The Prescription Drug Scam
As I wrote in my earlier article about the U.S. healthcare system, the costs Americans pay for their prescription drugs are wholly out of line with the prices that are charged for the same drugs in other developed countries. This problem became even more apparent to me late last year when I undertook to review the monthly statements sent to me by my prescription drug insurer. Those statements revealed an anomaly that I found disturbing. What seems apparent is that the prescription drug industry and the prescription drug insurers have joined forces to increase the prices that are charged in the U.S. for prescription drugs, all to the detriment of the American public.
When I first subscribed to my prescription drug plan a year ago I was surprised to learn that there were no monthly premium payments. I, therefore, assumed that I would be billed as the year progressed based upon the costs of the prescription drugs I was purchasing. Silly me. What I discovered was that the monthly statements sent to me (commonly referred to as “Explanations of Benefits” or “EOBs”) showed that my insurer was covering a significant percentage (usually around 60%) of the stated “costs” of the drugs I had purchased. This raised the question as to the source of the funds my insurer was using to help pay for my drug purchases.
Two thoughts immediately came to my mind. The first was that my insurer was simply claiming credit for monies that Medicare was paying on my behalf. This, however, seemed unlikely because my experience with Medicare has been that it generally only pays a small percentage of what doctors and hospitals charge—not 60%. Another possibility was that the amount that I was being “charged” for my prescription drugs was not a market-driven price and that my co-payment obligations actually represented more than the actual costs my pharmacy had to pay to acquire the drugs I was purchasing. While this latter theory seemed like a distinct possibility, what I later discovered was that my local pharmacy was working on a 2% mark-up and was paying the drug distributor from which it acquired my drugs almost as much I was paying for my drugs. This theory, while erroneous, was not far from the truth.
In my search for an explanation as to how the drug insurance system works, I called my prescription drug insurer and inquired as to the source of the monies it had used to help pay for my drug purchases. The young lady who answered my call suggested that her employer offered numerous types of policies for which it received premiums and that the monies earned from the sales of those policies was used to pay for the drugs I was purchasing. This seemed highly improbable because insurance companies have a long history (as well as an obligation to their shareholders) of dropping those customers who cause them to lose money. I, therefore, asked to speak with her supervisor. Her supervisor’s answer was no more enlightening as she told me that her company may have been using monies provided for my benefit by the Medicare Program. That answer was equally unsatisfying so I asked to speak with her supervisor who suggested a host of other possibilities without specifying the actual source of the funds that my insurer was using to pay for my drug purchases. It was beyond belief that someone at her level would have no clear understanding as to how her company operated.
My conclusion was that there was no way that my insurer was using its own resources to pay 60% of the costs of my drug purchases. It was similarly clear that neither my local pharmacy nor the drug wholesaler from which my pharmacy purchased my drugs was putting up any money on my behalf. In any event, there was something going on under the table that I and other insureds were not being told. These conclusions led me on a quest to figure out just how the whole system operates.
Prescription drugs are produced and consumed all over the world; and the U.S. produces 53% of them and consumes roughly 29% of those which it produces. This means the U.S. exports an almost equal amount of prescription drugs as it consumes. These numbers don’t tell the whole story, however, because U.S. pharmaceutical companies produce roughly 72% of the active ingredients incorporated in their products outside the U.S. This enables them to claim that the vast majority of the revenues generated from their drug sales is created abroad, thereby allowing them to avoid paying the U.S.’s higher corporate taxes on a majority of their profits.
Notwithstanding their overseas production which actually reduces their operating costs (as well as the taxes they pay to the U.S. government), the average price of all prescription drugs in the U.S. is roughly 2.78 times the average price of their drugs sold in other developed countries. This differential is primarily attributable to the fact the prices of prescription drugs in the U.S. are purportedly set through “free market” negotiations. By contrast, the prices of their drugs in other developed nations are regulated by their respective governments which focus more on the manufacturing costs of the drugs than on the costs of developing them (which could be more than ten times their manufacturing costs).
