“Houston, we have a problem…”
The problem is the skyrocketing cost of medical care in the United States. For every dollar that goes into the healthcare pot, there is one less dollar that goes into your personal pocket to spend on other necessities such as food, clothing, housing, and even entertainment. It is a serious drain on the quality of life in the US, and it is one of the primary reasons why real incomes are not increasing: your employer has to pay higher healthcare costs, so the company cannot afford to pay higher salaries. It is a problem that has been getting worse and worse for the past thirty years, and we seem to be getting closer and closer to a real breaking point. A major contributor to the problem is the pharmaceutical industry. The large pharmaceutical and biotech companies, known as Big Pharma, combine to be one of the reasons why American healthcare costs are significantly higher than anywhere else in the world. It is certainly not the only — or even the biggest — contributor to the high cost of health care, but it is a major cause, and drug prices continue to soar. Today I am going to discuss the problem, and next time I will present some possible solutions.
I am going to start with what I refer to as “the scum of the industry.” Valeant Pharmaceuticals is a company that purchases the rights to manufacture uncommonly used medications from other companies and then explodes the price. Since there is no competition in making these medications, the new inflated prices stick. Here are three medications that Valeant now owns, along with pricing comparisons between 2013 and 2015.
Drug 2013 2015
Curpimine $888 $26,189
Syrpine $1,395 $21,267
Glumetza $896 $10,020
In 2015 alone, Valeant raised prices on its brand-name drugs an average of 66%, according to a Deutsche Bank analysis, about five times more than its closest industry peers. This is a great business model for a company, and I’ll freely admit there is nothing illegal about these extreme price increases, but this highlights a deficiency in our system and the greed that is rampant within the industry. Here are some articles about this that you might find interesting, here and here .
The poster child for scummy pharmaceutical companies is Turing Pharmaceuticals, see here. This is a start-up run by a former hedge fund manager, Martin Shkreli (who is no longer Turing’s CEO since his arrest in mid-December for securities fraud). This company’s model is to buy the rights to manufacture certain drugs from other companies and then radically increase the prices. As noted in around-the-world headlines this past year, Turing bought a drug called Daraprim that sold for $13.50 per dose, and Turing immediately raised the price to $750 –yes, for just one pill. Big Pharma calls these companies “outliers” and says they are not representative of the industry. Extreme? Absolutely. Representative of the entire industry? Absolutely.
Big Pharma protests that these scum outlier companies are sullying the name of the pharmaceutical industry as a whole, and I would agree. But Big Pharma is not without a similar stain. Big Pharma institutes huge price increases in multiple medications simply because… well, because they can.
Let’s look at a drug called Betaseron. This was the first in a class of new medications for the treatment of MS, multiple sclerosis. Betaseron, released in 1993, changed the way we treated MS, and it was a miracle drug for MS sufferers. This drug would be expensive, according to the pharmaceutical industry, because of the high cost of its development. The cost to consumers in 1993 was a whopping $8,000 to $10,000 per year – WOW! The pharmaceutical industry rationalizes the initial high price of a drug because a company needs to recoup their development costs as well as generate a reasonable profit. Drugs have a limited patent protection, and competition from newer drugs and generics would — supposedly — eventually bring the price down. Did it? Did that happen? Well, let’s look at today’s market for MS drugs. There are currently eight or nine medications in the same class as Betaseron and, remarkably, their costs to consumers are all about the same, additional information here. A one-year course of Betaseron is about $60,000 a year. The cost of Betaseron has increased five to seven times more than the general rate of prescription drug inflation. The cost of the development of Betaseron was paid back years ago, but the price didn’t come down. As you can see, it actually accelerated. This drug has been on the market for over twenty years! What happened to free market price forces?
The drug companies argue that the cost of development is so enormous that they must charge what seems like excessively high prices initially, but that the high price is, in reality, fair. The pharmaceutical industry claims that the cost of developing a new drug averages over $1 billion (more than that in 2016 when adjusted for inflation). This billion dollar price tag comes from a study done in 2003 by the Tufts Center for The Study of Drug Development. They looked at 68 randomly chosen drugs (“randomly” chosen by self-reporting pharmaceutical companies) and they calculated the cost at $802 million in 2000 and then adjusted that amount for inflation to 2011, bringing the estimated cost to $1 billion. According to the Pharmaceutical Research and Manufacturers of America, even that cost estimate was too low. Their calculations in 2006 stated that the cost to develop a single major drug had risen to $1.32 billion, an increase of 64% since 2000. This, by the way, is more than twice the cost of medical inflation during this period. But, for the sake of argument, let’s go with the Tufts Center’s $1 billion price tag.
in 2011, The London School of Economics published a widely-respected comprehensive study co-authored by Donald W. Light and Rebecca Warburton entitled Demythologizing The High Costs of Pharmaceutical Research that suggests the true cost for the development of a new drug is actually closer to $55 million, a lot of money, sure, but nowhere near The Tufts Center’s claim of $1 billion. This study pointed out that the data from the Tufts Center was submitted by the drug companies themselves on a confidential basis and was therefore unable to be independently verified. Interestingly, The Tufts Center study was funded by — guess who? — the drug companies. Let’s take a closer look at the Light and Warburton study — and I suggest you read the seventeen page abstract yourself in its entirety to get a more thorough understanding of the complexity of the problem.
