Archives For health care

The two-year budget plan passed last week makes important changes to payment obligations in the Medicare Part D coverage gap, also known as the donut hole.  While the new plan produces a one-year benefit for seniors by reducing what they pay a year earlier than was already mandated, it permanently shifts much of the drug costs insurance companies were paying to drug makers.  It’s far from clear whether this windfall for insurers will result in lower drug costs for Medicare beneficiaries.

Medicare Part D is voluntary prescription drug insurance for seniors and the permanently disabled provided by private insurance plans that are approved by the Medicare program.  Last year, more than 42 million people enrolled in Medicare Part D plans. Payment for prescription drugs under Medicare Part D depends on how much enrollees spend on drugs.  In 2018, after hitting a deductible that varies by plan, enrollees pay 25% of their drug costs while the Part D plans pay 75%.  However, once the individual and the plan have spent a total of $3,750, enrollees hit the coverage gap that lasts until $8,418 has been spent.  In the coverage gap, enrollees pay 35% of brand drug costs, the Part D plans pay 15%, and drug makers are required to offer 50% discounts on brand drugs to cover the rest.  Once total spending reaches $8,418, enrollees enter catastrophic coverage in which they pay only 5% of drug costs, the Part D plans pay 15%, and the Medicare program pays the other 80%.

The Affordable Care Act (ACA) included provisions to phase out the coverage gap by 2020, so that enrollees will pay only 25% of drug costs from the time they meet the deductible until they hit the catastrophic coverage level.  The budget plan passed last week speeds up this phase out by one year, so enrollees will start paying only 25% in 2019 instead of 2020.  The ACA anticipated that with enrollees paying 25% of drug costs and drug maker discounts of 50%, the Part D plans would pay the other 25%.  However, last week’s budget plan drastically redistributed the payment responsibilities from the Part D insurance plans to drug makers. Under the new plan drug makers are required to offer 70% discounts so that the plans only have to pay 5% of the total drug costs.  That is, the new plan shifts 20% of total drug costs in the coverage gap from insurers to drug makers.

Although the drug spending in each individual’s coverage gap is less than $5,000, with over 42 million people covered, the total spending, and the 20% of spending shifted from insurers to drug makers, is significant.  CMS has estimated that when drug makers’ discounts were only covering 50% of drug spending in the gap, the annual total discounts amounted to over $5.6 billion.  Requiring drug makers to cover another 20% of drug spending will add several billion dollars more to this total.

A government intervention that forces suppliers to cover 70% of the spending in a market is a surprising move for Republicans—supposed advocates of free markets.  Moreover, although reducing prescription drug costs has become a national priority, it’s unclear whether shifting costs from insurers to drug makers will benefit individuals at all.  Theoretically, as the individual Part D plans pay less of their enrollees’ drug costs, they should pass on the savings to enrollees in the form of lower premiums.  However, several studies suggest that enrollees may not experience a net decrease in drug spending.  The Centers for Medicare and Medicaid Services (CMS) has determined that under Medicare Part D, drug makers increase list prices to offset other concessions and to more quickly move enrollees out of the coverage gap where drug makers are required to offer price discounts.  Higher list prices mean that enrollees’ total out-of-pocket drug spending increases; even a 5% cost-sharing obligation in the catastrophic coverage for a high-priced drug can be a significant expense. Higher list prices that push enrollees out of the coverage gap also shift more costs onto the Medicare program that pays 80% of drug costs in the catastrophic coverage phase.

A better, more direct way to reduce Medicare Part D enrollees’ out-of-pocket drug spending is to require point-of-sale rebates.  Currently, drug makers offer rebates to Part D plans in order to improve their access to the millions of individuals covered by the plans.  However, the rebates, which total over $16 billion annually, are paid after the point-of-sale, and evidence shows that only a portion of these rebates get passed through to beneficiaries in the form of reduced insurance premiums.  Moreover, a reduction in premiums does little to benefit those enrolled individuals who have the highest aggregate out-of-pocket spending on drugs. (As an aside, in contrast to the typical insurance subsidization of high-cost enrollees by low-cost enrollees, high-spending enrollees under Medicare Part D generate greater rebates for their plans, but then the rebates are spread across all enrollees in the form of lower premiums).

Drug maker rebates will more directly benefit Medicare Part D enrollees if rebates are passed through at the point-of-sale to reduce drug copays.  Point-of-sale rebates would ensure that enrollees see immediate savings as they meet their cost-sharing obligations.  Moreover, the enrollees with the highest aggregate out-of-pocket spending would be the ones to realize the greatest savings.  CMS has recently solicited comments on a plan to require some portion of drug makers’ rebates to be applied at the point of sale, and the President’s budget plan released yesterday proposes point-of-sale rebates to lower Medicare Part D enrollees’ out-of-pocket spending.  Ultimately, targeting rebates to consumers at the point-of-sale will more effectively lower drug spending than reducing insurance plans’ payment obligations in hopes that they pass on the savings to enrollees.

Last week, several major drug makers marked the new year by announcing annual increases on list prices.  In addition to drug maker Allergan—which pledged last year to confine price increases below 10 percent and, true to its word, reported 2018 price increases of 9.5 percent—several other companies also stuck to single-digit increases.   Although list or “sticker” prices generally increased by around 9 percent for most drugs, after discounts negotiated with various health plans, the net prices that consumers and insurers actually pay will see much lower increases. For example, Allergan expects that payors will only see net price increases of 2 to 3 percent in 2018.

However, price increases won’t generate the same returns for brand drug companies that they once did.  As insurers and pharmacy benefit managers consolidate and increase their market share, they have been able to capture an increasing share of the money spent on drugs for themselves. Indeed, a 2017 report found that, of the money spent on prescription drugs by patients and health plans at the point of sale, brand drug makers only realized 39 percent.  Meanwhile, supply-chain participants, such as pharmacy benefit managers, realized 42 percent of these expenditures.  What’s more, year-after-year, brand drug makers have seen their share of these point-of-sale expenditures decrease while supply-chain entities have kept a growing share of expenditures for themselves.

