Despite advances in the drug development process, the price of drugs in the United States continues to rise. Total healthcare spending in the US reached $3.6 trillion in 2018 (17.7% of the GDP). The percentage of total US healthcare spending on drugs is about 14%, and this has remained relatively constant in the past decade. Although some argue that healthcare spending on drugs and annual increases in prescription drug prices have been steady and moderate, surveys conducted by Bloomberg, the Commonwealth fund, and the Organization for Economic Co-operation and Development (OECD) suggest that wide gaps in prescription drug pricing and healthcare spending exist in the US when compared to other developed countries. To address the issue of high drug prices in the US, one needs to better understand the challenges involved in the drug development process, the US healthcare financing system and other drivers of rising healthcare costs.

So how are drug prices determined, and what are some reasons for this price disparity?

How are drug prices determined?

Drug development is a highly regulated, long, and complex process. On average, one in ten drug candidates survives the clinical trials and regulatory process to make it to market. It takes about ten years and $1B to bring a drug to market. These costs can go up to $2B in the case of cancer drugs and specialty drugs. Thus, in order to be sustainable and innovative, drug companies need to make enough revenue from their marketed drugs to not only cover the costs of manufacturing and distribution of the drugs, but also fuel the research for improving marketed drugs, and developing new drugs. Overall, pharma companies spend 18% of revenue on R&D. These R&D costs are factored in while determining the drug prices.

Other considerations that companies need to keep in mind while determining the price of a drug are the market, competition, patent life, and value of the drug. Pharma companies can use one of many pricing strategies such as cost-based pricing, competition-based pricing, and value-based pricing. In the recent times, there has been a push for value-based pricing of pharmaceuticals. Value based pricing determines the price of a drug based on the value added to the product by its stakeholders. How does one determine the true “value” of a drug? A drug’s value is based on the benefits it provides over the standard of care, and cost savings afforded by the product by preventing complications and hospitalization, which reduce the overall burden on the healthcare system. There are several organizations such as the Institute for Clinical and Economic Review (ICER) and  the National Institute for Health and Care Excellence (NICE) that determine Quality Adjusted Life Years (QALY) and perform Health Technology Assessments (HTA) for drugs. QALY and HTA are indices of clinical benefit and improvement in the quality and length of life that the drug adds to the patient. These indices provide a reference for a fair (cost-effective) price based on clinical benefit, health outcomes and cost savings provided by the drug. This value-based system is already used in Australia, Canada, and some European countries. It is increasingly being used by the Medicare and Medicaid programs, Veterans Administration, and private payers to negotiate drug prices with pharma and biotech companies.

What factors cause high drug prices in the US?

It is well-documented that despite similar drug utilization rates, drug prices are higher in the US compared to other high-income countries. The top six best-selling branded prescription drugs cost much more in the US than other developed countries, even after adjusting for rebates. For example, Lantus (long acting insulin) costs an average of $170 after discounts in the US compared to an average of $33 in 14 other countries. Additionally, before generic formulations were available in early 2019, Epipen®, the auto-injectable device for severe allergic reactions, cost $600 in the US, which was roughly ten-fold higher than its $69 price in the UK. Plainly, it is apparent that high drug prices are not a global phenomenon.

In many countries, single payer systems coupled with government regulation and oversight allow more bargaining power and keep drug prices under control. However, the US market is an open and free market, with relatively minimal governmental regulation on drug prices. According to Dr. James Robinson, a professor of Health policy at UC Berkeley, “the drug companies will charge whatever the [US] market will bear. To encourage innovation, the government has designed policies, during which companies enjoy temporary monopoly and can charge high prices on the drugs to recoup the R&D costs”. By policies, Dr. Robinson is referring to 20 years of patent protection and few years of post-launch regulatory exclusivities. Dr. Robinson adds, “The end limit of the patent in turn allows generics to enter the market, [which along with competitor drugs] helps to put a lid on the high drug prices.” Since it takes about 10 years after the initial issuance of patent for a drug to come to market, companies can enjoy about 10 years of patent protection on its drug entity. Sometimes, competitor drugs enter the market soon after the first drug launch, causing drug companies to lower prices on patent drugs. Currently, about 90% of the prescriptions filled in the US are generics, but still generics account for only 21% of the share of total spending on prescription drugs.

