Long wall of text incoming, but please read if you want to know why drug pricing works like it does:
It’s because of the way insurance works in the US. Insurance companies have formularies, which are essentially menus of what products they cover. They also will label certain medications as “preferred” and actively steer consumers to them. Pharma companies fight to get preferred coverage from insurers.
Because of this, pharmaceutical companies go through complex negotiations with insurance companies. In theory, this is to get pharma companies to compete on price and offer discounts (called “rebates”). An industry of middlemen called pharmacy benefit managers (PBMs) has arisen who negotiate with pharma companies on behalf of the insurers and create the formularies. The problem is, these guys take a percentage cut of the discount they secure for the insurers. This creates a perverse incentive to give preferred status to more expensive drugs. Take this hypothetical example of two competing drugs:
- Drug A costs $150, but gets negotiated down to $100
- Drug B costs $200, but gets negotiated down to $100
- The PBM gets a fee of 10% of the secured discount, meaning they make twice as much for creating a formulary with B rather than A
To no one’s surprise, drug B gets given preferred status over A.
Pharma companies figured this out a long time ago, and began to jack up their prices each year, only to immediately negotiate them back down to where they were previously, in the form of rebates, because this increased the likelihood of getting out ahead on the formulary by the PBM. The best example of this might be insulin, which has skyrocketed in list price, but profit for the insulin companies has actually remained much more stable. This is because each year the sticker price is raised, and then immediately slashed in the “negotiations” with the insurers.
After a while, the pure sticker shock began causing a lot of justified outrage among patients and the public. Pharma companies saw they were taking the blame for skyrocketing prices even though at the end of the day they were negotiating these prices down and weren’t actually making that money due to rebates. So they began to offer alternatives for customers not on insurance, in the form of “coupons”, “savings cards”, etc. These often get you prices close to what the actual cost of the medicine is before the “jack up the price then rebate it down” dog and pony show. But insurers/PBMs reacted poorly to these, and began punishing pharma companies through the formularies. This is why these have become shadowy “backdoor” programs.
It’s also important to note that the PBM’s aren’t even independent middlemen. 80% of the PBM industry is dominated by 3 companies, all of whom are owned by insurers: Express Scripts (Cigna), CVS Caremark (CVS/Aetna), and OptumRx (UnitedHealthcare)
So why even go through all this?
- Pharma companies don’t really have a choice, they have to to get on the formulary
- PBMs make their money entirely through this scheme
- Costs for insurers aren’t ultimately changing much from year to year. However, higher sticker prices means the public is ever more dependent on insurance for medical bills. It also provide justification for increasing premiums more than their costs might otherwise. And pharma ultimately takes the brunt of the blame.
Lastly, if you are wondering why this doesn’t exist in other countries, it’s an unsurprising reason: government subsidized health insurance. Unlike insurers and PBMs, there are no perverse incentives or profit motive, so cheaper prices are an actual benefit. Medicare/medicaid doesn’t have to go through these shenanigans, but they aren’t available widely in the US. You don’t even need healthcare for all. You just need a public healthcare option for everyone. That introduces an actor whose motives actually align with consumers, invalidates this entire charade, and forces insurers and PBMs to actually compete on merit and price.
TLDR: The lack of public healthcare options in the US has created an insurance cartel that has both consumers and pharmaceutical companies by the balls.
It’s because of the way insurance works in the US. Insurance companies have formularies, which are essentially menus of what products they cover. They also will label certain medications as “preferred” and actively steer consumers to them. Pharma companies fight to get preferred coverage from insurers.
Because of this, pharmaceutical companies go through complex negotiations with insurance companies. In theory, this is to get pharma companies to compete on price and offer discounts (called “rebates”). An industry of middlemen called pharmacy benefit managers (PBMs) has arisen who negotiate with pharma companies on behalf of the insurers and create the formularies. The problem is, these guys take a percentage cut of the discount they secure for the insurers. This creates a perverse incentive to give preferred status to more expensive drugs. Take this hypothetical example of two competing drugs:
- Drug A costs $150, but gets negotiated down to $100 - Drug B costs $200, but gets negotiated down to $100 - The PBM gets a fee of 10% of the secured discount, meaning they make twice as much for creating a formulary with B rather than A
To no one’s surprise, drug B gets given preferred status over A.
Pharma companies figured this out a long time ago, and began to jack up their prices each year, only to immediately negotiate them back down to where they were previously, in the form of rebates, because this increased the likelihood of getting out ahead on the formulary by the PBM. The best example of this might be insulin, which has skyrocketed in list price, but profit for the insulin companies has actually remained much more stable. This is because each year the sticker price is raised, and then immediately slashed in the “negotiations” with the insurers.
After a while, the pure sticker shock began causing a lot of justified outrage among patients and the public. Pharma companies saw they were taking the blame for skyrocketing prices even though at the end of the day they were negotiating these prices down and weren’t actually making that money due to rebates. So they began to offer alternatives for customers not on insurance, in the form of “coupons”, “savings cards”, etc. These often get you prices close to what the actual cost of the medicine is before the “jack up the price then rebate it down” dog and pony show. But insurers/PBMs reacted poorly to these, and began punishing pharma companies through the formularies. This is why these have become shadowy “backdoor” programs.
It’s also important to note that the PBM’s aren’t even independent middlemen. 80% of the PBM industry is dominated by 3 companies, all of whom are owned by insurers: Express Scripts (Cigna), CVS Caremark (CVS/Aetna), and OptumRx (UnitedHealthcare)
So why even go through all this?
- Pharma companies don’t really have a choice, they have to to get on the formulary
- PBMs make their money entirely through this scheme
- Costs for insurers aren’t ultimately changing much from year to year. However, higher sticker prices means the public is ever more dependent on insurance for medical bills. It also provide justification for increasing premiums more than their costs might otherwise. And pharma ultimately takes the brunt of the blame.
Lastly, if you are wondering why this doesn’t exist in other countries, it’s an unsurprising reason: government subsidized health insurance. Unlike insurers and PBMs, there are no perverse incentives or profit motive, so cheaper prices are an actual benefit. Medicare/medicaid doesn’t have to go through these shenanigans, but they aren’t available widely in the US. You don’t even need healthcare for all. You just need a public healthcare option for everyone. That introduces an actor whose motives actually align with consumers, invalidates this entire charade, and forces insurers and PBMs to actually compete on merit and price.
TLDR: The lack of public healthcare options in the US has created an insurance cartel that has both consumers and pharmaceutical companies by the balls.