The Real Cost of Medicines?

Two days ago, I attended a panel at American Enterprise Institute (AEI) that examined the drug pricing reports periodically issued by AARP. The focus of discussion was Stephen Schondelmeyer's, University of Minnesota, methodology behind Rx Price Watch Report - Trends in Retail Prices of Brand Name Prescription Drugs Widely Used by Medicare Beneficiaries 2005 to 2009. The panel, moderated by AEI Scholar John E. Calfee,  dissected Schondelmeyer's report, focusing on the use of econometric methods to examine the price of branded pharmaceuticals and compared it to a new report recently issued. 

The pricing reports examine changes in prices of what were the top 25 branded prescription medications used by Medicare recipients in 2006.   Murray Aitken, IMS Health, and Ernst Berndt, Massachusetts Institute of Technology, delivered a different perspective at the price of branded pharmaceuticals based on their research for the NBER (National Bureau of Economic Research) Working Paper titled, Brand Loyalty, Generic Entry and Price Competition in Pharmaceuticals in the Quarter Century After the 1984 Waxman-Hatch Legislation.  They found that pharmaceutical prices have declined by 21.3%.  This is a significant difference from Schondelmeyer's findings, which found that prices rose 27.6%.

Why such a stark difference between the two reports? The short answer lies in the econometric techniques used to analyze the data.  The long answer lies in the methodology of how you look at the pharmaceutical market.  John Calfee summarizes the differences in his analysis, where he points out that Schondelmeyer's report uses a list of the top 25 branded pharmaceuticals, that does not change over time, even when a generic alternative to a branded molecule is now available on the market.  Schondelmeyer examined the retail prices of branded prescription drugs, finding that these prices have risen above the inflation rate.  Using a different methodology, Aitken and Berndt take into account generic penetration into the market and the actual daily costs of treatment for major therapeutic areas and found that drug prices did not increase.

Why is the consideration of generics into the market important?  Hopefully the answer is straightforward.  When generics enter into the market a few things usually happen:

  1. A significant amount of the patients taking the branded medication switch to the generic version. The often cited statistic is that branded pharmaceuticals lose 86% of market share within one year of generic entry (from Aitken/Berndt analysis in "Prescription Drug Spending Trends in the United States: Looking Beyond the Turning Point," Health Affairs 28 (2008)).
  2. Generic prices are cheaper than branded medications.  For the first six months of generic entry, prices usually drop 10-20% (as governed by Hatch-Waxman), but then prices tend to significantly decrease.
  3. The branded medication often remains on the market and available to patients.

A primary focus of the Aitken and Berndt report is the impact of generic entry into the market, but other factors influence what drugs become top sellers from one year to the next, including: the entrance of innovative new medicines into the market and the shift in the prevalence of disease. 

We applaud AARP's concern over the impact of health care costs on their members, this is a challenge that everyone must work together to address. However, we must remember that innovation in health care isn't free.  It takes significant investments to bring new molecules to market. This is how the pharmaceutical market is supposed to work.  Innovative pharmaceutical companies invest billions of dollars in research to produce new medications and hold the patent for a number of years to recover research and development costs. But this research does not stop once the molecule enters the market. Once the patent expires, then generics are able to enter the market and compete.  This cycle fuels innovation and leads to new treatment options for patients.