A Price Worth Paying
A new book offers a manifesto for how the pharmaceutical industry should function.
The Great American Drug Deal: A New Prescription for Innovative and Affordable Medicines, by Peter Kolchinsky (Evelexa Press, 292 pp., $18.00)
As much of the world remains quarantined to control the Covid-19 pandemic, the need for better treatments and a vaccine makes drug development a key to returning to normal life. The pharmaceutical industry, in recent years labeled the least-popular sector of the economy due to its pricing practices, now has an opportunity to redeem itself. In The Great American Drug Deal, biotech investor Peter Kolchinsky offers a manifesto for the industry, laying out principles to justify and guide its practices. He lauds pharmaceutical innovation as the engine of medical progress and offers suggestions for protecting patients from high prices while preserving the enormous investments that the industry needs to thrive.
Kolchinsky begins with a discussion of hip-replacement surgeries, performed 400,000 times annually in the United States, at an average cost of $40,000. Estimates indicate that overall spending on such procedures could rise from $16 billion to $50 billion over the next few decades. He asks readers to imagine that “a company comes out with a drug that strengthens bones so effectively that a person’s risk of fracturing their hip is cut in half.” What, he asks, would that drug be worth to America? This is always the critical question from an investor’s point of view, one that provides a good perspective from which to understand appropriate drug pricing.
Developing new drugs requires billion-dollar, up-front investments in research and development, but the societal benefits accrue for decades. Kolchinsky observes that “because human biology is essentially unchanging, many drugs we use today will work as well in a century.” The goal of drug policy, then, should involve building up humanity’s “generic drug armamentarium.” Prices, he notes, “will be initially—and temporarily—high on branded drugs. But after the patent expires, society reaps the benefits of the cheap, effective generic versions for the rest of time.”
This dynamic makes the drug market very different from other economic sectors—including other parts of health care, which tend to be highly labor-intensive. Kolchinsky writes that a “heart bypass and a cardiac surgeon may never go generic, but cholesterol-lowering statins, which prevent hospital admissions and even surgeries, will be cheap indefinitely.”
But he concedes that some drugs appear exempt from this genericization process. This is especially true for biologic drugs, which involve living organisms rather than a replicated chemical formula. The production of biologics typically requires complex manufacturing processes, multiple elements of which may be covered by patents. Drug makers have used these processes to extend monopoly rights beyond patent terms specific to the drug. Since biosimilars (biologics resembling other, already-approved biological medicines) need their own FDA approval, manufacturers are tempted to use the regulatory process to impede the emergence of competitors. Competition is further inhibited by the difficulty in getting patients to enroll in clinical trials of an unproven imitation when a successful therapy exists.
As a backstop for these market imperfections, Kolchinsky suggests requiring drug makers to transfer production knowledge into the public domain. In addition, he recommends a ban on charging more than a modest margin over the level of manufacturing costs—maybe twofold—following the expiration of the initial patent. It’s possible that such costs could be inflated by drug makers, or that the amount of money saved could be too small. But Kolchinsky’s rationale seems to rest on the intuition that public outrage over egregious practices threatens to undermine appropriate rewards for new drugs, and that price controls to curb rare price-gouging—such as that engaged in by Martin Shrekli’s Turing Pharmaceuticals—may secure free-market pricing where it matters most.
Kolchinsky correctly argues, nonetheless, that high prices are often appropriate to fund investments in pathbreaking drugs that create enormous value. The real problem, and the reason for public dissatisfaction, is the inadequacy of insurance coverage. Even relatively ambitious proposals to cut prices wouldn’t help much, he argues, since “a 20 percent or 30 percent discount on a $20,000/year drug doesn’t make it affordable.” Not only are 9 percent of Americans currently uninsured; they’re also more exposed to drug costs than to other elements of health care. Whereas only 3 percent of hospital spending was paid out-of-pocket in 2018, 14 percent of drug expenditures were.
Kolchinsky suggests that cost-sharing associated with prescription drugs serves a limited purpose and, by inhibiting patients from completing medications as prescribed, increases the risk that they’ll incur needless and costly hospitalizations. But the purpose of copays isn’t merely to reduce unnecessary utilization. Cost-sharing tiers enable insurance plans to steer patients to more cost-effective therapies when legally obliged to cover all medically necessary treatments—providing a key source of leverage for drug plans to negotiate good prices without entirely excluding drugs from formularies. Indeed, these practices partly account for the high rate of generic drug utilization in the U.S. and help explain why Americans spend a smaller share of their household income on out-of-pocket drug costs than residents of other major industrialized nations.
Though one may quibble with some of his recommendations for insurance-market reform, The Great American Drug Deal offers a clearly written, thoughtful prescription for how the pharmaceutical industry should function.
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