Brand drug makers have also experienced a dramatic decline in the return on their R&D investment.  A recent Deloitte study reports that, for the large drug makers they’ve followed since 2010, R&D returns have dropped from over 10 percent to under 4 percent for the last two years.  The ability of supply-chain entities to capture an increasing share of drug expenditures is responsible for at least part of drug makers’ decreasing R&D returns; the study reports that average peak sales for drugs have slowly dropped over time, mirroring drug maker’s decreasing share of expenditures.  In addition, the decline in R&D returns can be traced to the increasing cost of bringing drugs to market; for the companies Deloitte studied, the cost to bring a drug to market has increased from just over $1.1 billion in 2010 to almost $2 billion in 2017.

Brand drug makers’ decreasing share of drug expenditures and declining R&D returns reduce incentives to innovate.  As the payoff from innovation declines, fewer companies will devote the substantial resources necessary to develop innovative new drugs.  In addition, innovation is threatened as brand companies increasingly face uncertainty about the patent rights of the drugs they do bring to market.  As I’ve discussed in a previous post,  the unbalanced inter partes review (IPR) process created under the Leahy-Smith America Invents Act in 2012 has led to significantly higher patent invalidation rates.  Compared to traditional district-court litigation, several pro-challenger provisions under IPR—including a lower standard of proof, a broader claim construction standard, and the ability of patent challengers to force patent owners into duplicative litigation—have resulted in twice as many patents deemed invalid in IPR proceedings.  Moreover, the lack of a standing requirement in IPR proceedings has given rise to “reverse patent trolling,” in which entities that are not litigation targets, or even participants in the same industry, threaten to file an IPR petition challenging the validity of a patent unless the patent holder agrees to specific settlement demands.  Even supporters of IPR proceedings recognize the flaws with the system; as Senator Orrin Hatch stated in a 2017 speech: “Such manipulation is contrary to the intent of IPR and the very purpose of intellectual property law. . . I think Congress needs to take a look at it.” Although the constitutionality of the IPR process is currently under review by the U.S. Supreme Court, if the unbalanced process remains unchanged, the significant uncertainty it creates for drug makers’ patent rights will lead to less innovation in the pharmaceutical industry.  Drug makers will have little incentive to spend billions of dollars to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.

We are likely to see a renewed push for drug pricing reforms in 2018 as access to affordable drugs remains a top policy priority.  Although Congress has yet to come together in support of any specific proposal, several states are experimenting with reforms that aim to lower drug prices by requiring more pricing transparency and notice of price increases.  As lawmakers consider these and other reforms, they should consider the current challenges that drug makers already face as their share of drug expenditures and R&D returns decline and patent rights remain uncertain.  Reforms that further threaten drug makers’ financial incentives to innovate could reduce our access to life-saving and life-improving new drugs.

“Houston, we have a problem.” It’s the most famous line from Apollo 13 and perhaps how most Republicans are feeling about their plans to repeal and replace Obamacare.

As repeal and replace has given way to tinker and punt, Congress should take a lesson from one of my favorite scenes from Apollo 13.

“We gotta find a way to make this, fit into the hole for this, using nothing but that.”

Let’s look at a way Congress can get rid of the individual mandate, lower prices, cover pre-existing conditions, and provide universal coverage, using the box of tools that we already have on the table.

Some ground rules

First ground rule: (Near) universal access to health insurance. It’s pretty clear that many, if not most Americans, believe that everyone should have health insurance. Some go so far as to call it a “basic human right.” This may be one of the biggest shifts in U.S. public opinion over time.

Second ground rule: Everything has a price, there’s no free lunch. If you want to add another essential benefit, premiums will go up. If you want community rating, young healthy people are going to subsidize older sicker people. If you want a lower deductible, you’ll pay a higher premium, as shown in the figure below all the plans available on Oregon’s ACA exchange in 2017. It shows that a $1,000 decrease in deductible is associated with almost $500 a year in additional premium payments. There’s no free lunch.

ACA-Oregon-Exchange-2017

Third ground rule: No new programs, no radical departures. Maybe Singapore has a better health insurance system. Maybe Canada’s is better. Switching to either system would be a radical departure from the tools we have to work with. This is America. This is Apollo 13. We gotta find a way to make this, fit into the hole for this, using nothing but that.

Private insurance

Employer and individual mandates: Gone. This would be a substantial change from the ACA, but is written into the Senate health insurance bill. The individual mandate is perhaps the most hated part of the ACA, but it was also the most important part Obamacare. Without the coverage mandate, much of the ACA falls apart, as we are seeing now.

Community rating, mandated benefits (aka “minimum essential benefit”), and pre-existing conditions. Sen. Ted Cruz has a brilliantly simple idea: As long as a health plan offers at least one ACA-compliant plan in a state, the plan would also be allowed to offer non-Obamacare-compliant plans in that state. In other words, every state would have at least one plan that checks all the Obamacare boxes of community rating, minimum essential benefits, and pre-existing conditions. If you like Obamacare, you can keep Obamacare. In addition, there could be hundreds of other plans for which consumers can pick each person’s unique situation of age, health status, and ability/willingness to pay. A single healthy 27-year-old would likely choose a plan that’s very different from a plan chosen by a family of four with 40-something parents and school aged children.

Allow—but don’t require—insurance to be bought and sold across state lines. I don’t know if this a big deal or not. Some folks on the right think this could be a panacea. Some folks on the left think this is terrible and would never work. Let’s find out. Some say insurance companies don’t want to sell policies across state lines. Some will, some won’t. Let’s find out, but it shouldn’t be illegal. No one is worse off by loosening a constraint.

Tax deduction for insurance premiums. Keep insurance premiums as a deductible expense for business: No change from current law. In addition, make insurance premiums deductible on individual taxes. This is a not-so-radical change from current law that allows deductions for medical expenses. If someone has employer-provided insurance, the business would be able deduct the share the company pays and the worker would be able to deduct the employee share of the premium from his or her personal taxes. Sure the deduction will reduce tax revenues, but the increase in private insurance coverage would reduce the costs of Medicaid and charity care.

