Are Drug Pricing Formulas Full Are Drug Pricing Formulas Full Employment Acts For State Employment Acts For State

Attorney Generals?Attorney Generals?

Gerard Anderson PhDGerard Anderson PhD

ProfessorProfessor

Johns Hopkins University Johns Hopkins University

Lake Wobegon Syndrome : How Lake Wobegon Syndrome : How Can Everyone Be Getting A Better Can Everyone Be Getting A Better

Deal?Deal?

U.S. vs. Other CountriesU.S. vs. Other Countries Medicaid vs. Other PayorsMedicaid vs. Other Payors Maryland vs. CaliforniaMaryland vs. California Maryland Medicaid vs. Maryland Maryland Medicaid vs. Maryland

PrisonsPrisons

Economics 101 – Fixed Economics 101 – Fixed vs. Variable Costsvs. Variable Costs

Fixed Costs Fixed Costs costs that must be incurred regardless costs that must be incurred regardless

of number of units soldof number of units sold Variable Costs Variable Costs

costs of producing one additional unitcosts of producing one additional unit ExamplesExamples

Fixed - plant and equipment or R & DFixed - plant and equipment or R & D Variable - materialsVariable - materials

Fixed Costs Decline As Fixed Costs Decline As Number of Units IncreaseNumber of Units Increase

Q

P

Variable Costs First Variable Costs First DecreaseDecrease

and Then Increase and Then Increase

Q

P

Standard Economic Theory – Price Standard Economic Theory – Price Determined By Where Variable Cost Determined By Where Variable Cost

is Lowest - Fixed Costs are is Lowest - Fixed Costs are IrrelevantIrrelevant

Q

P

Firms Produce Where Variable Cost is Lowest

In Reality –Fixed Costs In Reality –Fixed Costs MatterMatter

Pharmaceutical companies could not Pharmaceutical companies could not exist if everyone only paid only the exist if everyone only paid only the variable costvariable cost

Most Pharmaceutical Spending Most Pharmaceutical Spending Involves Fixed CostsInvolves Fixed Costs

Marketing: 32.8%Marketing: 32.8% Costs of Goods Sold: 25.3%Costs of Goods Sold: 25.3% Profit: 20.6%Profit: 20.6% R & D: 14%R & D: 14% Taxes: 7.3%Taxes: 7.3%

$64,000 Policy Question$64,000 Policy Question

Who should pay the fixed costs of Who should pay the fixed costs of pharmaceutical companies?pharmaceutical companies? U.S. vs. other countiesU.S. vs. other counties Medicaid vs. other payorsMedicaid vs. other payors Maryland vs. CaliforniaMaryland vs. California Maryland Medicaid vs. Maryland PrisonsMaryland Medicaid vs. Maryland Prisons

Who Is Paying The Fixed Costs?Who Is Paying The Fixed Costs?

U.S. pays twice as much as other countriesU.S. pays twice as much as other countries Almost 2 to 1 difference in government Almost 2 to 1 difference in government

payors:payors: MedicareMedicare 340 B340 B MedicaidMedicaid VAVA DoDDoD

Some states pay 3 times what other states Some states pay 3 times what other states paypay

Significant variation within state programsSignificant variation within state programs

Policy Issue – Spillover EffectsPolicy Issue – Spillover Effects

If payor (e.g. Medicaid) gets a lower price If payor (e.g. Medicaid) gets a lower price then will other payors have to make up the then will other payors have to make up the difference?difference? One economic assumption: One economic assumption:

Pharmaceutical companies will be able to raise prices Pharmaceutical companies will be able to raise prices to other payors (programs) to cover their fixed coststo other payors (programs) to cover their fixed costs

Alternative economic assumption:Alternative economic assumption: Each payor (program) negotiates the best price Each payor (program) negotiates the best price

independently of what other payors (programs) payindependently of what other payors (programs) pay

My Perspective On Spillover My Perspective On Spillover EffectsEffects

Each pharmaceutical executive will Each pharmaceutical executive will want to maximize the revenue from want to maximize the revenue from each payor (program)each payor (program)

Result is that states need an Result is that states need an economic not just a legal rationale economic not just a legal rationale for getting low drug pricesfor getting low drug prices

Full Employment for Full Employment for Attorney GeneralsAttorney Generals

Without an economic rationale Without an economic rationale companies will try to maximize companies will try to maximize revenue in Medicaid by revenue in Medicaid by ““gaminggaming”” the the systemsystem