Unquestionably, the pharmaceutical industry is filled with business risks and those risks can be huge. In fact, the costs of getting a new drug approved by the FDA can be as high as $100 million. That’s because the FDA requires extensive testing of each drug it approves in order to make sure that it’s both safe and efficacious. Moreover, it is not unusual for the FDA to refuse to approve a drug after its review or to even withdraw its approval if adverse side-effect appear after the drug has been approved. In both such cases the drug company would be forced to write-off its entire investment in the drug.
Another factor influencing the high cost of a new drug is that the approval process in the U.S. can take up to ten years and the patent life of a new drug is only 20 years. After the drug’s patent has expired the drug may be produced and sold by a dozen or more generic drug manufacturers causing the market price to drop by 90%. This means that prescription drug manufacturers have a relatively short window in which to capitalize on their investments in formulating, testing and getting their drugs approved by the FDA.
Prescription drug manufacturers not only have to fend off competition from generic drug manufacturers after their patents have expired, but also competition from other producers of similar drugs capable of addressing the same malady. That potential competition could affect the price that they are able to charge for their drug. Although most pharmaceutical manufacturers seek to protect themselves against this source of competition by erecting veritable walls of patents covering their drugs, there is ample reason to believe that competing drug manufacturers have “gentlemen’s understandings” that engaging in price wars over their competing drugs is not in their best interests. We currently see that phenomenon in the prices of two new weight-loss drugs, Ozempic and Wegovy, for which a 28-day supply without insurance at your local drugs store costs approximately $1,350 for both drug, even though it has been advertised that a 28 day supply of Ozempic may be purchased “on line” for as little as $145 (or 10.7% of its retail price).
While the similarity in their pricing could be a product of price-fixing, it must be understood that drugs that address the same malady do differ; and that even the highly successful ones are only effective for as much as 50% of the population. The result is that when a patient finds a drug that helps him/her there is a strong tendency not to try another drug even if the price of the drug he/she has been taking is constantly being increased (as is the case of most prescription drug with patent protection) or if another drug within the same class costs less. This reluctance of patients to switch drugs certainly helps to explain why pharmaceutical companies may not be tempted to engage in price competitions. However, it doesn’t explain why drug companies do not reduce the retail price of their drug if their drug can be purchased in Canada or on-line for a small fraction of its retail price.
The long and arduous task of developing a new prescription drug and getting it approved, however, only partially explains its high costs. The real problem is that, unlike in other developed countries, the U.S. government has historically taken a hands-off approach when it comes to drug pricing, allowing it to be controlled by “market forces”; i.e. supply and demand. The problem is that when you are ill, obtaining relief has a very high value so that individual patients are generally willing to pay almost anything that the pharmaceutical companies wish to charge. Enter the prescription drug insurers, one of the principal functions of which is to consolidate the purchasing power of drug users to offset the inherently stronger bargaining positions of the drug manufacturers. This seemingly explains why individuals without prescription drug insurance are asked to pay more than twice the out of pocket costs paid by those with prescription drug coverage.
U.S. pharmaceutical manufacturers claim that the prices they charge in the U.S. are justified by the high costs of developing their drugs which have been estimated to be over $60 billion each year. That claim, however, is belied by the fact that the average after-tax profit margins of the 35 largest U.S. pharmaceutical manufacturers is roughly 13.5% as compared to 7.7% for the remaining 357 largest U.S. manufacturing companies. In addition, U.S. pharmaceutical manufacturers sell their products in other countries at roughly a third of the price they charge in this country; and you can safely bet that they are still able to reap a profit at those lower prices. Certainly the generic drug manufacturers think they can earn a profit selling their products even at post-patent-expiration prices.
The puzzling thing is why the market price for almost any given drug in the U.S. is still over two and a half times greater than the price that U.S. pharmaceutical manufacturers charge for their products in other developed countries. The logical answer would appear to be that the bargaining power of U.S. prescription drug insurers is not as great as the bargaining power of the governments in other countries that negotiate drug prices on behalf of their citizens. What makes that differential particularly troubling is that the U.S. is by far the world’s largest market for prescription drugs which strongly indicates that drug prices in the U.S. should be lower.
