President-elect Donald Trump has bashed drug prices on numerous occasions. During his campaign, he championed the idea of having the government directly negotiate the price of Medicare drugs for Part D drug plans. Trump seemingly dropped the idea later in his campaign only to resurrect it again mid-January. Many Democrats also believe the government could secure a lower price for the drugs Medicare reimburses on seniors’ behalf. However, Republicans have long opposed the idea of government meddling in private markets and codified a non-interference clause in the Medicare Modernization Act of 2003.
Here’s the kicker: Medicare drugs are already negotiated by the large pharmaceutical benefit managers (PBMs) that administer Medicare Part D’s private drug plans. About a dozen large PBMs dominate the market. These include Express Scripts, CVS Caremark, Argus, Optum and Cigna among others. These are the same companies that manage drug benefits for employers and insurers. Many state Medicaid programs also rely on PBMs to administer Medicaid drug benefits.
Large PBMs negotiate drug prices across all their book of business combined — not just for one plan. With multiple clients, large national PBMs can negotiate lower prices from manufacturers, and therefore possess far more bargaining power than individual firms. PBMs use a variety of techniques to control costs for their clients and enrollees. They also negotiate with pharmacies and build preferred pharmacy networks.
Could the government do a better job? Probably not. As renowned health economist Alain Enthoven explained it over a decade ago:
…[I]t is not obvious that allowing the government to negotiate with pharmaceutical companies will lead to lower prices than those achieved by private drug plans. There are several good reasons why not. Negotiations are a bargaining process. The relative balance of bargaining power determines at which price the deal is struck. People often confuse market power with bargaining power. The thinking goes, the larger the share of the market the buyer represents, the greater the bargaining power and thus the lower the prices negotiated. That line of reasoning fails with drugs, however, because the seller is frequently a monopolist with an exclusive patent. That means the seller cannot be threatened with replacement by a substitute. Instead, the only threat is that the two sides fail to agree and the drug is withheld from the market. Rather than market share, a party’s bargaining power is determined simply by the ability to say no — to walk away from the table without an agreement. Whether the government or a private drug plan has greater bargaining power is not clear. Who can walk away more easily and declare some brand-name drug will not be covered on the formulary? Private plans like Kaiser Permanente or UnitedHealth Group are able to negotiate deep discounts with pharmaceutical companies precisely because of the plans’ ability to say no — to pay for some drugs and to exclude others, allowing the market to judge the resulting formulary. But when the government negotiates, there are few drugs it can exclude without facing political backlash from doctors and the Medicare voters.
If the government were to consolidate the purchasing of Medicare drugs to one government entity, variations in drug prices would likely narrow to where the average price could actually be higher than some of the previous discounts. Any deeper discount obtain by Medicare would likely be offset by higher prices for private plans. Requiring Medicare to get a fixed discount off average wholesale price, for example, would virtually guarantee all other drug prices would go up.
When drug plans create pharmacy networks they negotiate for the lowest possible prices. Negotiated discounts are the result of bargaining power — the ability of the drug plan to deny business to a drugmaker if their bid isn’t favorable. PBMs have the ability to say “no” and deny a given drugmaker their business in favor of a therapeutic substitute. This is something Medicare cannot do politically. Medicare cannot threaten to exclude one hospital from its network to negotiate a lower price. Neither can Medicare say it will only pay providers the lowest price bid by competing firms. If President-elect Trump and Members of Congress want to rein-in drug prices for Medicare, the best way is to make it easier to bring new drugs (and competing generics) to market.