Issue No. 65: Index Pricing Re-Emerges, in an Even More Virulent Form

President Trump on Sept. 13 issued a new executive order that would set strict price controls on Medicare drugs. Pharmaceutical companies would be limited to charging here at home the lowest price that other wealthy countries pay. The White House has proposed variations on this theme before, but the new order is more expansive and, if it goes into effect, will push price controls to their most egregious.

Medicare covers about 40 million older Americans, but the program’s policies often spread to commercial plans as well. If enacted, the change would be profound, and studies show it would hamper the ability of pharmaceutical manufacturers to conduct research at today’s levels.

The order follows ambivalence within the Administration about imposing price controls, which have in the past been advocated by Democrats rather than Republicans. In its May 2018 blueprint, “American Patients First,” a comprehensive strategic document on reducing drug costs, the Department of Health and Human Services (HHS) expressed skepticism about the kind of index, or reference, pricing that is at the heart of the Sept. 13 order:

In 2013, the World Health Organization published a paper describing the growing use of external reference pricing, or the practice of using the price of a medicine in one or several countries to derive a benchmark or reference price for the purposes of setting or negotiating the price of the product in a given country. Every time one country demands a lower price, it leads to a lower reference price used by other countries.

Such price controls, combined with the threat of market lockout or intellectual property infringement, prevent drug companies from charging market rates for their products, while delaying the availability of new cures to patients living in countries implementing these policies.

The crux of the matter, as the WHO paper states, is that price controls come at a cost, as we will see.

Details of a Reference-Pricing Model

The Sept. 13 order follows a promise the President made on July 24, when he unveiled four orders to lower drug costs. The other three – including rebate reform and drug importation – previously advanced to a lengthy rulemaking process by HHS. For the fourth order, which Trump called “the granddaddy of them all,” the President, stated, “We’re going to hold that until August 24, hoping that the pharmaceutical companies will come up with something that will substantially reduce drug prices. The clock starts right now.” Ultimately, negotiations between the Administration and the industry failed to yield an agreement – though both sides say one was close – and the order was issued.

The order is based on what’s usually termed an external reference pricing, or ERP, model – that is, one country’s prices are determined by the prices in other countries. The executive order, however, uses different terminology, referring to the system as a “payment model on the most-favored-nation price.”

The order states, “It is the policy of the United States that the Medicare program should not pay more for costly Part B or Part D prescription drugs than the most-favored nation price.” The July 24 order applied only to Medicare Part B drugs, administered in doctors’ offices; the new order extends the policy to Part D drugs purchased from pharmacies. Also, the term “costly” is unclear; it does not seem to cover all Medicare drugs, but which?

The most-favored-nation (MFN) price is defined as “the lowest price” for a drug that a “manufacturer sells in a member country of the Organization for Economic Cooperation and Development (OECD) that has a comparable per-capita gross domestic product.” The price is also adjusted for “volume and differences in national gross domestic product” – a vague formulation.

An OECD database lists U.S. GDP per capita in 2019 as $61,000. The only truly “comparable” countries (that is, with rates that are within plus or minus $5,000) are Switzerland, at $62,000, and Norway, at $66,000. Other candidates for comparison, but at rates in the low-$50,000s, are Austria, Denmark, Germany, the Netherlands, and Iceland. All of these countries have nationalized health care systems with government agencies determining prices.

Criticism of the Plan From Conservatives

Reliable Trump supporters have criticized ERP plans as imposing on Americans the health policies of socialist or social democratic countries. For example, Grace-Marie Turner, president of the conservative Galen Institute, wrote in Forbes that the President’s order threatens to “import price controls from countries with government-run health systems.” The piece was headlined, “Say No to Importing Foreign Price Controls for Drugs.” According to a FiercePharma article Sept. 14, “Republicans in Congress…say they think adopting drug prices from countries where prices are set by the government is effectively importing socialism.”

President Trump himself threatened to veto H.R. 3, the Democrats’ drug-pricing bill, which contains an international reference-pricing provision. The bill passed the House in December but won’t come up for a vote in the Republican-controlled Senate.