One factor that could explain this differential is that even though the vast majority of Americans have prescription drug insurance, the market for that insurance is quite fractured. Operating in the U.S are over 1,000 prescription drug insurers in addition to three agencies of the federal government (Medicare, Medicaid and the Veterans Administration) which alone fund over 40% of all domestic drug purchases.
Sadly, until this year the Medicare Program has been prohibited by law from negotiating the price of prescription drugs which it purchases for its beneficiaries. The result is that, despite its potentially huge bargaining power, the Medicare Program is simply required to pay the same price that the healthcare insurers negotiate for their insureds. This is because the federal government in 2010 gave up the right for the Medicare Program to bargain with the pharmaceutical industry in order to secure the passage of the Affordable Care Act. That was the price the pharmaceutical industry exacted to drop its opposition to the ACA. It’s important to understand the extent of the political influence which PhRMA, the trade association for large pharmaceutical companies, has over the U.S. Congress. Indeed, PhRMA is said to employ three lobbyists for every member of the U.S. Congress.
The Medicaid Program is also relatively powerless to negotiate prescription drug costs. That’s because each of the fifty states operate their Medicaid programs individually under guidelines prescribed by the federal government which subsidizes the state operated programs. Accordingly, of the three federal agencies which fund the purchase of prescription drugs only the Veterans Administration has been free to negotiate the price of drugs it purchases for its patients. The VA negotiates directly with pharmaceutical companies and, as a result, it pays less than half of what the Medicare and Medicaid programs are charged for the drug purchases they fund. I can assure you that it’s clearly not out of a sense of patriotism on the part of the pharmaceutical companies that accounts for the lower prices they charge the VA.
The inability of the Medicare and Medicaid programs to negotiate drug prices effectively means that the prescription drug insurers bargain with the pharmaceutical manufacturers over the prices that will be charged to the vast majority of Americans. Even though the prescription drug insurance industry consists of roughly 1,000 insurers, no more than a dozen of them have any significant bargaining power in negotiating drug prices. To further consolidate their negotiating power, the prescription drug insurers have chosen to employ the services of Pharmacy Benefit Managers (or PBM’s) to negotiate on their behalf with the prescription drug manufacturers. The result is that the three largest PBMs (CVS Caremark, Express Scripts and Optum Rx) manage the negotiations relating to roughly 80% of all prescription drugs purchased in the U.S.
While, on its face, this sounds like an arrangement that should achieve maximum bargaining power for the U.S. purchasers of prescription drugs, the results, however, do not even begin to fulfill that expectation. All of these negotiations take place behind closed doors so it’s difficult to know for sure why this is the case, much less who is getting what and from whom.
Based upon the known facts, two conclusions appear beyond dispute:
A. The drug prices negotiated between the PBMs and the prescription drug manufacturers are collusive arrangements and are not the result of arms-length negotiations. This conclusion is based upon the following facts:
a. As itemized below, other significant purchasers of prescription drugs (with considerably less bargaining power than the PBMs) who negotiate directly with the prescription drug manufacturers pay far less than the prices negotiated by the PBMs;
b. For the reasons mentioned above, there is a strong basis for believing that my prescription drug insurer’s ostensible payments toward my drug purchases are fictitious;
c. The prescription drug companies have admitted to paying the PBMs for including their drugs on the formularies (the list of drugs that an insurer will cover) the PBMs prepare for their insurance company clients. Such payments not only create a blatant conflicts of interests for the PBMs, but are also something no legitimate commercial enterprise would allow its bargaining agent to accept;
d. The PBM’s allow the prescription drug manufacturers to increase the prices of their drugs far faster than the rate of inflation even though at the same time increases in the manufacturer’s volume of sales is driving down its per-unit production costs;
e. The prescription drug manufacturers remain adamantly opposed to allowing the Medicare Program to negotiate drug prices; and
f. The entire negotiations between the PBMs and the pharmaceutical manufacturers are cloaked in secrecy.
