October 10 Update: SB-17 Signed Into Law

On October 9, 2017, California Governor Jerry Brown signed into law the bill described below, SB-17.

Original Post

Californians and others around the country following the California legislature’s multiyear debate on prescription drug pricing may have stood up and taken notice on September 13 when the state Senate followed the Assembly in passing SB-17 to facilitate greater transparency in brand-name and generic drug pricing.

While sponsors often make grandiose claims about the potential impact of their legislation, California senator Ed Hernandez may have set a new standard when he declared that the passage of SB-17 was “a monumental achievement for the entire nation” and “one of the most transformative pieces of health legislation in the country.”

The bill, backed by a broad coalition of consumer advocates, insurers, employers, and unions and strongly opposed by the Pharmaceutical Research and Manufacturers of America (PhRMA) and California life science companies, now goes to Governor Jerry Brown who has until October 15 to sign or reject the bill. Whichever way the governor goes, one thing is certain. This legislation is unlikely to have any impact on drug prices in California or anywhere else. In fact, if it has any impact at all, it’s possible it could lead to higher drug prices.

A Public Policy Conundrum

The context for SB-17 is the increasingly charged political atmosphere around drug pricing. The growing share of drug spending on high-cost specialty drugs, the regular list-price increases for many drugs beyond inflation, and the high-profile cases of EpiPen and pharma “bro” Martin Shkreli’s 5,000 percent drug-price increase have once again elevated drug pricing on the political agenda. President Donald Trump’s statement that drug companies are “getting away with murder” on pricing has added a bipartisan note to the debate.

Drug pricing represents a public policy conundrum. On one hand, we have policies including patents and marketing exclusivity that give brand drug makers the power to set and raise prices well above their costs so that they will have the incentive to undertake risky research and development work. On the other hand, once a drug company comes out with a new drug, everyone who pays for drugs (and everyone pays one way or the other) wants to pay less to address cost and access concerns.

Congress and state legislatures have failed to wrestle this particular conundrum to the ground. Legislatures, influenced by industry arguments and appeals from patient advocate groups, have rejected attempts to directly regulate drug prices for fear of killing—or at least wounding—the goose that lays the golden drug-breakthrough eggs. From prescription drug importation to giving Medicare the authority to directly negotiate drug prices (as opposed to letting private Medicare drug plans do the job), proposals have gotten close to passage only to fall short in the end.

Key Provisions

Into this vacuum of political concern have rushed many ideas, often pursued at the state level, to harass and shame drug companies into reducing their prices or price increases. SB-17 represents one particular flavor of this new strategy. The bill, as finally approved by the legislature, has several key provisions.

First, it would require health plans to describe the components of their premium increases including the role that prescription drugs play. Presumably, this will provide more grist for the mill of blaming health care cost increases on prescription drugs. However, besides the burden of reporting that the bill places on health plans, it is far from clear whether the resulting data will actually finger drug prices as the primary culprit. As inpatient and outpatient care makes up a larger portion of overall health care spending than drugs, we can expect that the reports will highlight those factors’ relatively more important contribution to health insurance cost increases.

Second, starting in 2019, the bill would require drug makers to prepare a report to the state on any drug that has had an increase in its list price of at least 16 percent over a period of less than three years. The report would be required to contain information including the factors that led the company to increase the price, the history of price increases, when the patent on the drug will expire, and any changes to the drug that might justify the price increases. For drugs acquired from other companies, the law would require the report to include information on the acquisition price. The report would appear on the web quarterly.

This transparency is largely, if not completely, useless. First, it only applies to increases in the wholesale acquisition cost, a list price. This price is well known in the marketplace and already readily available from the manufacturers and the services that track prices. Second, it is not the price that insurers and pharmacy benefit managers actually pay because it does not include rebates and other price discounts. Third, the legislation is clear that no reporting is required of any information that is not already in the public domain. Yes, you read that correctly. It requires companies to make transparent what is already transparent.

The bill would also require a similar report for any new specialty drug that the legislation defines as any drug costing more than $670 per month. For this report, the state seeks information on the manufacturer’s plans for marketing and pricing the drug throughout the world. And, like the other report, it would not require manufacturers to reveal anything that isn’t already public.

