By Benedic N. Ippolito
As Congress debates major overhauls to the US drug market, new research is highlighting the increasingly bifurcated nature of domestic drug prices. These data point to a more nuanced relationship between policy and innovation and can help inform ongoing debates about insurance design.
Political attention on drug pricing is understandable. Prices of branded drugs — those without generic copies — are typically higher in the US than in other countries. As a result, aggregate domestic pharmaceutical expenditures dwarf those of any other nation.
That said, brand drug prices are far from uniform within the US. As a recent Congressional Budget Office (CBO) report shows, drug prices vary substantially even across federal programs. Among the starkest findings are the low, and rapidly falling, prices paid by Medicaid.
In 2017, prices for branded retail pharmaceuticals were 65 percent lower in Medicaid than in Medicare Part D. Moreover, Medicaid prices have fallen sharply relative to other metrics. For example, Medicaid prices for branded outpatient drugs were roughly equal to prices available to direct federal purchasers (“FSS prices”) in 2003. Fourteen years later, they were 63 percent lower (see Figure).
More generally, the report re-emphasized the fact that list prices of drugs far outpace payments made by any domestic payers. While these facts are relevant to a host of ongoing debates, I’ll emphasize two.
Heterogenous Effects of Pricing Reforms
The drug pricing debate centers around a core tradeoff: Higher prices increase costs to consumers and taxpayers but also increase incentives to pursue innovations. However, the innovation effects of various reforms to drug pricing are likely to differ substantially depending on what markets they effect. Recent research is consistent with this.
The introduction of Medicare’s prescription drug benefit (Part D), for example, spurned investments targeting conditions that were prominent among those gaining coverage. Surprisingly, a recently released paper shows the same may not be true of recent Medicaid expansions. These divergent results could reflect the major differences in prices across markets, as documented by CBO. While Medicare reimbursements are similar to those in the commercial market, Medicaid prices are very low and falling relative to other payers.
This suggests a somewhat nuanced picture. If R&D is unresponsive to Medicaid program changes, this implies manufacturers may already view that market as unattractive. To the extent that means conditions common in this market are currently being overlooked, policymakers may want to increase incentives in those areas. However, if Medicaid’s prices already mean it plays a trivial role in R&D decisions, the innovation costs associated with further price cuts may be less pronounced than if applied to other markets.
Addressing List Prices
These data also vindicate efforts to reduce the influence of high list prices. Even amidst meaningful variation, none of the programs pay anywhere near list prices. Yet, enrollee cost sharing can still be a function of list prices (notably in Medicare and the commercial market). While these pricing decisions are those of the manufacturer, they appear consistent with the desires of insurers. This type of cost sharing partially unwinds the effects of community rating by lowering premiums for all consumers at the expense of those (generally sicker) that take high-priced medications.
This is particularly pronounced within Medicare Part D, as MedPAC has emphasized. In response, proposals from across the hill — including the Prescription Drug Pricing Reduction Act (PDPRA), the Elijah E. Cummings Lower Drug Costs Now Act (HR 3), and Lower Costs, More Cures Act (HR 19) — would all meaningfully reduce these problematic incentives.
Both the PDPRA and HR 3 would go further by limiting the rate at which list prices could increase over time. It is unclear that this solves the stated problem, in part, because manufacturers could respond by setting higher list prices at product launch. Instead, policymakers could work to ameliorate the incentives that encourage such differential pricing in the first place. One option is to disallow the use of list-price-based coinsurance in Medicare in favor of fixed copayments or coinsurance based on net prices.
By severing the link between high list-to-net pricing behavior and lower premiums, policymakers can better align incentives between plans and enrollees. Even if restricted to Medicare Part D, historical evidence suggests this could spill over into the commercial market.
 Note that this would need to use either a trailing measure of net prices or an estimate to reflect the ex-post nature of rebating. Ensuring compliance would likely only require that realized net prices are within acceptable range of “real-time” estimates. Policymakers might also further consider aggregating rebates across insurers to protect the confidentiality of payer-specific prices.