These straightforward changes would preserve one or more ACA-compliant plan for those who want to pay Obamacare’s “silver prices,” allow for consumer choice across other plans, and result in premiums that more closely aligned with benefits chosen by consumers. Allowing individuals to deduct health insurance premiums is also a crucial step in fostering insurance portability.

Medicaid

Even with the changes in the private market, some consumers will find that they can’t afford or don’t want to pay the market price for private insurance. These people would automatically get moved into Medicaid. Those in poverty (or some X% of the poverty rate) would pay nothing and everyone else would be charged a “premium” based on ability to pay. A single mother in poverty would pay nothing for Medicaid coverage, but Elon Musk (if he chose this option) would pay the full price. A middle class family would pay something in between free and full-price. Yes, this is a pretty wide divergence from the original intent of Medicaid, but it’s a relatively modest change from the ACA’s expansion.

While the individual mandate goes away, anyone who does not buy insurance in the private market or is not covered by Medicare will be “mandated” to have Medicaid coverage. At the same time, it preserves consumer choice. That is, consumers have a choice of buying an ACA compliant plan, one of the hundreds of other private plans offered throughout the states, or enrolling in Medicaid.

Would the Medicaid rolls explode? Who knows?

The Census Bureau reports that 15 percent of adults and 40 percent of children currently are enrolled in Medicaid. Research published in the New England Journal of Medicine finds that 44 percent of people who were enrolled in the Medicaid under Obamacare qualified for Medicaid before the ACA.

With low cost private insurance alternatives to Medicaid, some consumers would likely choose the private plans over Medicaid coverage. Also, if Medicaid premiums increased with incomes, able-bodied and working adults would likely shift out of Medicaid to private coverage as the government plan loses its cost-competitiveness.

The cost sharing of income-based premiums means that Medicaid would become partially self supporting.

Opponents of Medicaid expansion claim that the program provides inferior service: fewer providers, lower quality, worse outcomes. If that’s true, then that’s a feature, not a bug. If consumers have to pay for their government insurance and that coverage is inferior, then consumers have an incentive to exit the Medicaid market and enter the private market. Medicaid becomes the insurer of last resort that it was intended to be.

A win-win

The coverage problem is solved. Every American would have health insurance.

Consumer choice is expanded. By allowing non-ACA-compliant plans, consumers can choose the insurance that fits their unique situation.

The individual mandate penalty is gone. Those who choose not to buy insurance would get placed into Medicaid. Higher income individuals would pay a portion of the Medicaid costs, but this isn’t a penalty for having no insurance, it’s the price of having insurance.

The pre-existing conditions problem is solved. Americans with pre-existing conditions would have a choice of at least two insurance options: At least one ACA-compliant plan in the private market and Medicaid.

This isn’t a perfect solution, it may not even be a good solution, but it’s a solution that’s better than what we’ve got and better than what Congress has come up with so far. And, it works with the box of tools that’s already been dumped on the table.

Today, the Senate Committee on Health, Education, Labor, and Pensions (HELP) enters the drug pricing debate with a hearing on “The Cost of Prescription Drugs: How the Drug Delivery System Affects What Patients Pay.”  By questioning the role of the drug delivery system in pricing, the hearing goes beyond the more narrow focus of recent hearings that have explored how drug companies set prices.  Instead, today’s hearing will explore how pharmacy benefit managers, insurers, providers, and others influence the amounts that patients pay.

In 2016, net U.S. drug spending increased by 4.8% to $323 billion (after adjusting for rebates and off-invoice discounts).  This rate of growth slowed to less than half the rates of 2014 and 2015, when net drug spending grew at rates of 10% and 8.9% respectively.  Yet despite the slowing in drug spending, the public outcry over the cost of prescription drugs continues.

In today’s hearing, there will be testimony both on the various causes of drug spending increases and on various proposals that could reduce the cost of drugs.  Several of the proposals will focus on ways to increase competition in the pharmaceutical industry, and in turn, reduce drug prices.  I have previously explained several ways that the government could reduce prices through enhanced competition, including reducing the backlog of generic drugs awaiting FDA approval and expediting the approval and acceptance of biosimilars.  Other proposals today will likely call for regulatory reforms to enable innovative contractual arrangements that allow for outcome- or indication-based pricing and other novel reimbursement designs.

However, some proposals will undoubtedly return to the familiar call for more government negotiation of drug prices, especially drugs covered under Medicare Part D.  As I’ve discussed in a previous post, in order for government negotiation to significantly lower drug prices, the government must be able to put pressure on drug makers to secure price concessions. This could be achieved if the government could set prices administratively, penalize manufacturers that don’t offer price reductions, or establish a formulary.  Setting prices or penalizing drug makers that don’t reduce prices would produce the same disastrous effects as price controls: drug shortages in certain markets, increased prices for non-Medicare patients, and reduced incentives for innovation. A government formulary for Medicare Part D coverage would provide leverage to obtain discounts from manufacturers, but it would mean that many patients could no longer access some of their optimal drugs.

As lawmakers seriously consider changes that would produce these negative consequences, industry would do well to voluntarily constrain prices.  Indeed, in the last year, many drug makers have pledged to limit price increases to keep drug spending under control.  Allergan was first, with its “social contract” introduced last September that promised to keep price increases below 10 percent. Since then, Novo Nordisk, AbbVie, and Takeda, have also voluntarily committed to single-digit price increases.

So far, the evidence shows the drug makers are sticking to their promises. Allergan has raised the price of U.S. branded products by an average of 6.7% in 2017, and no drug’s list price has increased by more than single digits.  In contrast, Pfizer, who has made no pricing commitment, has raised the price of many of its drugs by 20%.

If more drug makers brought about meaningful change by committing to voluntary pricing restraints, the industry could prevent the market-distorting consequences of government intervention while helping patients afford the drugs they need.   Moreover, avoiding intrusive government mandates and price controls would preserve drug innovation that has brought life-saving and life-enhancing drugs to millions of Americans.

