Politicians have recently called for price controls to address the high costs of pharmaceuticals. Price controls are government-mandated limits on prices, or government-required discounts on prices. On the campaign trail, Hillary Clinton has called for price controls for lower-income Medicare patients while Donald Trump has recently joined Clinton, Bernie Sanders, and President Obama in calling for more government intervention in the Medicare Part D program. Before embarking upon additional price controls for the drug industry, policymakers and presidential candidates would do well to understand the impacts and problems arising from existing controls.

Unbeknownst to many, a vast array of price controls are already in place in the pharmaceutical market. Over 40 percent of outpatient drug spending is spent in public programs that use price controls. In order to sell drugs to consumers covered by these public programs, manufacturers must agree to offer certain rebates or discounts on drug prices. The calculations are generally based on the Average Manufacturer Price (AMP–the average price wholesalers pay manufacturers for drugs that are sold to retail pharmacies) or the Best Price (the lowest price the manufacturer offers the drug to any purchaser including all rebates and discounts). The most significant public programs using some form of price control are described below.

Medicaid

The Medicaid program provides health insurance for low-income and medically needy individuals. The legally-required rebate depends on the specific category of drug; for example, brand manufacturers are required to sell drugs for the lesser of 23.1% off AMP or the best price offered to any purchaser.

The Affordable Care Act significantly expanded Medicaid eligibility so that in 2014, the program covered approximately 64.9 million individuals, or 20 percent of the U.S. population. State Medicaid data indicates that manufacturers paid an enormous sum — in excess of $16.7 billion — in Medicaid rebates in 2012.

340B Program

The “340B Program”, created by Congress in 1992, requires drug manufacturers to provide outpatient drugs at significantly reduced prices to 340B-eligible entities—entities that serve a high proportion of low-income or uninsured patients. Like Medicaid, the 340B discount must be at least 23.1 percent off AMP. However, the statutory formula calculates different discounts for different products and is estimated to produce discounts that average 45 percent off average prices. Surprisingly, the formulas can even result in a negative 340B selling price for a drug, in which case manufacturers are instructed to set the drug price at a penny.

The Affordable Care Act broadened the definition of qualified buyers to include many additional types of hospitals. As a result, both the number of 340B-eligible hospitals and the money spent on 340B drugs tripled between 2005 and 2014. By 2014, there were over 14,000 hospitals and affiliated sites in the 340B program, representing about one-third of all U.S. hospitals.

The 340B program has a glaring flaw that punishes the pharmaceutical industry without any offsetting benefits for low-income patients. The 340B statute does NOT require that providers only dispense 340B drugs to needy patients. In what amounts to merely shifting profits from pharmaceutical companies to other health care providers, providers may also sell drugs purchased at the steep 340B discount to non-qualified patients and pocket the difference between the 340B discounted price and the reimbursement of the non-qualified patients’ private insurance companies. About half of the 340B entities generate significant revenues from private insurer reimbursements that exceed 340B prices.

Departments of Defense and Veterans Affairs Drug Programs

In order to sell drugs through the Medicaid program, drug manufacturers must also provide drugs to four government agencies—the VA, Department of Defense, Public Health Service and Coast Guard—at statutorily-imposed discounts. The required discounted price is the lesser of 24% off AMP or the lowest price manufacturers charge their most-favored nonfederal customers under comparable terms. Because of additional contracts that generate pricing concessions from specific vendors, studies indicate that VA and DOD pricing for brand pharmaceuticals was approximately 41-42% of the average wholesale price.

Medicare Part D

An optional Medicare prescription drug benefit (Medicare Part D) was enacted in 2005 to offer coverage to many of the nation’s retirees and disabled persons. Unlike Medicaid and the 340B program, there is no statutory rebate level on prescription drugs covered under the program. Instead, private Medicare Part D plans, acting on behalf of the Medicare program, negotiate prices with pharmaceutical manufacturers and may obtain price concessions in the form of rebates. Manufacturers are willing to offer significant rebates and discounts in order to provide drugs to the millions of covered participants. The rebates often amount to as much as a 20-30 percent discount on brand medicines. CMS reported that manufacturers paid in excess of $10.3 billion in Part D rebates in 2012.

The Medicare Part D program does include direct price controls on drugs sold in the coverage gap. The coverage gap (or “donut hole”) is a spending level in which enrollees are responsible for a larger share of their total drug costs. For 2016, the coverage gap begins when the individual and the plan have spent $3,310 on covered drugs and ends when $7,515 has been spent. Medicare Part D requires brand drug manufacturers to offer 50 percent discounts on drugs sold during the coverage gap. These required discounts will cost drug manufacturers approximately $41 billion between 2012-2021.

While existing price controls do produce lower prices for some consumers, they may also result in increased prices for others, and in the long-term may drive up prices for all. Many of the required rebates under Medicaid, the 340B program, and VA and DOD programs are based on drugs’ AMP. Calculating rebates from average drug prices gives manufactures an incentive to charge higher prices to wholesalers and pharmacies in order to offset discounts. Moreover, with at least 40% of drugs sold under price controls, and some programs even requiring drugs to be sold for a penny, manufacturers are forced to sell many drugs at significant discounts. This creates incentives to charge higher prices to other non-covered patients to offset the discounts. Further price controls will only amplify these incentives and create inefficient market imbalances.

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