An estimated 150 million Americans receive insurance through their employer — and employees and employers alike continue to suffer from “sticker shock” for prices for new drugs, despite several years of debate and threatened congressional action to control the high prices of pharmaceutical products. While considerable attention has been paid to potential actions by Medicare or the Food and Drug Administration (FDA), there has been less focus on the role of private payers to solve the issue. Employers sponsoring health benefits are not bound by the same statutory constraints that apply to Medicare and can decide with fewer restrictions what is covered and how much of the cost employees pay for each service. However, employers are sensitive to making changes to health benefits that could interfere with employee recruitment and this article will discuss employers’ options to address high drug prices more aggressively in that context.

The increase in spending for pharmaceuticals has been the major driver of annual increases in employer health care costs for the last several years. Employees are also paying more for drugs due to steadily increasing deductibles. Drug spending is the product of volume multiplied by price and health insurers or pharmacy benefit managers (PBMs) manage both sides of the equation for employers. Programs like prior authorization and quantity limits, which approve payment only for those medications that meet evidence-based guidelines, manage the volume side and decrease the amount of unnecessary medication. On the price side, PBMs use their purchasing clout to negotiate discounts off of list prices and then steer patients to use the lowest cost drugs that have equivalent outcomes. More control over utilization leads to greater price discounts often in the form of rebates, of which PBMs take a percentage, or in many cases, return completely to the client. But even substantial rebates off of unbridled launch prices still lead to overall high prices.

The Problem of Launch Price

There is evidence that the aforementioned programs have had an impact on non-specialty drug costs. However, specialty drugs comprised 32 percent of overall drug expense in 2014 and their cost has been rising at a rate greater than any other good or service in the economy. A high launch price, or the price set by the manufacturer when the drug first becomes available, provides the starting point for the ultimate cost of the drug and in the absence of a therapeutic alternative there is little that the PBMs can do. Nor does the government have tools to address launch price: the statutory limitations on the Centers for Medicare and Medicaid Services (CMS) that prohibit establishing or negotiating price combined with the long intellectual property protection on drug patents give pharmaceutical companies a free hand to set initial price.

Trend Forecast by Year and Drug Type

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Artemetrx– Specialty Drug Trend Across the Pharmacy and Medical Benefit.

Pharmacy manufacturers argue that the high prices are necessary for three reasons: first, research and development is itself expensive; second, launch prices need to start high due to the rebates, discounts, and generics that determine the much lower actual price; and third, unless profit margins adequately reflect the high value delivered by the new drugs, less innovation will occur. Each of these positions has been incompletely challenged and debated. The first of these arguments ignores the fact that under price pressure other industries have found ways to continue to innovate while dramatically reducing the costs of research and development, e.g., aerospace or biotechnology services like genome mapping. The second of the arguments obscures the fact that even a large rebate on a very inflated price still results in an unaffordably high cost for patients and payers. The third contention, that breakthrough innovations warrant very high profit margins, is indisputable. But it begs the question of how high the profits should be and how this level should be determined. The current approach most closely resembles real estate pricing: whatever the market bears based on the recent sales prices of similar assets.

Options to Lower the Launch Price

In the absence of the forces of supply and demand or government price setting, employers need to establish a model that relates price to value. An approach in which the price of a drug varies based on the outcome it delivers, so-called value-based payment, has recently emerged. While several initiatives are underway there is reason to believe that this model will have a limited impact on overall drug pricing. Outcome measures have proven very challenging to develop and acceptable metrics are likely to apply to only selected drugs. Process measures, e.g., decreasing cholesterol levels, vary considerably in their contribution to how patients fare. A variation of this approach, more likely to have greater impact in the short run, is indication-based pricing in which drugs are priced differentially based on evidence of their efficacy in the different conditions. In other words, a drug known to have a specific outcome in one kind of cancer would receive the launch price set by the drug company but a lower price would be applied when the drug was used for conditions in which the impact was less. However, it is difficult to see why a drug company would agree to cut the price significantly for any indication.

A third approach is to exclude drugs from a formulary unless the price meets a specific value ratio. Health services researchers have developed ways to compare effectiveness of interventions, most frequently using the notion of cost per quality adjusted life year (QALY). QALYs have generated controversy in the US but European countries and health economists have used them widely. In the US, Medicare is prohibited from using this approach explicitly and managed care companies and PBMs have not adopted it.

Although no country has a stated “number” threshold, by way of comparison, a high priced, accepted treatment like renal dialysis has a current QALY of $50,000 in the US. As might be expected, the value varies widely for drug prices from less than a thousand dollars per QALY for some generic medications to greater than $250,000 per QALY for PCSK9 inhibitors, a new specialty medication that decreases the cholesterol level.

As an example, employers would set a rule that new drugs would be covered only if their price did not exceed a specified cost per quality adjusted life year. One option would choose $100,000 per QALY, which is in line with many other high-value medical therapies. An independent organization of health services analysts, like the Institute for Comparative Effectiveness Research or the Memorial Sloan Kettering Abacus project, would calculate the cost per QALY. Pharmaceutical company health economists would consult directly with the arbiter to ensure agreement on assumptions. If the price was set at greater than the $100,000 threshold, the employers would not cover any part of the cost of the drug. Once the threshold was met, the benefit would be covered and the PBM could start its work to reduce prices and hold inflation back. The entire program would be public and transparent.

Would employers actually adopt such a strong intervention? While reluctant in general to make health benefit changes that risk employee unhappiness, firms have been bold when cost pressures are high, e.g., the move to managed care in the 1990’s and the current uptake of high deductible designs. Employers would institute a QALY-driven formulary only if they could assure employees that access to evidence-based, breakthrough, life-saving drugs was available, no matter what the price. A good recent example might be Spiranza, used to treat spinal muscular atrophy, but costing more than $750,000 per year. To assure this access, an objective group of experts in pharmacy, medicine, and economics—a “super Pharmacy and Therapeutics committee”—could be developed to decide on exceptions. This kind of panel could be readily organized and supported by the PBMs, with an arm’s length agreement to assure impartiality.

Moving Forward

The initial or launch price at which a new drug enters the market is the most important factor in increasing drug costs. One way to control launch price is for employers and PBMs to refuse to provide coverage for drugs that do not meet an objectively derived threshold for cost effectiveness. While drug manufacturers will argue that they need current pricing levels to make profits sufficient to fund innovations, non-drug manufacturers have shown that firms in the innovation business are quite good at lowering their costs of production while still innovating. The bigger challenge will be assuring employees that their access to the right drug will not be impeded.