 

 

 

In a weekend interview with the Washington Post, Donald Trump vowed to force drug companies to negotiate directly with the government on prices in Medicare and Medicaid.  It’s unclear what, if anything, Trump intends for Medicaid; drug makers are already required to sell drugs to Medicaid at the lowest price they negotiate with any other buyer.  For Medicare, Trump didn’t offer any more details about the intended negotiations, but he’s referring to his campaign proposals to allow the Department of Health and Human Services (HHS) to negotiate directly with manufacturers the prices of drugs covered under Medicare Part D.

Such proposals have been around for quite a while.  As soon as the Medicare Modernization Act (MMA) of 2003 was enacted, creating the Medicare Part D prescription drug benefit, many lawmakers began advocating for government negotiation of drug prices. Both Hillary Clinton and Bernie Sanders favored this approach during their campaigns, and the Obama Administration’s proposed budget for fiscal years 2016 and 2017 included a provision that would have allowed the HHS to negotiate prices for a subset of drugs: biologics and certain high-cost prescription drugs.

However, federal law would have to change if there is to be any government negotiation of drug prices under Medicare Part D. Congress explicitly included a “noninterference” clause in the MMA that stipulates that HHS “may not interfere with the negotiations between drug manufacturers and pharmacies and PDP sponsors, and may not require a particular formulary or institute a price structure for the reimbursement of covered part D drugs.”

Most people don’t understand what it means for the government to “negotiate” drug prices and the implications of the various options.  Some proposals would simply eliminate the MMA’s noninterference clause and allow HHS to negotiate prices for a broad set of drugs on behalf of Medicare beneficiaries.  However, the Congressional Budget Office has already concluded that such a plan would have “a negligible effect on federal spending” because it is unlikely that HHS could achieve deeper discounts than the current private Part D plans (there are 746 such plans in 2017).  The private plans are currently able to negotiate significant discounts from drug manufacturers by offering preferred formulary status for their drugs and channeling enrollees to the formulary drugs with lower cost-sharing incentives. In most drug classes, manufacturers compete intensely for formulary status and offer considerable discounts to be included.

The private Part D plans are required to provide only two drugs in each of several drug classes, giving the plans significant bargaining power over manufacturers by threatening to exclude their drugs.  However, in six protected classes (immunosuppressant, anti-cancer, anti-retroviral, antidepressant, antipsychotic and anticonvulsant drugs), private Part D plans must include “all or substantially all” drugs, thereby eliminating their bargaining power and ability to achieve significant discounts.  Although the purpose of the limitation is to prevent plans from cherry-picking customers by denying coverage of certain high cost drugs, giving the private Part D plans more ability to exclude drugs in the protected classes should increase competition among manufacturers for formulary status and, in turn, lower prices.  And it’s important to note that these price reductions would not involve any government negotiation or intervention in Medicare Part D.  However, as discussed below, excluding more drugs in the protected classes would reduce the value of the Part D plans to many patients by limiting access to preferred drugs.

For government negotiation to make any real difference on Medicare drug prices, HHS must have the ability to not only negotiate prices, but also to put some pressure on drug makers to secure price concessions.  This could be achieved by allowing HHS to also establish a formulary, set prices administratively, or take other regulatory actions against manufacturers that don’t offer price reductions.  Setting prices administratively or penalizing manufacturers that don’t offer satisfactory reductions would be tantamount to a price control.  I’ve previously explained that price controls—whether direct or indirect—are a bad idea for prescription drugs for several reasons. Evidence shows that price controls lead to higher initial launch prices for drugs, increased drug prices for consumers with private insurance coverage,  drug shortages in certain markets, and reduced incentives for innovation.

Giving HHS the authority to establish a formulary for Medicare Part D coverage would provide leverage to obtain discounts from manufacturers, but it would produce other negative consequences.  Currently, private Medicare Part D plans cover an average of 85% of the 200 most popular drugs, with some plans covering as much as 93%.  In contrast, the drug benefit offered by the Department of Veterans Affairs (VA), one government program that is able to set its own formulary to achieve leverage over drug companies, covers only 59% of the 200 most popular drugs.  The VA’s ability to exclude drugs from the formulary has generated significant price reductions. Indeed, estimates suggest that if the Medicare Part D formulary was restricted to the VA offerings and obtained similar price reductions, it would save Medicare Part D $510 per beneficiary.  However, the loss of access to so many popular drugs would reduce the value of the Part D plans by $405 per enrollee, greatly narrowing the net gains.

History has shown that consumers don’t like their access to drugs reduced.  In 2014, Medicare proposed to take antidepressants, antipsychotic and immunosuppressant drugs off the protected list, thereby allowing the private Part D plans to reduce offerings of these drugs on the formulary and, in turn, reduce prices.  However, patients and their advocates were outraged at the possibility of losing access to their preferred drugs, and the proposal was quickly withdrawn.

Thus, allowing the government to negotiate prices under Medicare Part D could carry important negative consequences.  Policy-makers must fully understand what it means for government to negotiate directly with drug makers, and what the potential consequences are for price reductions, access to popular drugs, drug innovation, and drug prices for other consumers.

I just posted a new ICLE white paper, co-authored with former ICLE Associate Director, Ben Sperry:

When Past Is Not Prologue: The Weakness of the Economic Evidence Against Health Insurance Mergers.

Yesterday the hearing in the DOJ’s challenge to stop the Aetna-Humana merger got underway, and last week phase 1 of the Cigna-Anthem merger trial came to a close.

The DOJ’s challenge in both cases is fundamentally rooted in a timeworn structural analysis: More consolidation in the market (where “the market” is a hotly-contested issue, of course) means less competition and higher premiums for consumers.

