How to Lower Specialty Drug Prices

Gilead Sciences did us all a favor. Their business decision to charge $84,000 for Sovaldi, which cures Hepatitis C, elevated the issue of specialty drug pricing to a level of health policy awareness that rivals the King v. Burwell Supreme Court decision. Without the ruckus over high prices, not many would have noticed that Gilead earned a cool $12.1 billion in profit off its $24.9 billion in 2014 sales. Even for risky products like prescription drugs, with a rate of return that high, the price far exceeds what anyone would have considered justifiable.

Simply put, this level of profit is not required to induce innovation. These kinds of prices, increasingly charged for many complex drugs often targeted to relatively small patient populations (hence the name, “specialty” drugs), are so unaffordable for people and for governments that they threaten other vital health services and priorities. We must do better. As a nation, we cannot afford the monopoly power we are now granting to encourage innovation.

Drug price growth (6 percent per annum) and spending growth (12 percent per annum per person) are driving overall health care costs above GDP growth again, after five straight uncommonly good years. Specialty drugs made up 1 percent of prescriptions written but accounted for 25 percent of drug spending in 2013. Spending on these medications is growing faster than for all other drugs and will account for more than 50 percent of all drug spending by 2019. Regardless of whether one takes these drugs or not, we all pay the cost. Drug prices threaten premiums and pocketbooks everywhere.

There is no doubt that we need innovation. . Drug development is expensive, time-consuming and risky in that most products never make it to market. But the tools we use to encourage innovation — patent protection of the basic science and additional market or data exclusivity once the product is declared safe and ready for sale — confer monopoly power and high profits. Our system is now set up to depend upon competition to drive down costs while providing patients with more treatment options and better value for their health care dollars.

This all has worked well enough for traditional drugs (antibiotics, cholesterol drugs, etc), wherein 85 percent of prescriptions are generic today. But drug companies have figured out it is more profitable to invest in specialty drugs precisely because competition for them is harder to create. Most specialty drugs are products of growing organisms instead of chemical compounds, and are often called “biologics.” Examples include most anti-cancer drugs and new treatments for multiple sclerosis and rheumatoid arthritis.

Therein lies our great dilemma. The Affordable Care Act included a provision which tried to create the same kinds of competition in biologics that we have for traditional drugs. But it granted 12 years of exclusivity for biologics after launch, which is a very long time. That extra time confers enormous monopoly pricing power to drugmakers. At the same time, it took five years just to create regulations for biosimilars to be approved – the analogues to generics. The first biosimilar drug was finally approved for sale this spring –to compete with a drug that was launched in 1991. Case in point: we clearly do NOT have a robust biosimilar market today.

The truth is competition for biologics is hard to jumpstart, and prices are way too high. Yet, the stakes for patients and the health system more broadly are even higher, so there is no shortage of policy suggestions. Most proposals require substituting public money for private capital in order to reduce the private investment at risk and to enable the same high profit rates to be earned with lower prices. Other proposals range from the use of existing diagnostic programs to match patients with the right drugs to freeing government and commercial payers from covering some drugs to indication-specific pricing, especially those that either do not extend the quality or length of life very much.

All of these policies have merit. But a cleaner solution would avoid relying on federal bureaucracies to make complex judgments about which company’s products are more promising or which clinical tests are required before access to potentially life-saving treatment is granted.

But to directly address the issue of monopoly pricing power that is difficult to challenge, what if we made market exclusivity contingent on pricing behavior? Suppose we allowed drugmakers to charge what they want for new drugs – after all this is America –but if they charge a price that is “too high,” they will NOT get the market exclusivity they were expecting once the patent has expired. For drugmakers looking down the biologics pipeline, who depend on post-market exclusivity to have a monopoly for extended periods, this would be a serious matter indeed.

Pay-for-performance is ubiquitous at this point with providers and payers. Why should drug pricing be any different? We first need to ask ourselves how high is “too high?” I would suggest for new drugs that are not clinical breakthroughs – like most of the recent anti-cancer drugs that do not deliver extend life very long – a price is too high if it enables the firm to earn a profit rate on sales more than 20 percent higher than its own cost of capital in the competitive marketplace.

Investors and money managers are very sophisticated about risk and drug failure rates, and so the observed cost of capital to the firm reflects that collective assessment of risk very well. Allowing the firm to earn 20 percent higher than that – for example, a 12 percent rate of return if they can borrow today at 10 percent — would cover current R&D which is the main point of drug company profit anyway.   For big breakthroughs we might allow 40 percent higher return than the cost of capital, and for new firms without current sales we might allow 50 percent higher than the cost of capital to encourage them to invest and compete. The resulting profit rates should be sufficient to sustain appropriate and new R&D investment without giving drug companies windfalls due to the absence of competition. But all these profit rates are way below what Gilead earned in 2014. In effect, the policy of conditional exclusivity would force pricing behavior more consistent with what competition could do if there was some in a reasonable time frame, and thus would make clear we value competition as much as innovation as a tool to keep costs down.

So what price we should pay for specialty drugs? High enough to keep productive R&D investment flowing into a risky and vital industry, but not whatever the successful companies want to charge just because they can.   In short, we need to make clear that monopoly grants come with responsibility and accountability, and that competition is more important to the public than a blank check for innovation we cannot afford.

Len M. Nichols, Ph.D. is the director at the Center For Health Policy Research and Ethics and a Professor of Health Policy at George Mason University