Unlike Most Goods and Services Unlike Most Goods and Services the Consumer Is Not King In the Consumer Is Not King In

Pharmaceutical PricingPharmaceutical Pricing

Physicians must prescribe drugsPhysicians must prescribe drugs Hospitals, nursing homes, HHAs use Hospitals, nursing homes, HHAs use

formulariesformularies Pharmacies can push drugs that earn Pharmacies can push drugs that earn

them greater profitsthem greater profits Patients pay small portion of bill out-Patients pay small portion of bill out-

of-pocketof-pocket

Medicaid is NOT the Entity Purchasing Medicaid is NOT the Entity Purchasing Prescription DrugsPrescription Drugs

Remember the SpreadRemember the Spread

Spread is the difference between Spread is the difference between pharmacy (hospital, LTC, HHA) purchase pharmacy (hospital, LTC, HHA) purchase price and what Medicaid believes is the price and what Medicaid believes is the purchase pricepurchase price

In 2002 CBO calculated that pharmacies In 2002 CBO calculated that pharmacies earned the following spreads in Medicaidearned the following spreads in Medicaid 23% overall23% overall 30% generics30% generics 14% brand names14% brand names

What Are The Economic What Are The Economic Incentives?Incentives?

Drug companies want pharmacies to earn Drug companies want pharmacies to earn the most money on their drugs so they will the most money on their drugs so they will prescribe themprescribe them

Pharmacies will want to prescribe drugs Pharmacies will want to prescribe drugs that earn them the most moneythat earn them the most money

Both drug companies and pharmacies Both drug companies and pharmacies benefit when the spread is greaterbenefit when the spread is greater

Medicaid loses when the spread is largerMedicaid loses when the spread is larger

Trust Me I Am From Trust Me I Am From PharmaPharma

The source of all the pricing data is The source of all the pricing data is the pharmaceutical companiesthe pharmaceutical companies AWP, AMP, ASP, EAC, FUL, MAC, WACAWP, AMP, ASP, EAC, FUL, MAC, WAC

AMP and Best PriceAMP and Best Price

Average Manufacturers Price (AMP) is Average Manufacturers Price (AMP) is supposedly what a drug company receives supposedly what a drug company receives for a drug in a given quarter from retail for a drug in a given quarter from retail pharmaciespharmacies

Best price is supposedly the lowest price in Best price is supposedly the lowest price in retail pharmaciesretail pharmacies

Medicaid rebates are determined based on Medicaid rebates are determined based on differencedifference

How can any state validate either best or How can any state validate either best or AMP?AMP?

AuditingAuditing

CMS investigated pharmaceutical CMS investigated pharmaceutical company reported data on only 4 company reported data on only 4 occasions over a 10 year period occasions over a 10 year period according to GAOaccording to GAO

Lake WobegonLake Wobegon

Rebates are difficult to monitor when Rebates are difficult to monitor when the pharmaceutical industry has all the pharmaceutical industry has all the datathe data

Not every state can be getting the Not every state can be getting the best dealbest deal Some states pay almost 5 times more Some states pay almost 5 times more

for the same drugfor the same drug

Price TransparencyPrice Transparency

Find out the actual prices other Find out the actual prices other payors are paying for the same drugs payors are paying for the same drugs U.S. vs. Other CountriesU.S. vs. Other Countries Medicaid vs. Other PayorsMedicaid vs. Other Payors Maryland vs. CaliforniaMaryland vs. California Maryland Medicaid vs. Maryland PrisonsMaryland Medicaid vs. Maryland Prisons

Comparative Data Allows Comparative Data Allows A Bully PulpitA Bully Pulpit

With comparative price data states can With comparative price data states can see where they are getting a good deal see where they are getting a good deal and when they are paying higher pricesand when they are paying higher prices Must be done on a drug by drug basisMust be done on a drug by drug basis

States can then focus their negotiations on States can then focus their negotiations on the prices of drugs where they pay much the prices of drugs where they pay much higher priceshigher prices

ConclusionConclusion

Who is going to pay the fixed costs of Who is going to pay the fixed costs of the pharmaceutical industry?the pharmaceutical industry?

Gaming will occur without an economic Gaming will occur without an economic rationale for discounts and rebatesrationale for discounts and rebates

Cannot rely on pharmaceutical Cannot rely on pharmaceutical companies for all the data to determine companies for all the data to determine pricesprices

Price transparency will tell states when Price transparency will tell states when they are getting a good dealthey are getting a good deal