The third and final major requirement of SB-17 is its most noteworthy and potentially significant element. It would require companies meeting the threshold of a product price increase of at least 16 percent over a period of less than three years to provide its customers with a 60-day advance notice of such a price increase. The reporting threshold means that many if not most brand-name drug price increases would trigger advance notice as an increase of 5.1 percent annually for three years would exceed 16 percent. According to a widely reported analysis from Credit Suisse earlier this year, list prices for prescription drugs rose an average of 9.8 percent in 2016. These data are consistent with the apparent tendency of price increase announcements to consistently stay close to but just below the 10 percent mark.

And what could customers learn from and do with this information? The legislation would only require the manufacturer to tell them what the increase will be and whether there has been any change or improvement to the product that “necessitates” the price increase. The bill’s sponsors and supporters assert that this advance price increase notice requirement could aid purchasers or possibly lead to a scaling back of price increases.

What is unclear is how this might happen. To the extent that, as purchasers, they have the power to push back against increases, they can already do so through rebate negotiations. However, it is difficult to foresee how advance notice would facilitate such negotiations.

Also at work appears to be the theory that the advance notice might shame the manufacturers so that they will be reluctant to seek a price increase that might trigger a notice. Given the relatively low annual increases that might trigger the notice requirement, we can anticipate that many if not most product price increases will generate notices. Companies that are already content to live with the public relations consequences of list-price increases can hardly be expected to recoil at suffering those consequences 60 days earlier.

Potential Negative Consequences

Countering these likely illusory advantages of the advance price increase notices is the risk that they will have unintended, negative consequences. We can expect drug wholesalers and distributors to react to the notices by increasing their purchases to beat the price rise. This would allow them to buy low and then sell their inventory at higher prices later. This is already a common practice as wholesalers and distributors do their best to anticipate increases. This practice, while legal, appears to serve no one’s interest but those profiting from the spread. SB-17 would help these players eliminate the current risk that they might be purchasing too far in advance of an increase or that the size of the increase (and the opportunity to profit from it) might be too modest to justify the added cash flow and inventory costs.

More troubling is the possibility that the disclosures mandated by SB-17 may provide competitors with information that would allow them to coordinate tacitly to raise prices. Those who study competition policy have long identified nonbinding advance price announcements such as this as a facilitator of industry coordination. Of course, directly working with competitors to set prices is a violation of the antitrust laws and is the kind of thing that can land drug company executives in jail. However, drug makers certainly keep a close eye on one another when it comes to launch prices and price increases, and disclosures under SB-17 would make competitors’ prices even more easily accessible.

In highly competitive markets, price transparency can be a force that brings prices down. However, in much of the prescription drug world, where there are many classes of drugs with few competitors, there is more risk that competitors will look at a dominant competitive brand’s price increase to judge how far they might go without risking a significant loss of sales. While this is already an industry dynamic, SB-17 has the potential to make such price shadowing easier.

If SB-17 becomes law, competitors won’t have to wait to see each other’s final price changes. They would only have to wait for the 60-day notices to become public (and become public they will). Then, they can decide their own price strategies and issue their own notices. Furthermore, as there is no requirement to proceed with the noticed increases, competitors—without ever speaking to each other—can take into account others’ actions before finalizing their own prices.

Whether such behavior would raise antitrust law concerns is beyond the scope of this post, but it is safe to anticipate that manufacturers would offer as a defense that the disclosure activity in this case is required by the California law. And the price increases to which it could theoretically lead would affect all US purchasers.

SB-17 has already succeeded in serving as an outlet for frustration with high and rising prescription drug prices. It has sent a message to the drug industry that it cannot stop all the legislation it opposes. However, as an actual remedy for the policy conundrum that drug pricing presents, it will certainly fail to achieve any meaningful change and has the potential to cause real harm.

Author’s Notes

The author wishes to acknowledge the contribution of Lisl Dunlop, a partner at Manatt, Phelps and Phillips, for her review and comments on this posting. The author represents a number of stakeholders with interests in prescription drug pricing including pharmaceutical manufacturers.