Following the traditional structural playbook, the DOJ argues that the Aetna-Humana merger (to pick one) would result in presumptively anticompetitive levels of concentration, and that neither new entry not divestiture would suffice to introduce sufficient competition. It does not (in its pretrial brief, at least) consider other market dynamics (including especially the complex and evolving regulatory environment) that would constrain the firm’s ability to charge supracompetitive prices.

Aetna & Humana, for their part, contend that things are a bit more complicated than the government suggests, that the government defines the relevant market incorrectly, and that

the evidence will show that there is no correlation between the number of [Medicare Advantage organizations] in a county (or their shares) and Medicare Advantage pricing—a fundamental fact that the Government’s theories of harm cannot overcome.

The trial will, of course, feature expert economic evidence from both sides. But until we see that evidence, or read the inevitable papers derived from it, we are stuck evaluating the basic outlines of the economic arguments based on the existing literature.

A host of antitrust commentators, politicians, and other interested parties have determined that the literature condemns the mergers, based largely on a small set of papers purporting to demonstrate that an increase of premiums, without corresponding benefit, inexorably follows health insurance “consolidation.” In fact, virtually all of these critics base their claims on a 2012 case study of a 1999 merger (between Aetna and Prudential) by economists Leemore Dafny, Mark Duggan, and Subramaniam Ramanarayanan, Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry, as well as associated testimony by Prof. Dafny, along with a small number of other papers by her (and a couple others).

Our paper challenges these claims. As we summarize:

This white paper counsels extreme caution in the use of past statistical studies of the purported effects of health insurance company mergers to infer that today’s proposed mergers—between Aetna/Humana and Anthem/Cigna—will likely have similar effects. Focusing on one influential study—Paying a Premium on Your Premium…—as a jumping off point, we highlight some of the many reasons that past is not prologue.

In short: extrapolated, long-term, cumulative, average effects drawn from 17-year-old data may grab headlines, but they really don’t tell us much of anything about the likely effects of a particular merger today, or about the effects of increased concentration in any particular product or geographic market.

While our analysis doesn’t necessarily undermine the paper’s limited, historical conclusions, it does counsel extreme caution for inferring the study’s applicability to today’s proposed mergers.

By way of reference, Dafny, et al. found average premium price increases from the 1999 Aetna/Prudential merger of only 0.25 percent per year for two years following the merger in the geographic markets they studied. “Health Insurance Mergers May Lead to 0.25 Percent Price Increases!” isn’t quite as compelling a claim as what critics have been saying, but it’s arguably more accurate (and more relevant) than the 7 percent price increase purportedly based on the paper that merger critics like to throw around.

Moreover, different markets and a changed regulatory environment alone aren’t the only things suggesting that past is not prologue. When we delve into the paper more closely we find even more significant limitations on the paper’s support for the claims made in its name, and its relevance to the current proposed mergers.

The full paper is available here.

On November 9, pharmaceutical stocks soared as Donald Trump’s election victory eased concerns about government intervention in drug pricing. Shares of Pfizer rose 8.5%, Allergan PLC was up 8%, and biotech Celgene jumped 10.4%. Drug distributors also gained, with McKesson up 6.4% and Express Scripts climbing 3.4%. Throughout the campaign, Clinton had vowed to take on the pharmaceutical industry and proposed various reforms to reign in drug prices, from levying fines on drug companies that imposed unjustified price increases to capping patients’ annual expenditures on drugs. Pharmaceutical stocks had generally underperformed this year as the market, like much of America, awaited a Clinton victory.

In contrast, Trump generally had less to say on the subject of drug pricing, hence the market’s favorable response to his unexpected victory. Yet, as the end of the first post-election month draws near, we are still uncertain whether Trump is friend or foe to the pharmaceutical industry. Trump’s only proposal that directly impacts the industry would allow the government to negotiate the prices of Medicare Part D drugs with drug makers. Although this proposal would likely have little impact on prices because existing Part D plans already negotiate prices with drug makers, there is a risk that this “negotiation” could ultimately lead to price controls imposed on the industry. And as I have previously discussed, price controls—whether direct or indirect—are a bad idea for prescription drugs: they lead to higher initial launch prices for drugs, increased drug prices for consumers with private insurance coverage, drug shortages in certain markets, and reduced incentives for innovation.

Several of Trump’s other health proposals have mixed implications for the industry. For example, a repeal or overhaul of the Affordable Care Act could eliminate the current tax on drug makers and loosen requirements for Medicaid drug rebates and Medicare part D discounts. On the other hand, if repealing the ACA reduces the number of people insured, spending on pharmaceuticals would fall. Similarly, if Trump renegotiates international trade deals, pharmaceutical firms could benefit from stronger markets or longer patent exclusivity rights, or they could suffer if foreign countries abandon trade agreements altogether or retaliate with disadvantageous terms.

Yet, with drug spending up 8.5 percent last year and recent pricing scandals launched by 500+ percentage increases in individual drugs (i.e., Martin Shkreli, Valeant Pharmaceuticals, Mylan), the current debate over drug pricing is unlikely to fade. Even a Republican-led Congress and White House is likely to heed the public outcry and do something about drug prices.

Drug makers would be wise to stave off any government-imposed price restrictions by voluntarily limiting price increases on important drugs. Major pharmaceutical company Allergan has recently done just this by issuing a “social contract with patients” that made several drug pricing commitments to its customers. Among other assurances, Allergan has promised to limit price increases to single-digit percentage increases and no longer engage in the common industry tactic of dramatically increasing prices for branded drugs nearing patent expiry. Last year throughout the pharmaceutical industry, the prices of the most commonly-used brand drugs increased by over 16 percent and, in the last two years before patent expiry, drug makers increased the list prices of drugs by an average of 35 percent. Thus, Allergan’s commitment will produce significant savings over the life of a product, creating hundreds of millions of dollars in savings to health plans, patients, and the health care system.

If Allergan can make this commitment for its entire drug inventory—over 80+ drugs—why haven’t other companies done the same? Similar commitments by other drug makers might be enough to prevent lawmakers from turning to market-distorting reforms, such as price controls, that could end up doing more harm than good for consumers, the pharmaceutical industry, and long-term innovation.