Another factor adding to high drug costs in the US is stakeholders. A lot of intermediaries are involved in getting drugs from the pharma manufacturers to patients –pharmacy benefit managers (PBMs), wholesalers, pharmacies, payers (insurers), patient advocacy groups – and these intermediaries play a role in deciding drug prices. The ‘sticker’ price (the listed price) of the drug seldom reflects the actual price that is paid for that drug by the patient or payer, or the price received by the company for that drug. For example, PBMs are companies that negotiate which drugs make it to the formulary, and also negotiate ‘discounted’ prices for those drugs on behalf of the payers and pharmacies. In turn, PBMs get rebates from pharma companies to incentivize listing their drug on the formulary, which pharma companies claim add to the rising prices of the drugs over the cost of research and development (R&D). On the other hand, insurers are willing to cover a drug if it is effective and reduces overall healthcare costs. However, insurers tend to regulate drug prices by employing barriers such as prior authorization requirements on expensive treatments or giving preferred status to a ‘cheaper’ competitor drug. Unfavorably, more than a million people on the US are uninsured and must bear the burden of full prices of the drug. Some insurance plans and PBMs may restrict coverage for some drugs or have higher deductibles, leading to higher out-of-pocket costs for the patients, making some life-saving drugs unaffordable.

Potential strategies to lower drug prices in the US

The system in the US is designed to incentivize drug companies to innovate by instituting patents, regulatory exclusivities, and healthy competition. This enables pharma companies to enjoy substantial revenues and profits on its drugs, while also being able to divert some revenue back towards R&D. However, it is not possible to reap high revenues (profits) from developing countries and countries that have government-imposed caps or regulation on pricing. Does this mean that the US disproportionately bears the burden for innovation? According to Dr. Robinson, “while it may be true, selling drugs just above marginal costs in [the] US and globally will squeeze the profits and this can stifle R&D of truly innovative therapies and drugs”. These include cell and gene therapies, and drugs for orphan diseases and difficult to treat diseases like cancer.

One solution proposed by the current government to bridge pricing disparity employs international reference pricing, which aims to achieve price harmonization by setting drug prices in the US based on the average price of those drugs in certain high income countries. This was originally proposed for drugs covered under Medicare Part B, (drugs typically prescribed in a doctor’s office) but can be expanded to other drugs. In fact in 2019, House speaker Nancy Pelosi introduced the bill for the international price index, which also proposes using average international prices to set a baseline for negotiating drug prices in the US, and extends to 250 branded drugs with penalties for drug companies that fail to comply. It will be interesting to observe how this policy is received and implemented and the potential barriers or push back that might come to light if the bill is passed.

While drug pricing is a hotly debated topic, it is only a part of the problem within the US healthcare system. Hospitals, physicians, and clinical services account for 85% of the US healthcare spending. In fact, the cost of these services continues to rise and drive the healthcare spending upward, even without the same level of innovation that we see in the drug space. If pharma companies are more transparent about the cost of developing drugs and the percentage of profits diverted back to R&D and marketing, it may help appropriately determine and justify drug prices, and help inform policy changes. For example, instead of regulating pricing, the government could get a share of the profits made by pharma companies as compensation for the R&D dollars (of taxpayers) invested by the government for early pre-clinical research, some of which feeds into the pharma’s R&D pipeline. These royalties can be diverted by the government back into the healthcare system to alleviate the cost burden of patients. Alternatively, for international reference pricing, it may be important to consider the cost share of the R&D burden borne by the different countries while determining average pricing.

The recent COVID-19 pandemic has brought the issue of drug pricing to the fore. With Remdesivir receiving emergency use authorization (EUA) from the FDA, there has been a lot of speculation and scrutiny around how it will be priced. According to an ICER report, based on the cost of making the drug, a 10-day course of Remdesivir should cost $10; however, based on the drug’s effectiveness, it could be valued at $4500. While there are some valid arguments suggesting that the estimates used for QALY’s value are very conservative, and that using cost-based pricing is problematic, there is a moral obligation in the face of a pandemic to make this drug affordable and accessible to all. Its pricing will also set a precedent for competitors, who may or may not be incentivized to develop newer and better therapies for the disease. For example, if Remdesivir is priced at cost-plus and not the true value the drug brings for the patients and public health, pharma companies may be discouraged from innovating new drugs for COVID due to low reward on innovation. Ultimately, this is definitely a ripe time for meaningful discourse and policy discussions around drug pricing to find potential solutions that balance both these aspects.

In summary, the drug pricing landscape is complex, and we will need multipronged solutions that ensure a balance between innovation and affordability. Reduction in costs of medical innovation and clinical trials, streamlining regulations, promoting competition, improving insurance policies, identifying inefficiencies in other areas of healthcare spending and most importantly, policy changes at the governmental level will play a crucial part in shaping the future landscape for drug prices in the US.

Neha P. Paranjape, PhD is a postdoctoral scholar in the department of Laboratory Medicine at the University of California, San Francisco.