According to research firm IMS Health, 2012 was a remarkable year for prescription drug prices, marking the first time since 1957 that prescription drug prices fell -- albeit, the drop was just a minuscule 1% to $325.7 billion in total sales. At the heart of the drop was the rising usage of generic medications coupled with the patent cliff, which removed a number of branded therapeutics from patent exclusivity.
However, this dip is more of an anomaly than a shift of the trend. Even with the patent cliff expected to claim dozens of high-profile branded pharmaceuticals over the coming years, there are numerous specialty pharmaceutical products targeted at treating cancer, hepatitis C, and other high-profile, chronic, or rare diseases which are set to take their place with price tags that could be significantly higher than their predecessors.
Worse yet, for U.S. consumers, prescription drug costs in the United States are already the highest in the world, by a mile, which makes high prescription prices really stand out here.
According to research from the Organisation for Economic Co-operation and Development, or OECD, U.S. spending on pharmaceutical products per person in 2011 was 50% higher than the next closest country and 156% higher than the OECD 34-country average cost per person.
With some prescription drug prices regularly topping $30,000, $50,000, or even $100,000 per year, the question has to be asked: "Why are your prescription drug costs so darn high?"
Here are 10 reasons that may help explain why:
High research and development costs
To start with, many pharmaceutical companies are utilizing the latest technologies to develop pharmaceutical products. This means relying on costly state-of-the-art diagnostics equipment and genomic mapping techniques to personalize pharmacologic compounds. Research costs also include running preclinical and clinical studies, paying highly trained researchers and scientists to discover new compounds and conduct clinical studies, and hopefully paying to file for a new drug application with the appropriate regulatory agency. These costs must all be recouped in order for a pharmaceutical company to be successful, and they are ultimately passed along to consumers and insurers in the form of lofty drug prices.
America may be the land of the free, but it's also the home of the lawyer. There are few places in the world do pharmaceutical companies need to spend more of their money defending their branded drugs against patent infringement lawsuits and personal claims. Authors of a white paper released in 1996, Product Liability and Prescription Drug Prices in Canada and the U.S., postulated that the reason some U.S. prescription drug prices were then averaging 43% higher than neighboring Canada was due to high legal expenses. The authors determined that one-third to one-half of the difference was simply due to legal protection costs that American pharmaceutical companies endured in order to protect their drugs from hefty lawsuits.
But, legal expenses aren't just limited to the U.S.as patent claims arise all over the world. Gilead Sciences, for instance, is currently defending its hepatitis C drug Sovaldi against claims from Idenix Pharmaceuticals that it's infringing on one of its key patents in both the U.S. and Europe. These patent defense costs can certainly push up prescription prices around the globe.
In addition to developing prescription drugs, pharmaceutical companies spend a small fortune marketing them to physicians and the public. Regardless of whether you believe the idea that big pharma spends more on marketing than R&D is irrelevant – in the end they both boost end drug costs. According to estimates from a Johns Hopkins Bloomberg School of Public Health study conducted in 2010, marketing to physicians in the U.S. cost big pharma $27.7 billion. In addition, as FiercePharma points out, direct-to-consumer advertising racked up another $4 billion in costs. Combined, that's $31.7 billion in marketing costs which are passed along to consumers, physicians, hospitals, and insurers through high drug prices.
An often forgotten component of any products' pricing is supply versus demand. In the U.S. this can be a big price-driver as Americans consume more pharmaceutical products than any other developed nation around the globe.
Per PBS, the U.S. ranks highest for antipsychotic drug usage, as well as dementia, respiratory problem, and rheumatoid arthritis drug consumption. Because of the U.S.'s high rate of disease diagnosis and likely its high obesity rate, the burden of disease in the U.S. is much higher than in many other OECD countries, leading to increased drug demand. Just as you'll see with any supply versus-demand scenario, increasing demand will almost always lead to rising prices.
Faster access to new drugs
Although getting a drug approved by the Food and Drug Administration (or any global regulatory agency for that matter) is no easy task, once approved it can usually be immediately brought to market in the U.S. This isn't so for some of the other countries around the globe. In Europe, for example, after a drug is approved a pharmaceutical company will need to seek pricing and reimbursement approval from each individual country before it can launch its new therapy within that country. And, given that the U.S. market is so large and lucrative, drug companies tend to target it early in their sales ramp. In other words, Americans are paying the high cost of rapid access to new medications.
No universal health plan
This is a big prescription drug cost-driver that most consumers often overlook. Of the 34 OECD countries, just two fail to offer a universal public health plan to cover core health services such as doctor consultations, exams, and surgical procedures. Mexico is one and the United States is the other.
As you can see above, as of 2011 just 31.8% of Americans were covered by a core health service plan (in this case Medicare or Medicaid), while the remainder was made up of private health coverage or simply uninsured Americans. In Mexico this coverage figure was still closer to 87% despite not having a national plan in place. This is important because countries that offer universal health coverage have the ability to cap drug developers' prices. Within the U.S. the idea of capping pharmaceutical product prices would be an uphill struggle.
Insurers accept it
Now that you've been reminded that a few countries have no universal health plan in place, it's easier to understand that insurers have very little negotiating power with drug companies and often accept drugmakers' prices as given. In cases where competition to treat the same indication exists between two or more drugs insurers may be able to work drug prices lower, but this isn't always the case. In instances where a single drug is approved to treat a specific ailment insurers are more often than not going to simply pass along higher co-pays to their members.
Instead of big pharma focusing on treating chronic diseases and disorders, we've seen a genuine shift over the past couple of years toward focusing on orphan diseases (i.e., those which affect a small amount of the population). Orphan drugs are important to pharmaceutical companies' pipelines because they're protected from competition for a number of years, and they often come with five or six-digit annual price tags, allowing companies to quickly recoup their development costs. Alexion Pharmaceuticals (NASDAQ:ALXN), for example, markets Soliris to treat a rare blood disorder for an annual cost of more than $400,000 per year! Long story short, if the drug is exclusive, it's going to command a premium and insurers can do little to stop it.
Higher standard of living
Keep in mind that a country's standard of living can play in important role, too. For instance, the United States has one of the highest standards of living in the world. According to Foolish macroeconomic guru Morgan Housel, you need an annual income of just $34,000 to be among the top 1% of income earners around the globe, at least as of 2010. Higher incomes in the U.S. make sky-high drug price fluctuations a little easier to absorb (although obviously still difficult for many folks, particularly those without insurance). By contrast, if a pharmaceutical company goes to a country where 70% of the population makes the equivalent of $2 per day or less and introduce a drug that costs $100,000 per year, it's bound to turn some heads and face possible price control actions.
Emerging markets subsidized
Finally, as my Foolish health care colleague Keith Speights noted last year, U.S. pharmaceutical companies are prone to expanding their drug coverage beyond just the borders of the U.S. However, because many countries outside the U.S. have price-capping capabilities big pharma instead relies on higher U.S. drug prices to make up the difference and essentially subsidize the offering of a drug or a portfolio of drugs to the rest of the world. Keep in mind that this isn't just a U.S. phenomenon as European pharmaceutical companies also face the same subsidized rigors when expanded into Asia and the Middle East.
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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