Chapter 25
The High Price of Prescription Drugs
1. Prescription drug expenditures are increasing faster than other medical
expenditures (see slide)
 Expenditures growing faster than prices indicate that use is increasing
o An increase in the number of aged leads to more use (see slide)
o An increase in insurance coverage leads to more use (see slide)
o Baby boom will continue upward trend
o Out of pocket share is steadily declining (see slide)
 The replacement of older drugs by newer drugs is the most important
reason for the increase in drug expenditures.
o Innovative new drugs that cost more and have preventive and
curative effects that result in greater use.
o New “lifestyle” drugs have been developed that improve quality of
life and can be taken for decades.
2. Are rising drug expenditures necessarily bad? No.
 Rising drug prices often reflect new and improved drugs. For example,
there are new pain relievers to treat severe arthritis, but they cost $150 a
month, nearly 20 times more than previous pain relievers. A new biotech
drug, Enbrel, to treat rheumatoid arthritis can cost $1,500 a month.
 A greater number of prescriptions per person, particularly for the aged,
may indicate that chronic diseases can be better managed and the aged can
live longer with a higher quality of life.
 New drugs, although expensive, reduce nonpharmaceutical medical costs;
for example, new antidepressants have reduced costly psychotherapy, and
beta-blockers and blood pressure drugs have reduced the costs of
cardiovascular-related hospital admissions and surgeries.
3. Is the high price of drugs determined by the high cost of developing a new
drug? No.
 High research and development (R&D) costs are not the reason for high or
rising drug prices.
 Large fixed or “sunk” costs are costs that have already been incurred; hence
they are not relevant for setting a drug’s price. Fixed costs must be
recouped, however, or a firm will lose money.
 High prices of drugs are determined by their greater value relative to other
drugs to treat the same disease. Only if a drug provides greater benefits
than competitor drugs are insurers willing to pay a higher price for that
drug. New drugs that aren’t better than existing ones can’t sell for more.
 Patent protection for new Rx drugs typically lasts 20, but since they’re
usually granted prior to clinical trials, they usually last about 8-10 years
after FDA approval.
4. Why do drug manufacturers charge different purchasers different prices for the
same prescription drug? It is the ability to shift market share rather than just the
volume purchased that drives discounts.
 Purchasers who are not price sensitive are charged higher prices than those
who are.
 Large MCOs pay less because they’re more elastic demanders willing to
switch all of their patients to a competitor drug.
 High prices to some is not intended to cross-subsidize losses to others. It’s
simply a matter of the elasticity of demand.
 Not all large volume purchasers receive price discounts.
o Retail pharmacies in total sell a large number of drugs, but they do
not receive the same price discounts as do managed care plans.
o MCOs receive larger discounts because of their willingness to switch
patients from one drug to another (via their formulary).
o Prescription Benefit Managers (PBMS) operating on behalf of health
plans can also promote particular brand names which leads to large
discounts.
o Retail pharmacies pay the highest prices for their prescription drugs
because they must carry all branded drugs. They cannot promote
substitution between branded drugs because the physician may be
prescribing according to a health plan’s formulary. Because the
pharmacy cannot shift volume, the drug manufacturer has no need
to give it a price discount.
5. What methods have managed care plans used to limit their enrollees’ drug
costs?
 Drug costs have become health plans’ fastest increasing expense.
 In response to rising costs, MCOs have provided the patient with incentives
to use less expensive drugs.
o A three-tiered system is used: patients pay a small copayment for
generic drugs, a higher copayment for prescription drugs on the
HMO’s formulary (where the manufacturer gives a large discount),
and a much higher copayment for branded drugs not on the health
plan’s formulary.
6. How have drug firms changed their marketing strategy as a result of managed
care?
 Previously, physicians decided the patient’s prescription drug, and drug
manufacturers spent a great deal of money marketing directly to
physicians.
 Managed care shifted the purchasing decision from the individual physician
to the committee overseeing a managed care organization’s formulary.
 Physicians continue to be important in prescribing drugs to their patients,
but PBMs and health plans determine which brand-name drugs the
physician is able to prescribe and the prices paid for those drugs.
 To counteract the closed formularies, drug firms started direct-to-consumer
advertising to generate consumer pressure on physicians to prescribe
certain drugs. This advertising has proved very effective in increasing sales
of advertised prescription drugs.
o Drug companies claim the ads are meant to inform the patient and to
stimulate a discussion between the patient and his or her physician.
o Critics claim that the ads do not inform patients about who is most
likely to benefit from that drug, possible side effects, or other
treatment options.