B. The prices of prescription pharmaceuticals negotiated by the PBMs are almost three times the prices that would be achieved through arms-length negotiations. That conclusion is based upon the following facts:
a. The prescription drug manufacturers charge the VA (which funds roughly 15% of prescription drug purchases in the U.S.) less than half of what they ostensibly charge the insurers who fund roughly 80% of the prescription drug purchases made in the U.S.;
b. The prescription drug manufacturers ostensibly sell their products in the U.S. for an average of roughly 2.78 times the prices at which they sell those same products abroad;
c. The U.S. prescription drug manufacturers are reputed to sell their products in on-line transactions at prices equal to roughly 10.7% of the prices charged in U.S. retail drug stores; and
d. The costs of actually producing and selling the drugs produced by U.S. pharmaceutical manufacturers is significantly less than 10% of the retail prices negotiated by the PBMs as revealed by the price of prescription drug sales following the expiration of the drugs’ patent protection.
The evidence thus strongly indicates that the PBMs allow the drug manufacturers to establish extraordinarily high prices for their products as a means of getting individual drug purchasers and the Medicare and Medicaid Programs to pay amounts which will be sufficient to richly reward both the prescription drug insurers and the PBMs as well as the drug manufacturers. Stated another way, it appears that the system in the U.S. for the pricing of prescription drugs has been manipulated to the detriment of drug purchasers and the Medicare and Medicaid Programs.
Admittedly, the machinations orchestrated by the PBMs remain under a cloak of secrecy so it is difficult to determine the exact flows of the monies among those participating in the distribution of prescription pharmaceuticals. The one possibility that stands out is that the insurance companies may not be paying anything toward the drug purchases of the American public. Just how the monies taken in are actually divided and whose hands they may pass through in achieving that distribution remains a secret. There is also a real possibility that it may be different for different insurers, depending on the extent to which their organizations are vertically integrated with drug pharmacies and drug distributors.
This raises the question as to what, if anything, our federal government has been doing to control the prices of prescription drugs. The sad truth seems to be “precious little.” As noted above, the large drug manufacturers have considerable influence over the members of the U.S. Congress. This influence is primarily achieved through campaign contributions. Specifically in 2020 pharmaceutical manufacturers made political contributions to 72 U.S. Senators and 302 members of the House of Representatives totaling $29.9 million. In 2024 their political contributions are believed to be slightly below that amount.
President Biden sought to chip away at the prohibition preventing Medicare from negotiating drug prices by inserting a provision into his Inflation Reduction Act (IRA). That provision authorizes the Medicare Program to negotiate the prices of a limited number high-priced drugs, starting with ten items in 2025. Even that effort has largely become a sham as nine of the ten drugs that were selected have (or will have) lost their patent protection by the time the negotiated price reductions will become effective. Although the negotiated prices will have little practical impact, it’s still instructive to understand that the median negotiated decreases in the prices of the ten selected drugs would have been roughly 65%.
As matters now stand, the Medicare Program is still empowered to negotiate prices for an additional 15 drugs in each of 2026 and 2027. The problem is that there is no assurance that these negotiations will ever take place as the Trump administration has vowed to rescind many of President Biden’s efforts to reduce the costs of prescription drugs.
Earlier in this article I pointed out that one of the principal functions of prescription drug insurers is to consolidate and utilize the collective bargaining power of their insureds. Although that power is intended to be used for the benefit of their insureds, it’s now being employed almost exclusively for the benefit of drug insurers. I have labeled this development a “scam” because persons purchasing prescription drug insurance have a reasonable expectation that their insurers will be seeking to enable them to purchase their prescription drugs at a price derived through good faith negotiations. That’s particularly true when you consider that the insurer is representing to be paying a majority of the costs of its insured’s drug purchases. The question remains, however, as to whether that reasonable expectation gives rise to an implied legal obligation on the part of prescription drug insurers to satisfy the expectations of their insureds.