The trends are clear: patients and institutions across the nation are concerned about skyrocketing drug prices. This post offers some information about drug pricing, explores the notion of market intervention, and proposes a series of responses to high pharmaceutical costs.

A few jaw-dropping facts quickly illustrate the pattern of rising drug costs. The average annual cost of cancer drugs increased from roughly $10,000 before 2000 to over $100,000 by 2012, according to a recent study in Mayo Clinic Proceedings. Several breakthrough specialty medications and orphan drugs recently approved by the Food and Drug Administration (FDA) have subsequently entered the pharmaceutical market with hefty price tags. Consider Biogen Idec’s multiple sclerosis drug, Tecfidera, which costs $54,900 per patient per year; hepatitis C cures from Gilead Sciences, with a sticker price of $84,000 per patient; and Orkambi, a cystic fibrosis drug from Vertex Pharmaceuticals approved this month, priced at a whopping $259,000 per year.

If specialty pharmaceutical prices are dropping jaws, generic drug prices have at least managed to raise eyebrows. In 222 generic drug groups, prices increased by 100 percent or more between 2013 and 2014, according to Forbes. As generic drugs have long provided payers some respite from other more expensive products and services, rising prices in generics like Mylan NV’s albuterol sulfate—which increased about 4,000 percent from 2013 to 2014—are well worth the concerns.

The increase in drug costs—projected by the Centers for Medicare and Medicaid Services Office of the Actuary to be 12. 6 percent in 2014—has far outpaced inflation, which has hovered between zero and 2 percent over the last three years; it has also outstripped growth in other medical costs. Pricewaterhouse Coopers (PwC), in its 2013 annual medical cost trend report, projected overall cost growth to be 6.5 percent in 2014 in the large employer market. In stark contrast, a recent Express Scripts analysis declared a 13.1 percent increase in prescription drug spend in the same period.

On the surface, it appears as if drug manufacturers are unduly milking the udder of American health care reimbursement, even as it runs dry for insurers and providers.

Yet, this is hardly a crime. The behavior of the pharmaceutical industry is tolerated, suggesting that drugmakers have sufficient rationale for pricing products. In contrast, a Kaiser Health Tracking Poll last month found that 73 percent of Americans find the cost of drugs to be unreasonable, and most blamed drug manufacturers for setting prices too high. Some particularly high cost medications for hepatitis C have even forced insurers and Medicaid programs to limit usage of the drugs.

The financial success of Big Pharma, medical innovations brought by its investments, absence of price intervention, public concerns, reactionary measures that affect clinical care — together these phenomena paint a puzzling picture.

Pricing Drugs

While research and development can indeed carry large costs and span multiple years, there is simply more to pricing drugs. Many modern-day assessments cite the value that a new drug brings to patients, along with savings incurred by the health system, as more relevant factors that drive drug price. BloombergView columnist Megan McArdle says that drugmakers set prices based on whatever the market will bear, especially since demand for some therapeutic drugs is relatively inelastic — in other words, demand does not change much in response to price changes.

Pharmacoeconomic studies may seek to quantify the value of a drug by calculating the estimated cost of an intervention per quality-adjusted life year (QALY) added by the drug. Cost savings resulting from a drug are often calculated through the cost of clinical services, hospitalizations, and other less effective medications that untreated patients would otherwise incur.

Since the main buyers of the drugs are private insurances and the government, pricing decisions do not generally consider an individual’s purchasing power. On the contrary, manufacturers offer many expensive medications free of charge to patients with inadequate insurance coverage, which has earned Big Pharma some applause.

If rare value and lack of alternatives drive high cost for specialty drugs, what could cause increases in generic drug prices? One reason could be drug shortages brought about by facility issues and production slowdowns due to tightened quality controls. Another theory is that consolidation among drugmakers or the departure of existing manufacturers is limiting competition in the generic drug market.

Other theories about price-setting are more cynical. Bloomberg’s Robert Langreth writes that some desperate pharmaceutical companies are raising prices on products still under patent to offset losses from former blockbuster drugs that have lost patent protection.

Perhaps the words of the former CEO of Genzyme ideally sums up the method of setting drug prices: “It is not a science. It is a feel.”

Pay Or Lose

Pharmaceutical firms in America enjoy a hands-off approach by government to pricing products, atypical by global standards. In fact, Medicare is barred from negotiating prices with manufacturers, and the FDA does not consider cost in the approval of a medication. Government agencies in Canada, Australia, and European countries can negotiate medication prices, often by conducting their own studies to evaluate therapeutic benefits.

The difference in negotiating rules shows.

A 2013 issue brief from the Center for Economic and Policy Research (CEPR) estimates that Denmark spends about a 34 cents on drugs for each dollar spent per person in the United States. Prices for well-known drugs can vary widely across international borders. One month of Lipitor costs $100 in America, compared to $6 in New Zealand. Gilead’s Sovaldi costs $84,000 for a 12-week course of treatment in the United States, compared to $900 in Egypt.

While it may appear that market intervention is the cure, this notion is riddled with complexity.

Pharmaceutical companies and free market proponents were unhappy at the Obama administration’s recent proposal to grant Medicare the authority to negotiate drug prices. A Republican-controlled Congress is unlikely to accept such meddling in private markets, and a lobbying firm in Washington called the proposal “dead on arrival.”