In an editorial two years ago, when a less expansive plan than the current one was proposed, a Wall Street Journal editorial stated, “The reason European countries pay less for drugs is because they run single-payer health systems and dictate the prices they’re willing to pay. Don’t like it? They’ll then vitiate your patents and make a copycat.”

Origins of the Sept. 13 Proposal

The plan that was the target of the Journal’s scorn followed President Trump’s January 2018 State of the Union Address, when he said was “very, very unfair” that people who live in other rich countries pay less for medicines than Americans do. The May HHS blueprint made the same point, listing as one of “four major challenges” that “foreign governments [are] free-riding off of American investment in innovation.” In a Senate hearing the next month later, HHS Secretary Alex Azar said that he looked at the idea of ERP but said, “I don’t think it would be effective” because companies could simply raise prices abroad to gain leeway in setting prices here.

But in a few more months, the model was back on the table. On Oct. 25, 2018, the White House solution proposed a plan to set drug prices in this country based on 126% of an average price derived from an index of what 14 other countries, 12 in Europe plus Canada and Japan, are paying. The plan was entered in the Federal Register as a proposed rulemaking of the Centers for Medicare and Medicaid Services five days later and then languished.

Those earlier price controls would have applied only to single-source drugs and biologicals in Medicare Part B, such as infusions of cancer medicines. The system “would be phased in over a five-year period [and] would apply to 50 percent of the country.” It would, in effect, be a limited and long-lasting pilot program.

Prices under the new order would almost certainly be set lower than under the 2018 model. Rather than about one-fourth more than an average of several countries, a price would be identical to the lowest of the low. How low? In a September 2019 comparison of the prices of about 60 pharmaceuticals by the House Ways & Means Committee staff, the U.S. drugs sampled had an average list price of $466, but the average list price in Switzerland was $116; in the Netherlands, $153; in Denmark, $182. Because of rebates, “list prices” are not the prices Americans, or even their insurance plans, actually pay. Still, a most-favored-nation model could easily mean reductions of one-third to one-half.

The Order and the Election

The Sept. 13 executive order does not put the new pricing system for Medicare into effect immediately. Instead, it directs Azar to “develop and implement a rulemaking plan” for a model that will “test whether, for patients who require pharmaceutical treatment, paying no more than the most-favored-nation price would mitigate poor clinical outcomes and increased expenditures associated with high costs.” It is unclear how long the plan and the test would take, but an article in the New York Times said “the process could take months, if not longer, and it would almost certainly be challenged in court.”

Also unclear is whether HHS will examine the effect of MFN on future “clinical outcomes.” If reduced revenues lead to reduced R&D, which seems inevitable, then fewer new drugs will be available – with a devastating effect on outcomes.

The new MFN order itself “does not by itself do anything,” as Kaiser Family Foundation executive vice president of health policy Larry Levitt wrote on Twitter. “It has to be followed up by regulations, which will take time.” 

The Times article also noted that the President has already “made the executive order – the war that has broken out with the pharmaceutical industry – a centerpiece of his campaign for re-election.” The original July 24 order ignited an explosive reaction from drug companies and their supporters, which, in turn, was followed by a tough TV spot from the Trump for President campaign committee. It begins, “Greedy drug companies seeking even bigger profits are lying about President Trump. Here’s what President Trump’s plan really does: Reduces Medicare and prescription drug prices.”

The Effect of Price Controls on U.S. Drug Innovation

If pharmaceutical revenues are sharply reduced by price controls, drug companies argue that their investment in research and development will fall as well. The result will be a falloff in new treatments – and in overall health – for Americans as well as the foreigners who depend on U.S. innovation.

In Newsletter No. 63, we used the example of Regeneron’s popular Eylea, an injectable Medicare Part B treatment for macular degeneration, a disease that leads to blindness. An MFN rule would cut Eylea revenues by at least one-third. Regeneron is currently spending large sums to develop a double antibody cocktail for the treatment and prevention of COVID-19. That drug entered late-stage clinical trials on July 6, and the company last month announced that results will be coming soon. Regeneron also announced that its research and development costs rose 36% to $580 million, or 36%, mainly as a result of its COVID-19 work. R&D costs represented 30% of revenues in the quarter and 65% of net income.