Mylan Pharmaceuticals recently reinvigorated the public outcry over pharmaceutical price increases when news surfaced that the company had raised the price of EpiPens by more than 500% over the past decade and, purportedly, had plans to increase the price even more. The Mylan controversy comes on the heels of several notorious pricing scandals last year. Recall Valeant Pharmaceuticals, that acquired cardiac drugs Isuprel and Nitropress and then quickly raised their prices by 525% and 212%, respectively. And of course, who can forget Martin Shkreli of Turing Pharmaceuticals, who increased the price of toxoplasmosis treatment Daraprim by 5,000% and then claimed he should have raised the price even higher.

However, one company, pharmaceutical giant Allergan, seems to be taking a different approach to pricing.   Last week, Allergan CEO Brent Saunders condemned the scandalous pricing increases that have raised suspicions of drug companies and placed the entire industry in the political hot seat. In an entry on the company’s blog, Saunders issued Allergan’s “social contract with patients” that made several drug pricing commitments to its customers.

Some of the most important commitments Allergan made to its customers include:

  • A promise to not increase prices more than once a year, and to limit price increases to singe-digit percentage increases.
  • A pledge to improve patient access to Allergan medications by enhancing patient assistance programs in 2017
  • A vow to cooperate with policy makers and payers (including government drug plans, private insurers, and pharmacy benefit managers) to facilitate better access to Allergan products by offering pricing discounts and paying rebates to lower drug costs.
  • An assurance that Allergan will no longer engage in the common industry tactic of dramatically increasing prices for branded drugs nearing patent expiry, without cost increases that justify the increase.
  • A commitment to provide annual updates on how pricing affects Allergan’s business.
  • A pledge to price Allergan products in a way that is commensurate with, or lower than, the value they create.

Saunders also makes several non-pricing pledges to maintain a continuous supply of its drugs, diligently monitor the safety of its products, and appropriately educate physicians about its medicines. He also makes the point that the recent pricing scandals have shifted attention away from the vibrant medical innovation ecosystem that develops new life-saving and life-enhancing drugs. Saunders contends that the focus on pricing by regulators and the public has incited suspicions about this innovation ecosystem: “This ecosystem can quickly fall apart if it is not continually nourished with the confidence that there will be a longer term opportunity for appropriate return on investment in the long R&D journey.”

Policy-makers and the public would be wise to focus on the importance of brand drug innovation. Brand drug companies are largely responsible for pharmaceutical innovation. Since 2000, brand companies have spent over half a trillion dollars on R&D, and they currently account for over 90 percent of the spending on the clinical trials necessary to bring new drugs to market. As a result of this spending, over 550 new drugs have been approved by the FDA since 2000, and another 7,000 are currently in development globally. And this innovation is directly tied to health advances. Empirical estimates of the benefits of pharmaceutical innovation indicate that each new drug brought to market saves 11,200 life-years each year.  Moreover, new drugs save money by reducing doctor visits, hospitalizations, and other medical procedures, ultimately for every $1 spent on new drugs, total medical spending decreases by more than $7.

But, as Saunders suggests, this innovation depends on drugmakers earning a sufficient return on their investment in R&D. The costs to bring a new drug to market with FDA approval are now estimated at over $2 billion, and only 1 in 10 drugs that begin clinical trials are ever approved by the FDA. Brand drug companies must price a drug not only to recoup the drug’s own costs, they must also consider the costs of all the product failures in their pricing decisions. However, they have a very limited window to recoup these costs before generic competition destroys brand profits: within three months of the first generic entry, generics have already captured over 70 percent of the brand drugs’ market. Drug companies must be able to price drugs at a level where they can earn profits sufficient to offset their R&D costs and the risk of failures. Failure to cover these costs will slow investment in R&D; drug companies will not spend millions and billions of dollars developing drugs if they cannot recoup the costs of that development.

Yet several recent proposals threaten to control prices in a way that could prevent drug companies from earning a sufficient return on their investment in R&D. Ultimately, we must remember that a social contract involves commitment from all members of a group; it should involve commitments from drug companies to price responsibly, and commitments from the public and policy makers to protect innovation. Hopefully, more drug companies will follow Allergan’s lead and renounce the exorbitant price increases we’ve seen in recent times. But in return, we should all remember that innovation and, in turn, health improvements, depend on drug companies’ profitability.

As regulatory review of the merger between Aetna and Humana hits the homestretch, merger critics have become increasingly vocal in their opposition to the deal. This is particularly true of a subset of healthcare providers concerned about losing bargaining power over insurers.

Fortunately for consumers, the merger appears to be well on its way to approval. California recently became the 16th of 20 state insurance commissions that will eventually review the merger to approve it. The U.S. Department of Justice is currently reviewing the merger and may issue its determination as early as July.

Only Missouri has issued a preliminary opinion that the merger might lead to competitive harm. But Missouri is almost certain to remain an outlier, and its analysis simply doesn’t hold up to scrutiny.

The Missouri opinion echoed the Missouri Hospital Association’s (MHA) concerns about the effect of the merger on Medicare Advantage (MA) plans. It’s important to remember, however, that hospital associations like the MHA are not consumer advocacy groups. They are trade organizations whose primary function is to protect the interests of their member hospitals.

In fact, the American Hospital Association (AHA) has mounted continuous opposition to the deal. This is itself a good indication that the merger will benefit consumers, in part by reducing hospital reimbursement costs under MA plans.

More generally, critics have argued that history proves that health insurance mergers lead to higher premiums, without any countervailing benefits. Merger opponents place great stock in a study by economist Leemore Dafny and co-authors that purports to show that insurance mergers have historically led to seven percent higher premiums.

But that study, which looked at a pre-Affordable Care Act (ACA) deal and assessed its effects only on premiums for traditional employer-provided plans, has little relevance today.

The Dafny study first performed a straightforward statistical analysis of overall changes in concentration (that is, the number of insurers in a given market) and price, and concluded that “there is no significant association between concentration levels and premium growth.” Critics never mention this finding.