Basic scientific research is the first step in identifying and developing a new drug. 84% of this research is funded by the federal government — under programs such as the National Institutes of Health (NIH) — with various universities providing additional funding. The Tufts Center made the assumption that the drug companies spent $121 million in this phase. The Light and Warburton study asserts that this number is way too high since, in fact, the industry pays only 1.2% of their sales for all their basic research, not the 17-19%, or one-third of the cost of development, that the Tufts Center claims.
Now let’s look at the funny math of the Tufts Center study. Research and Development (R&D) costs are tax deductible. The costs are not depreciated but are deducted directly from taxable profits. This alone lowers net costs by 39%! The L&W authors point out an incredibly odd accounting trick that the Tufts Center study used:
Finally, the authors added the ‘cost of capital,’ that is, the costs of returns from funds that would have been invested in the stock market, were the R&D project not undertaken. The authors used an estimated ‘cost of capital’ of 11 per cent, based on equity returns between 1985 and 2000, adjusted to remove inflation (implicitly assuming that similar returns could be obtained, risk-free, in the future). They compounded the 11 per cent over the estimated time (90.3 months) required for clinical trials and USFDA review; although it is unclear just how the times were estimated. Compounding at 11 per cent doubled the estimated cost for R&D from $403 million to ‘a total pre-approval cost estimate of US$802 million (estimated in 2000 dollars.)
“When Light and Warburton correct for all these flaws—well, all the ones that can be quantified—they end up with an average cost of bringing a drug to market that’s $59 million and a median cost that’s $43 million. In 2011 dollars, that’s a $75 million average and a $55 million median.”
This is just absurd! No other industry gets to consider the loss of potential stock market returns from their profits as a cost to their business. But it sure does work if you’re trying to make it look like your costs are way higher than they actually are. See more information here. To be fair, the Tufts Center group has roundly disputed all of the claims of Light and Warburton and feel they (L&W) have misinterpreted the data.
So considering the “huge” cost of new drug development, let’s take a look at how Big Pharma, as a whole, is doing. All companies have a right to make a profit. That is the basis of capitalism, the American way. All industries experience good times and bad times, better periods and worse periods. In 2013, the oil companies did very well when oil was selling at over $100 per barrel, as opposed to now, in 2016, when oil is below $30 per barrel. As a result, oil companies that specialize in exploration and drilling are declaring bankruptcy today at a startling rate.
The profit margin of a company is the percentage of profit they make off of every dollar of product they sell. If you sell one dollar of product and make ten cents in profit, your margin is 10%. To give you an idea of typical profit margins, grocery stores operate on a profit margin of 1-2%; in 2011, a banner year for oil, Exxon’s margin was less than 10%. For most of the past twenty-plus years, Big Pharma has enjoyed the highest margins (or tied for first) of any American industry – for every single one of those years! Look at the graph below. The top blue line is the operating margin for Big Pharma, between 19% – 25% and still rising! Impressive. Exxon, eat your heart out!
Keep in mind that these astonishing profit margins include the costs of big fines for bad behavior.
$3 billion: that’s how much GlaxoSmithKline agreed to pay the U.S. Department of Justice in 2012 to settle civil and criminal charges related to its misbranding of the drugs Paxil and Wellbutrin and its failure to disclose safety information about the diabetes drug Avandia.
Although the $3 billion fine was the largest fine ever levied against a drug company, it was a mere drop in the bucket for GSK, accounting for less than 11% of its associated revenue for the year, according to The Economist. And during the years that Glaxo illegally marketed antidepressants to kids under 18, the company reportedly raked in $27.5 billion, says the Christian Science Monitor.
So here are just a couple of truly eye-popping facts about medication costs:
- The average cost to an individual consumer for cancer drugs in 2000 was about $10,000. By 2012, that same cost had risen ten-fold to over $100,000.
- Specialty drugs and the so-called “orphan” drug costs have skyrocketed. (Orphan drugs are those that are not brought to market because they will be commercially unprofitable for the developer as their application, while necessary to some, is very limited.) MS drugs are around $60,000. Hepatitis C drug costs are upwards of $80,000, and a new drug for cystic fibrosis is $259,000 per year of treatment.
- Between 2013 and 2014, 222 generic drug groups increased in price by100% or more.
- Mylan NV’s albuterol sulfate, an older commonly prescribed asthma drug, increased in price by 4000% in just one year from 2013 to 2014.