Indeed, shaking the boughs could hurt the research-and-reward economy where Big Pharma thrives, and slow down future innovations in medicine. Ed Silverman of The Wall Street Journal reports that in response to the proposal to negotiate prices, the pharmaceutical industry trade group warned of reduced access and hindrance in drug development.

Where Do We Go From Here?

There is the famous tale of Sanofi’s Zaltrap. The colon cancer drug, priced over twice as high as a competing product at the time of approval, was rejected by doctors at Memorial Sloan Kettering Cancer Center in New York because of its price — an unprecedented act. Three weeks after the announcement, Sanofi cut its price in half, according to CBS News’ recent “60 Minutes” feature.

Insurers are pushing a larger portion of the cost to patients by placing brand-name and specialty drugs on their highest copayment tiers. Some payers are simply limiting coverage and denying treatment. Prescription of hepatitis C drugs is now subject to intensive approval processes. Most private insurers as well as State Medicaid programs are only covering the drugs for patients at advanced stages of disease, leaving others to pay for it themselves or wait until their conditions worsen.

To avoid the controversies, administrative burden, and ethical dilemmas produced by these radical reactions, I recommend three measures: participative pricing, joint accountability for outcomes, and increased regulation of the generic drug market.

Participative Pricing

Use of pharmacoeconomic research to appraise new medications is highlighted in a recent World Health Organization (WHO) study, which directs national health authorities to closely scrutinize the price of a drug based on its therapeutic results.

While the prospect of Medicare negotiation appears slim, private payers, doctors, and Accountable Care Organizations (ACOs) should collaborate with manufacturers on pharmacoeconomic studies in order to value the outcomes and financial benefits brought to the health system by a therapeutic drug. McKinsey and Company provides helpful tips on conducting such a process, like discussing outcome measures several years before launch of a drug, and offers guidance on who should be part of the evaluation team.

While drug manufacturers evidently conduct valuation studies prior to pricing decisions, other entities appear to be doing so today simply as a reaction to high prices. The American Society of Clinical Oncology (ASCO), fueled by the rising cost of cancer care, is developing an algorithm to rate drugs in terms of cost-effectiveness. Bloomberg reported this month that a panel of experts has drafted a report that concludes that new hepatitis C drugs manufactured by Gilead and Abbvie are indeed cost-effective, a finding that is likely to be debated further. In either case, each stakeholder could be better off by consolidating its efforts with drugmakers’ analyses in a participative environment prior to the launch of a drug.

A Modern Healthcare article suggests that payers are already beginning to collaborate with pharmaceutical firms by providing access to patient data that may help design clinical studies, increase precision, and better understand value of medical interventions.

Joint Accountability For Outcomes

If providers are facing greater accountability in the form of bundled reimbursement, pay-for-performance, and penalties for inadequate care, Big Pharma should not be off the hook. When a fairly priced product fails to yield the benefits quantified through joint pharmacoeconomic studies, the producer should reimburse payers for the drug price, or lead corrective measures—like an additional treatment regimen—at no further cost to other stakeholders.

Outcome failure can be a complex issue since it can be driven by a variety of factors including non-adherence to medication, drug inefficacy, and inability to agree on metrics and methods of measurement. While the parameters would have to be carefully set prior to entering such an arrangement, this should certainly not act as a barrier to joint accountability. Even factors as patient-centered as dosage adherence can be impacted favorably by other stakeholders, perhaps through affordable copays, automated reminders, and so on.

Despite the apparently complexity, Deloitte’s ConvergeHealth unit cites examples of the practice of drugmaker accountability. When the UK’s drug authorities initially rejected Velcade, a drug that treats multiple myeloma and mantle cell lymphoma, Johnson & Johnson decided to forgo payment for any patients who did not respond adequately to the drug. In Denmark, patients not satisfied with Bayer’s Levitra could get a refund under a “no cure, no pay” initiative.

Increased Regulation Of Generic Drug Pricing

Controlling increases in generic drug prices can be construed as an antitrust issue, rather than price negotiation by Medicare, which is barred.

Generic drugs in theory operate in a free market where competition regulates prices. However, for certain drugs, the number of manufacturers may be small, thus putting this system at risk. For instance, a New York Times article last year reported that after a few manufacturers stopped producing digoxin in 2013, two large drugmakers—Lannett Company and Global Pharmaceuticals—were left in the market. By January 2014, digoxin cost 40 cents per pill, about double the price that was charged six months before.

In monopoly-like environments, regulators should set caps on price increases. Of course, any such rule must include concessions for changes in ingredient prices or other uncontrollable factors.

In addition, antitrust regulators reviewing merger proposals—like Teva Pharmaceuticals’ recent takeover bid of Mylan NV, which has drawn national attention—should ensure that such integrations can eventually result in operating efficiencies that would lead to reductions in drug prices.

The short-term results of the recent wave of rising drug costs are concerning and point to the acute need for such interventions. Financial success of Big Pharma is important in ensuring continued innovation and significant medical breakthroughs. However, the ability to charge prices based on what the market will pay, coupled with the lack of collaboration among market players, have propelled prescription drug costs to being a major reason why the United States spends substantially more on health care than other developed nations. Meanwhile, payers, institutions, and patients are grappling with ways to survive in the face of these rising prices, which often means pulling the lever of limitation, putting medical accountability at risk.

We are on an unsustainable playing field that is likely on the brink of a makeover.