Profit-seeking, confidential rebates driving up cost of generic drugs

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Jacob Levitt, MD: “The elephant in the room is, ‘Why are drug prices so high?’”

Spending on prescription drugs in the United States increased 13 percent in 2014, reaching $374 billion. Although much of the increase was driven by expensive new drugs, more than 80 percent of prescriptions are filled with supposedly less expensive generics, but the cost of some generic dermatology medicines still has increased more than 1,000 percent for consumers in recent years.

Listen to Dr. Levitt’s podcast at aad-365.aadmeetingnews.org

“If there is a drug shortage, the people who are in the market can raise the price appropriately in relation to the laws of supply and demand. Some reasons for shortages include raw material shortages, manufacturer drop-out, or FDA regulations,” Jacob Levitt, MD, said. “That all makes sense, but doesn’t explain current prices because these kinds of phenomena were present before runaway price escalation.

“Before 2008, generics were less expensive, but after 2010, you saw this dramatic increase in prices. The elephant in the room is, ‘Why are drug prices so high?’”

Dr. Levitt tackled that question Friday in his Plenary presentation, “Derm Drugs: The Price Is Too Darn High!” and in a separate interview. He is vice chairman of dermatology at Mount Sinai Hospital, New York, but has a unique perspective because he grew up in the pharmaceutical industry. His grandfather started Taro Pharmaceuticals and his father, Barrie Levitt, MD, was CEO of the company until it was sold in 2010. Dr. Jacob Levitt pulled double-duty by working at Taro during his residency until the sale.

The high cost of branded drugs is defended by pharmaceutical companies who point to the cost of research and development, and manufacturing. But many generic drugs have been on the market for more than a dozen years and are supposed to be priced at no more than 80 percent of the cost of their branded versions. For decades, generic drug manufacturers continually reduced prices to increase their market share as they competed with one another for space on pharmacy shelves, Dr. Levitt said.

But a trend that began in 1965, with the advent of Medicare and Medicaid, and other economic factors slowly changed the face of the market for drugs. Before 1965, most patients paid for their drugs out of pocket and shopped for the best prices. Medicaid, and subsequently Medicare, though, paid for drugs, and more insurance plans began covering drugs.

In the early 1970s, inflation began to drive up costs, cutting the profit margins of drug manufacturers. With third-party payers covering the cost of drugs, manufacturers developed a different business paradigm to restore lost profits.

“If you are a manufacturer, what you can do is make your selling price very high, and then give a rebate to the buyer to get the price down to the originally intended competitive price. Then, if your costs go up, you just decrease the rebate, and what you have established is a buffer on your profit margin,” Dr. Levitt said. “This idea of creating a high price and giving a rebate became the standard in the industry for pharmaceuticals.”

Manufacturers continued to use the confidential rebate system with buyers who were situated between them and the consumers — the middlemen, such as wholesalers, chain pharmacies, and other large third parties. The system worked for years as drug manufacturers tried to increase profits by lowering prices to try to increase their market share, he said.

But in 2008, manufacturers began changing their strategy. Examining the influence of price on profits, they realized that at very high prices they would sell nothing and make no profit, and at very low prices they may sell a lot but make no profit. In-between these two unsustainable extremes, they can select prices that optimize profit. Therefore, they raised prices to increase profits and stopped worrying about market share, Dr. Levitt said. About the same time, the middlemen also began increasing their prices, holding on to the confidential rebates from manufacturers in addition to their own price increases.

“So why are drug prices high? Manufacturers are not lowering prices because it is not rational for them to do that, and rebates in the supply chain are not passed on to consumers,” he said. “Nor is there any legal precedent to make that happen.”

The real change began about the time of great economic upheaval in the form of a massive recession in 2008. That was quickly followed by the start of health system reform and the adoption of the Affordable Care Act. Did one of these factors — or all of them — influence the change?

“I don’t know,” Dr. Levitt said. “It just evolved that way. Once people in the marketplace started raising prices, then realized they did not lose money, but made more money, everyone else started raising prices, and then it got a little obscene.”

This also means there is no clear solution to the dilemma of exorbitant prices.

“If you try to introduce some kind of regulation, you have to understand the marketplace and the implications of whatever regulation you put on that marketplace,” Dr. Levitt said. “For me, price concessions from manufacturers should be transparent and passed on to the consumer. This rebate business with this confidential contract pricing with the middleman should not be confidential; it should be out on the table. Let everyone be aware of the rebates and the high prices.”

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