The study’s secondary, more speculative, analysis took the observed effects of a single merger — the 1999 merger between Prudential and Aetna — and extrapolated for all changes in concentration (i.e., the number of insurers in a given market) and price over an eight-year period. It concluded that, on average, seven percent of the cumulative increase in premium prices between 1998 and 2006 was the result of a reduction in the number of insurers.

But what critics fail to mention is that when the authors looked at the actual consequences of the 1999 Prudential/Aetna merger, they found effects lasting only two years — and an average price increase of only one half of one percent. And these negligible effects were restricted to premiums paid under plans purchased by large employers, a critical limitation of the studies’ relevance to today’s proposed mergers.

Moreover, as the study notes in passing, over the same eight-year period, average premium prices increased in total by 54 percent. Yet the study offers no insights into what was driving the vast bulk of premium price increases — or whether those factors are still present today.  

Few sectors of the economy have changed more radically in the past few decades than healthcare has. While extrapolated effects drawn from 17-year-old data may grab headlines, they really don’t tell us much of anything about the likely effects of a particular merger today.

Indeed, the ACA and current trends in healthcare policy have dramatically altered the way health insurance markets work. Among other things, the advent of new technologies and the move to “value-based” care are redefining the relationship between insurers and healthcare providers. Nowhere is this more evident than in the Medicare and Medicare Advantage market at the heart of the Aetna/Humana merger.

In an effort to stop the merger on antitrust grounds, critics claim that Medicare and MA are distinct products, in distinct markets. But it is simply incorrect to claim that Medicare Advantage and traditional Medicare aren’t “genuine alternatives.”

In fact, as the Office of Insurance Regulation in Florida — a bellwether state for healthcare policy — concluded in approving the merger: “Medicare Advantage, the private market product, competes directly with Traditional Medicare.”

Consumers who search for plans at Medicare.gov are presented with a direct comparison between traditional Medicare and available MA plans. And the evidence suggests that they regularly switch between the two. Today, almost a third of eligible Medicare recipients choose MA plans, and the majority of current MA enrollees switched to MA from traditional Medicare.

True, Medicare and MA plans are not identical. But for antitrust purposes, substitutes need not be perfect to exert pricing discipline on each other. Take HMOs and PPOs, for example. No one disputes that they are substitutes, and that prices for one constrain prices for the other. But as anyone who has considered switching between an HMO and a PPO knows, price is not the only variable that influences consumers’ decisions.

The same is true for MA and traditional Medicare. For many consumers, Medicare’s standard benefits, more-expensive supplemental benefits, plus a wider range of provider options present a viable alternative to MA’s lower-cost expanded benefits and narrower, managed provider network.

The move away from a traditional fee-for-service model changes how insurers do business. It requires larger investments in technology, better tracking of preventive care and health outcomes, and more-holistic supervision of patient care by insurers. Arguably, all of this may be accomplished most efficiently by larger insurers with more resources and a greater ability to work with larger, more integrated providers.

This is exactly why many hospitals, which continue to profit from traditional, fee-for-service systems, are opposed to a merger that promises to expand these value-based plans. Significantly, healthcare providers like Encompass Medical Group, which have done the most to transition their services to the value-based care model, have offered letters of support for the merger.

Regardless of their rhetoric — whether about market definition or historic precedent — the most vocal merger critics are opposed to the deal for a very simple reason: They stand to lose money if the merger is approved. That may be a good reason for some hospitals to wish the merger would go away, but it is a terrible reason to actually stop it.

[This post was first published on June 27, 2016 in The Hill as “Don’t believe the critics, Aetna-Humana merger a good deal for consumers“]

Thanks to Geoff for the introduction. I look forward to posting a few things over the summer.

I’d like to begin by discussing Geoff’s post on the pending legislative proposals designed to combat strategic abuse of drug safety regulations to prevent generic competition. Specifically, I’d like to address the economic incentive structure that is in effect in this highly regulated market.

Like many others, I first noticed the abuse of drug safety regulations to prevent competition when Turing Pharmaceuticals—then led by now infamous CEO Martin Shkreli—acquired the manufacturing rights for the anti-parasitic drug Daraprim, and raised the price of the drug by over 5,000%. The result was a drug that cost $750 per tablet. Daraprim (pyrimethamine) is used to combat malaria and toxoplasma gondii infections in immune-compromised patients, especially those with HIV. The World Health Organization includes Daraprim on its “List of Essential Medicines” as a medicine important to basic health systems. After the huge price hike, the drug was effectively out of reach for many insurance plans and uninsured patients who needed it for the six to eight week course of treatment for toxoplasma gondii infections.

It’s not unusual for drugs to sell at huge multiples above their manufacturing cost. Indeed, a primary purpose of patent law is to allow drug companies to earn sufficient profits to engage in the expensive and risky business of developing new drugs. But Daraprim was first sold in 1953 and thus has been off patent for decades. With no intellectual property protection Daraprim should, theoretically, now be available from generic drug manufactures for only a little above cost. Indeed, this is what we see in the rest of the world. Daraprim is available all over the world for very cheap prices. The per tablet price is 3 rupees (US$0.04) in India, R$0.07 (US$0.02) in Brazil, US$0.18 in Australia, and US$0.66 in the UK.

So what gives in the U.S.? Or rather, what does not give? What in our system of drug distribution has gotten stuck and is preventing generic competition from swooping in to compete down the high price of off-patent drugs like Daraprim? The answer is not market failure, but rather regulatory failure, as Geoff noted in his post. While generics would love to enter a market where a drug is currently selling for high profits, they cannot do so without getting FDA approval for their generic version of the drug at issue. To get approval, a generic simply has to file an Abbreviated New Drug Application (“ANDA”) that shows that its drug is equivalent to the branded drug with which it wants to compete. There’s no need for the generic to repeat the safety and efficacy tests that the brand manufacturer originally conducted. To test for equivalence, the generic needs samples of the brand drug. Without those samples, the generic cannot meet its burden of showing equivalence. This is where the strategic use of regulation can come into play.

