steeper discounts from manufacturers. (Though as a practical matter, and as a matter of law, both programs cover drugs that are medically necessary.)
Little-known outside policy circles, the 340B Program (named after section 340B of the Public Health Service Act, which authorizes it) requires drug manufacturers to offer discounts on outpatient drugs to certain hospitals, community health centers, and other facilities that treat large numbers of low-income patients. These discounts are available for drugs dispensed by a 340B provider, or for drugs dispensed by an outside pharmacy that has contracted with a 340B provider.* For the most part, these discounts are similar to the rebates in the Medicaid program.
The 340B Program also works with a private company called a “prime vendor” to negotiate even steeper markdowns. Because the combined market share of 340B providers is quite large—roughly 45 percent of all hospitals participate—the prime vendor can sometimes negotiate better deals with drug manufacturers than the mandated discounts.
Medicare Part B?
On the topic of drug pricing and public programs, we’d be remiss not to mention the Centers for Medicare and Medicaid Services’ recently proposed pricing change for drugs administered under Medicare Part B. Currently, Part B reimburses doctors and hospitals 106 percent of the average sales prices for a given drug—the extra 6 percent serves as a fee to account for providers’ nonmedication costs, or overhead. The concern is that the 6 percent fee is larger for an expensive drug than a cheaper drug, providing a financial incentive for doctors to prescribe pricier medication. Under the proposed model, the fee would instead be 2.5 percent of a drug’s price plus a flat rate of $16.80.
So, contrary to how it has at times been described, the proposed change is not an attempt to reduce drug prices paid by the Part B program directly. Rather, it aims to remove an unintended financial incentive under the current system for health professionals to provide highly expensive pharmaceuticals. Because the proposed reform has prompted considerable opposition from providers and elected officials, its fate remains uncertain. A second phase of the proposed Part B payment model, which aims to encourage value-based prescribing, may include some elements that reduce drug prices for the program. However, the details for this phase have yet to be laid out.
The strategies described above clearly result in cheaper drugs for the VA, DOD, Medicaid, and 340B providers. The Congressional Budget Office has estimated that the VA and DOD pay drug prices that are roughly half as much as those paid by retail pharmacies, and that Medicaid pays about one-third less than Medicare Part D (which pays whatever prices its plans negotiate in private markets). The agency that runs the 340B program estimates that it reduces drug prices for participating providers by one-third.
The bottom line is that the government can and does get better deals on drugs than private purchasers. The effects of these policies on quality and innovation need to be better understood—but were the government to expand them, it would be more of an evolution than a revolution.
* An earlier version of this blog incorrectly stated that 340B discounts were only available for drugs dispensed by a 340B provider.