Drug price inflation

In general, technology costs come down over time. Take for example TVs. Large-screen LCD TV’s that were several thousand dollars a few years ago cost less than $1,000 today (declines of 60% over a few years). This happens because:

  1. New competition enters the market
  2. The cost of manufacturing declines, especially with improvements in technology
  3. As there is wider adoption, fixed costs (production plants, advertising) are spread over more units, so the cost per unit declines. Thus profit is preserved, even with falling prices. Further, larger volumes also bolster profits.

Drugs are a notable exception to this dynamic, despite the fact that the factors above still apply to medicines (especially in terms of competition, as similar alternatives come to market once a new intervention is discovered). However, the complex nature of healthcare economics (which I recently discussed here) allows drug companies to keep prices high and even raise prices. Once patients are on a drug, there is no reason for them to stop if it’s working. Once doctors are accustomed to prescribing a drug, their habits are established and hard to change. Finally, both doctors and patients are insulated from price increases, since neither of them is the ultimate payer (often, neither doctor nor patient has any idea what the cost of therapy actually is).

The most egregious example of price increases that comes to my mind is for those agents used to treat multiple sclerosis (MS). Prices have risen steadily at the rate of 10-20% per year. In 2008, the average price of therapy was about $22,000 per year (arguably an already high price). Now, at the start of 2013, the price of the average MS therapy is in excess of $50,000 per year.

While other therapeutic areas have not seen prices increase as much as for MS drugs, drug price inflation has far exceeded general inflation (CPI). For example, insulin prices have increased at a rate of about 10% per year for several years. Anti-depressants have faced similar price increases. The price for Enbrel, for rheumatoid arthritis, has risen by about 15% over the past year. Anecdotally, as I keep an eye on drug prices, inflation of high single digits to low double digits looks to be the norm.

An important offset to drug price inflation is that drugs have a limited patent life. Once patents expire, drugs face generic competition, at which time the price of a generic drug might fall to as low as 1-3 cents per pill. Once there is a generic drug in a class, insurance companies charge high co-pays for competitor branded drugs, thereby economically incentivizing patients to switch to the low-cost generic choice. (For example, it is both medically and economically reasonable for a person with high cholesterol to use generic Lipitor [atorvastatin] instead of using branded Crestor.) Insurance companies also use this strategy of tiered co-pays to limit branded price increases. They negotiate lower prices for some drugs and exclude higher-priced alternatives from their formularies.

An additional noteworthy point is that Medicaid limits price increases to the general rate of inflation. This is also the case for some insurance plans that have contracts to limit price increases. Therefore, ‘list’ price increases do not get fully realized by drug manufacturers.

In addition to price increases on existing drugs, there has been a steady upward pressure on price as new drugs get launched. In general, primary care drugs launched in the 1990s were priced at $50-$100 per month. Similar drugs launched today are priced at $150-$250 per month. This translates into price inflation for new drug launches overall of about 6-8%, well in excess of CPI.

Drug companies are beholden to their shareholders and are tasked with maximizing profits, but I think price increases are a double edged sword. They have engendered animosity as patients have faced higher prices and sometimes inability to buy drugs due to cost. Sadly (in my opinion), pharmaceutical companies, which were once lauded as innovators that advanced science and fought disease, are now sometimes vilified.

sources: company disclosures, PriceRx, Wolters Kluver

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1 comment for “Drug price inflation

  1. Edward Murray
    January 29, 2013 at 5:58 pm

    There is something grossly wrong with the US system.

    The MS drugs which show only marginal benefit over 10 years and come with side effects that are as bad as the disease itself cost one-third as much in the UK and other countries as they do in the US.

    Someone needs to start suing payors who are as much of a problem as those selling the drugs.

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