Would potentially life-saving medicines – not just for COVID but for many other diseases – even be developed if an MFN rule slashes future revenues?

A study of the original, milder October 2018 plan by the consulting firm Vital Transformation concluded that reference pricing “penalizes innovation, targets companies with the most advanced, newest products in the market for what are often the most challenging diseases.”

The study notes that many of the most innovative drugs are developed not by pharmaceutical giants but by smaller biotechs, which are often purchased by the larger companies. Reference pricing, the study found, “will radically reduce the amount of liquidity available for investments into new products/mergers/partnerships etc., negatively impacting market entry of new medicines .”

The study also casts doubt on the notion that, in response to an ERP model, drug companies will raise prices in Europe so that reference prices will rise. The study calls this scenario “highly unlikely and could lead to compulsory licenses against U.S. products” – that is, outright confiscation of American intellectual property by foreign governments. The study also concludes that if ERP applies only to the most advanced drugs, then R&D will skew away from those medicines.

A earlier study by Thomas Abbott and John Vernon, published as a working paper by the National Bureau of Economic Research, found that “cutting prices by 40 to 50 percent in the United States will lead to between 30 and 60 percent fewer R and D projects being undertaken in the early stage of developing a new drug.” The 2018 plan would have reduced prices by 30%, and interpolating from the Abbott and Vernon calculations, we figure that R&D projects would drop between 20% and 40% – a disaster for global health. The new Sept. 13 MFN plan would cause an even deeper price cut.

Already in 2020, the Food & Drug Administration has approved 40 new drugs, fighting such diseases as lung cancer, HIV/AIDS, multiple myeloma, muscular dystrophy, migraine, malaria, thyroid eye disease and more. At this rate, by year end, more than 50 new drugs will be approved. Imagine that 10 or 20 of those were never developed.

The U.S. has taken the lead in pharmaceutical innovation because of our relatively free market. As Europe and Japan have moved to monopsony (single-buyer) price controls, their drug industries have suffered. We can expect the same if the U.S. adopts reference pricing.

How to Tackle Free-Riding?

What is to be done, then, to address the unfairness of free-riding?

More than 200 U.S. economists, including several Nobel Prize winners, tackled the price-disparity issue in a public 2004 letter. They wrote: “The ideal solution would be for other wealthy nations to remove their price controls over pharmaceuticals. America is the last major market without these controls. Imposing price controls here would have a major impact on drug development worldwide, harming not only Americans but people all over the world. On the other hand, removing foreign price controls would bolster research incentives.”
 
But how to get those “other wealthy nations” to do the right thing? The best answer is for the Trump Administration to play to its professed strength in trade negotiations. Through tough bargaining, the U.S. can pressure other rich countries to relax, or end, their price controls. Those countries could still provide tax credits or direct subsidies to their citizens for drugs and other health services if their aim is to ease the burden of health-care costs, but they should not be allowed to set prices for American medicines – any more than the U.S. government should be able to set prices for German cars.
 
Price controls badly distort trade and may be impermissible under current trade agreements – and can certainly be changed in future ones. The U.S. could begin the process by appointing a special USTR negotiator with jurisdiction over complicated issues of pharmaceutical trade, sanctions for countries that cheat on current agreements, and tough negotiations for future agreements.

Unfairness or Out-of-Pocket Costs?

The real problem, however, is not so much unfairness as high out-of-pocket costs for Americans. That is a subject we addressed at length in our last newsletter, which offered five ways for the Administration to reduce the amount that people pay themselves, especially the sickest patients: easing co-pay assistance so that manufacturers can assist Medicare beneficiaries in the same way they assist the commercially insured, enforcing insurance caps on monthly spending (here, states are out in front of the White House), placing a ceiling on Part D Medicare expenditures by beneficiaries (easy to do), changing regulations to speed biosimilars to market (thus increasing competition to drive down prices of the most advanced drugs), and reforming the opaque and corrupt rebate system (the object of one of the Administration’s orders).

Meanwhile, the first rule in health care is to do no harm. It’s critical that the U.S. avoid steps that would harm pharmaceutical innovation – and the nation’s health at the same time.