If you believe that brand-name prescription drug prices are out of control, you're probably not alone. Prescription drug costs have been soaring at a pace that's far beyond the rate of inflation for years, and the pattern has shown few signs of slowing. What's become a cash cow for drugmakers and their investors has become a major financial drain for insurance companies and patients who may need life-saving medicines.
Why prescription drugs cost so much in America
Exceptional pricing power for drug companies in the U.S. isn't a function of one or two key advantages. There are several reasons they're able to charge a lot for game-changing medicines.
1. Lengthy periods of patent protection
One reason why U.S. drugmakers have such strong pricing power is the lengthy patent-protection periods on branded therapeutics. Patent protection begins when the Food and Drug Administration (FDA) allows a drug developer to begin human clinical trials, and those protections usually extend about 20 years. This means that most drug companies have a decade, give or take a few years, of protection from generic drugs if their product reaches pharmacy shelves.
2. No universal health plan
Unlike practically every other country in the Organisation for Economic Co-operation and Development, the U.S. has no universal health plan. Without a universal health plan, the U.S. can't cap prescription drug prices.
3. Insurers unwilling to question costs
There's also a general unwillingness among insurers to question drugmakers' branded-drug pricing. Though insurers do exclude some drugs from their formularies, we're usually talking about a few dozen drugs excluded and thousands accepted. Insurers run the risk of alienating and angering their policyholders if they exclude a popular drug from their approval formulary because of price, so they rarely do so, which allows drugmakers to get their way on pricing far more often than not.
4. Highest pharmaceutical demand in the world
Sometimes it's a simple case of supply and demand. The U.S. has the highest demand for pharmaceutical products in the entire world, which has the effect of increasing the price for branded therapeutics. If drugmakers know the demand is there, there's no incentive to cut prices or minimize price hikes from one year to the next.
5. Faster access to new drugs
Consumers in the U.S. also have considerably quicker access to branded therapies compared to other developed countries. Once a drug is approved by the FDA, it can legally be sold by pharmacies. However, in Europe a drug may not reach pharmacy shelves until well after its approval by the European Medicines Agency. This is because each country within the EU has its own health plan and needs to set its own reimbursement rate with drugmakers. In other words, Americans are paying for their quick access to branded drugs.
6. Higher standard of living
The U.S. also arguably has one of the highest standards of living in the world. With the average American better off financially than the average individual around the globe as a whole, drugmakers have the mindset that they can get away with charging a higher price for branded therapeutics.
7. Subsidizing emerging markets
Finally, drugmakers use the U.S. pharmaceutical market as a means to subsidize their ventures into emerging and underdeveloped markets. Emerging and underdeveloped countries couldn't cover the costs drugmakers pay to develop most branded drugs, so these drugmakers rely on their high prices in the U.S. to help subsidize the losses they incur by selling medicine in emerging and underdeveloped countries.
The result? The scariest prescription drug inflation chart you'll ever see
The end result of these factors is that drug developers have been able to pass along substantially higher prices to consumers, even in years where the Consumer Price Index for All Urban Consumers (CPI-U), a popular measure of inflation, has hardly budged.
Here's an illustration of just how rapidly prescription prices have grown over the past decade compared to the CPI-U, courtesy of data from the AARP Public Policy Institute (link opens PDF).
As an aggregate, the average cost of a basket of goods and services at the end of 2005 was 21.6% pricier by the end of 2015. When it comes to prescription drugs, the average cost between the end of 2005 and the end of 2015 has exploded higher by 172.1%! That outpaced the CPI-U by more than 150 percentage points in just 10 years. And we certainly don't have to look far for the offenders.
Valeant Pharmaceuticals (NYSE:BHC) came under fire last year for its pricing of two cardiovascular drugs that were acquired from Marathon Pharmaceuticals, Nitropress and Isuprel. The list prices of both drugs were increased by 525% and 212%, respectively, yet neither drug underwent any formulary or manufacturing changes. Valeant merely increased the list prices of both products because it could, and it got caught with its hand in the cookie jar by lawmakers.
Mylan (NASDAQ:MYL), the company behind severe allergic reaction injectable medicine EpiPen, suffered a similar fate in the court of public opinion. Since 2009, the two-pack of EpiPen has risen from less than $100 to $609 as of 2016, which has sparked criticism among lawmakers on Capitol Hill. Mylan also recently agreed to a $465 million settlement with the Justice Department over incorrectly classifying its lifesaving drug with Medicaid, and thus overcharging the federal government.
Though drug developers do get caught red-handed from time to time, the practice of hiking branded-drug prices is simply too enticing for most companies to ignore.
Can Trump curb high drug prices? Probably not.
On numerous occasions over the past couple of months, President Trump has opined that lowering prescription drug prices is one of his priorities while in the Oval Office. Among his core proposals, Trump has suggested deregulating the FDA, allowing consumers to buy drugs in overseas markets, and creating a bidding process in the U.S. to reduce drug prices.
While these ideas might sound great, they're highly impractical.
For example, the FDA is the regulatory body that oversees the safety and manufacturing of all prescription drugs sold in the United States. There's a reason the FDA's regulations are as rigorous as they are: to ensure the safety of prescription-drug users. If drugs were allowed to be imported from foreign countries, it would complete nullify one of the safeguards of the FDA's existence, which seems unlikely to happen.
Trump would also probably have a difficult time garnering support for such a measure in Congress. Republicans generally believe in less government intervention and free-market economics, which means they'd be unlikely to agree with Trump that an artificial price cap or bidding process should be set up to control pricing.
Trump's prescription drug pricing ideas also ignore one of the primary reasons why prescription drugs are so costly: lengthy patent protection periods. Sure, capping the inflation rate of drugs already on the market could help somewhat, but a good portion of drug inflation stems from newly priced products, and Trump's proposals don't impact the pricing of new therapies one iota.
Long story short, prescription drug price inflation is gaining steam, and it's showing no signs of slowing anytime soon.
Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool recommends Mylan. The Motley Fool has a disclosure policy.