And, of course, there is deception from the industry about these consumer price increases:
Dr. John Lechleiter, the CEO of Eli Lilly, recently attempted to debunk five “Big Myths” about Big Pharma. As he wrote, “Only about 10 cents of every U.S. healthcare dollar is spent on retail prescription medicines—which is the same share that was spent on prescriptions in 1960. While the overall use of medicines to treat many diseases has increased dramatically in that same period of time—and average life expectancy at birth in the U.S. has increased by more than nine years—the share of spending accounted for by prescription medicines is the same as it was 55 years ago. That comparison makes pretty clear that medicines are delivering value to the system rather than driving unsustainable cost increases.”
The percentage of healthcare dollars spent on prescriptions dropped from 9.8 percent in 1960 to 7.3 percent in 1970, and then sank further down to 4.7 percent in 1980. This percentage then began to rise again, going to 5.6 percent in 1990, to 8.8 percent in 2000, and to 10.2 percent in 2009 (data compiled by the Centers for Medicare and Medicaid Services).
So if we pick a year, let’s say 1960, when the practice of medicine was much simpler and thus cheaper than it is today, we see that US healthcare dollars were spent on just three items: surgery, x-rays and drugs, because that was the sum total of the options physicians had in their bag to treat patients. This fact alone made the cost of drugs a relatively high percentage of the healthcare dollar. But consider all the expensive treatments that have been developed since 1960! We now have dialysis, open heart surgery, MRI and CT scans, pacemakers, cardiac stenting, organ transplantation, and a whole host of other therapies that were not available in 1960. These high tech, expensive therapies have increased the overall cost of health care significantly and THAT is the reason, the ONLY reason, why the costs of drugs, percentage-wise, has declined. As these newer, costlier treatments became available, the percentage of the health care dollar spent on drugs dropped to 4.7% in 1980. But now drug costs are well above the 1960 levels at 10.8% of healthcare dollars. And this increase is because of Big Pharma’s excessively high pricing of both new and old medications.
Pharmacy spending is an even higher percentage of employer based healthcare costs. 77% of employers spend 16% or more of their healthcare dollars on pharmacy benefits, and this number continues to increase as the cost of specialty drugs continues to skyrocket.
One of the ways that Big Pharma is able to keep prices and profits high is with the patents on their drugs. J. Kyle Bass, a hedge fund manager, formed a company last year called The Coalition for Affordable Drugs. This company makes money by short selling (another Big Short — read the book or see the movie, if you haven’t yet) drug companies whose patents they believe are shaky, and buying shares in drug companies whose patents reflect true innovation. See here.
“Some patents and extensions to patents represent an unreasonable use of government regulation to enshrine monopoly power to the detriment of the public at large,” Mr. Bass said. “This system must be fixed or we will continue to pay more and more for the same old drugs we’ve been buying for decades.”
One of the patents that is being challenged is for a drug called Propofol which is marketed under the trade name Diprivan. This drug has been around for 30 years and is protected by a patent — not because of the drug itself, but because of the rubber stopper used in the container.
Suprenza, a weight loss medication, had its patent extended in 2013 to 2029. The patent was for the orally disintegrating tablet with a “speckled appearance.” The speckles are the colored granules of a water-soluble sugar which are not patentable.
A process called “evergreening” or “product-hopping” is what happens when a company makes a very minor change in a medication just before it goes off patent. It then markets the new product to take away sales from the old product. When the old product goes off patent, and generics come on the market, the new product has already been ingrained in physician practicing patterns and has thus assumed a large portion of the old drug’s customers.
But to me the worst practice — which is not illegal, but should be — is known as pay-for-delay. When a branded drug approaches the end of its patent life — so that generic companies can begin to produce the medication as a generic — the Big Pharma company pays the generic drug maker huge sums of money if the generic company agrees to not sell a generic version. The FTC believes this anti-competitive inter-drug company dealing costs consumers and tax payers $3.5 billion in higher drug costs every year. See here. A law was introduced in 2013 to make this process illegal, but it has failed –twice! — to even make it out of committee. Where are the antitrust lawyers when you need them?
The pharmaceutical industry has developed some truly spectacular medications. Many of the medications they’ve developed have greatly improved — and definitely prolonged — the lives of many people. But it’s also true that many of the drugs they have developed are known as “me, too” drugs, which are drugs that are essentially the same as already existing medications, introduced as competition to another company’s similar drug, or released just as their own, very similar, drug is about to come off patent.
Consumers in the United States pay an unfair share of the costs of development for new medications as well as of the pharmaceutical industry’s profits. These costs are hurting our economy, burdening patients with high out-of-pocket costs and frequently rationing the availability of many lifesaving medications to those in need. I don’t blame the pharmaceutical industry for taking advantage of our broken and easily abused system. I blame our Congress, which is controlled by Big Pharma money, for not fixing this problem. In my next blog, I am going to discuss the vast difference in pricing for the same medications throughout the world and some steps that we can take here in the US to make medications and healthcare more affordable.
Thanks for reading and, as always, I welcome your comments.
- Retirement: Two Years On