Geoff’s post explains the potential abuse of Risk Evaluation and Mitigation Strategies (“REMS”). REMS are put in place to require certain safety steps (like testing a woman for pregnancy before prescribing a drug that can cause birth defects) or to restrict the distribution channels for dangerous or addictive drugs. As Geoff points out, there is evidence that a few brand name manufacturers have engaged in bad-faith refusals to provide samples using the excuse of REMS or restricted distribution programs to (1) deny requests for samples, (2) prevent generic manufacturers from buying samples from resellers, and (3) deny generics whose drugs have won approval access to the REMS system that is required for generics to distribute their drugs. Once the FDA has certified that a generic manufacturer can safely handle the drug at issue, there is no legitimate basis for the owners of brand name drugs to deny samples to the generic maker. Expressed worries about liability from entering joint REMS programs with generics also ring hollow, for the most part, and would be ameliorated by the pending legislation.

It’s important to note that this pricing situation is unique to drugs because of the regulatory framework surrounding drug manufacture and distribution. If a manufacturer of, say, an off-patent vacuum cleaner wants to prevent competitors from copying its vacuum cleaner design, it is unlikely to be successful. Even if the original manufacturer refuses to sell any vacuum cleaners to a competitor, and instructs its retailers not to sell either, this will be very difficult to monitor and enforce. Moreover, because of an unrestricted resale market, a competitor would inevitably be able to obtain samples of the vacuum cleaner it wishes to copy. Only patent law can successfully protect against the copying of a product sold to the general public, and when the patent expires, so too will the ability to prevent copying.

Drugs are different. The only way a consumer can resell prescription drugs is by breaking the law. Pills bought from an illegal secondary market would be useless to generics for purposes of FDA approval anyway, because the chain of custody would not exist to prove that the samples are the real thing. This means generics need to get samples from the authorized manufacturer or distribution company. When a drug is subject to a REMS-required restricted distribution program, it is even more difficult, if not impossible, for a generic maker to get samples of the drugs for which it wants to make generic versions. Restricted distribution programs, which are used for dangerous or addictive drugs, by design very tightly control the chain of distribution so that the drugs go only to patients with proper prescriptions from authorized doctors.

A troubling trend has arisen recently in which drug owners put their branded drugs into restricted distribution programs not because of any FDA REMS requirement, but instead as a method to prevent generics from obtaining samples and making generic versions of the drugs. This is the strategy that Turing used before it raised prices over 5,000% on Daraprim. And Turing isn’t the only company to use this strategy. It is being emulated by others, although perhaps not so conspicuously. For instance, in 2015, Valeant Pharmaceuticals completed a hostile takeover of Allergan Pharmaceuticals, with the help of the hedge fund, Pershing Square. Once Valeant obtained ownership of Allergan and its drug portfolio, it adopted restricted distribution programs and raised the prices on its off-patent drugs substantially. It raised the price of two life-saving heart drugs by 212% and 525% respectively. Others have followed suit.

A key component of the strategy to profit from hiking prices on off-patent drugs while avoiding competition from generics is to select drugs that do not currently have generic competitors. Sometimes this is because a drug has recently come off patent, and sometimes it is because the drug is for a small patient population, and thus generics haven’t bothered to enter the market given that brand name manufacturers generally drop their prices to close to cost after the drug comes off patent. But with the strategic control of samples and refusals to allow generics to enter REMS programs, the (often new) owners of the brand name drugs seek to prevent the generic competition that we count on to make products cheap and plentiful once their patent protection expires.

Most brand name drug makers do not engage in withholding samples from generics and abusing restricted distribution and REMS programs. But the few that do cost patients and insurers dearly for important medicines that should be much cheaper once they go off patent. More troubling still is the recent strategy of taking drugs that have been off patent and cheap for years, and abusing the regulatory regime to raise prices and block competition. This growing trend of abusing restricted distribution and REMS to facilitate rent extraction from drug purchasers needs to be corrected.

Two bills addressing this issue are pending in Congress. Both bills (1) require drug companies to provide samples to generics after the FDA has certified the generic, (2) require drug companies to enter into shared REMS programs with generics, (3) allow generics to set up their own REMS compliant systems, and (4) exempt drug companies from liability for sharing products and REMS-compliant systems with generic companies in accordance with the steps set out in the bills. When it comes to remedies, however, the Senate version is significantly better. The penalties provided in the House bill are both vague and overly broad. The bill provides for treble damages and costs against the drug company “of the kind described in section 4(a) of the Clayton Act.” Not only is the application of the Clayton Act unclear in the context of the heavily regulated market for drugs (see Trinko), but treble damages may over-deter reasonably restrictive behavior by drug companies when it comes to distributing dangerous drugs.

The remedies in the Senate version are very well crafted to deter rent seeking behavior while not overly deterring reasonable behavior. The remedial scheme is particularly good, because it punishes most those companies that attempt to make exorbitant profits on drugs by denying generic entry. The Senate version provides as a remedy for unreasonable delay that the plaintiff shall be awarded attorneys’ fees, costs, and the defending drug company’s profits on the drug at issue during the time of the unreasonable delay. This means that a brand name drug company that sells an old drug for a low price and delays sharing only because of honest concern about the safety standards of a particular generic company will not face terribly high damages if it is found unreasonable. On the other hand, a company that sends the price of an off-patent drug soaring and then attempts to block generic entry will know that it can lose all of its rent-seeking profits, plus the cost of the victorious generic company’s attorneys fees. This vastly reduces the incentive for the company owning the brand name drug to raise prices and keep competitors out. It likewise greatly increases the incentive of a generic company to enter the market and–if it is unreasonably blocked–to file a civil action the result of which would be to transfer the excess profits to the generic. This provides a rather elegant fix to the regulatory gaming in this area that has become an increasing problem. The balancing of interests and incentives in the Senate bill should leave many congresspersons feeling comfortable to support the bill.