Shares of drug companies have been sinking over the last few weeks as drug pricing has blown up in the media, and politicians have latched on. Lowering drug prices is a hot-bed topic with voters. Don't be surprised if you hear more about it on tonight's Democratic presidential candidate debate.
Unfortunately for consumers -- and fortunately for drugmakers and their investors -- none of these proposals will actually do much to lower drug prices.
Proposal 1: Import drugs from overseas
Most brand-name drugs are cheaper overseas. If we just allow patients to buy drugs in foreign countries and bring them into the U.S., they'll save money. In many cases, the drugs were manufactured in the same plant where the drugs sold in the U.S. were made, and there are plenty of countries with high enough manufacturing standards that we shouldn't be worried.
Why it won't work: Drugmakers don't actually want to charge less in other countries. They're forced to by the governments and figure that some revenue is better than no revenue at all. If widespread importation into the U.S. started, drugmakers would simply limit the supply that could go to foreign countries, and the countries would subsequently limit the export of the drug to ensure there was enough for their citizens.
Proposal 2: Let Medicare negotiate prices
Currently, Medicare gets the lowest price private insurers are able to negotiate, but there are so many people enrolled in Medicare that the agency should be able to get a lower price than private insurers.
Why it won't work: You only have leverage in a negotiation if you're willing to walk away. Private insurers can do that; at some price, it makes more sense to not cover a drug and lose the business from members that might actually want the drug. Foreign governments can do it because their citizens tolerate the inability to be treated with certain drugs.
Would U.S. citizens accept that they -- or their grandmother -- might not be treated by a drug prescribed by their doctor because it wasn't covered by Medicare? The opposition just needs to shout the words "death panel" in a commercial during the evening news, and the idea will get shot down.
Proposal 3: Set maximum out-of-pocket spending for drugs
Whether you're on private insurance, Medicare, or some other public insurance, the government could limit the maximum that anyone has to pay for drugs each month.
Why it won't work: While the consumer will pay less, this won't lower the revenue drugmakers get. The insurance will pay the same amount to drug companies. For public insurance, the lower out-of-pocket payments will have to be made up by raising taxes, increasing Medicare Part D payments, cutting spending elsewhere, or borrowing to increase the deficit.
Assuming private insurers don't want to give up their profits, the lost out-of-pocket expenses will be transferred to consumers in the form of higher premiums. Since insurers can no longer set prices based on preexisting conditions, healthy people will end up picking up a portion of the costs that were previously paid for by those who require large amounts of drugs.
The real threat to drug prices
In one word: competition.
Obviously, generic competition lowers drug prices dramatically, but we've also seen the price of brand-name drugs come down as additional drugs have come on the market. Asthma drugs, insulin, and more recently, hepatitis C drugs have all been forced to offer discounts as insurers pitted drugmakers against each other.
Gilead Sciences (NASDAQ:GILD), for instance, was able to fetch a premium price for its hepatitis C drug Harvoni when it first launched because it was an all-oral therapy that allowed patients to avoid older injected drugs with horrible side effects. But once AbbVie (NYSE:ABBV) launched its competing hepatitis C drug Viekira Pak, Gilead Sciences was forced to discount its drug substantially. This year, Gilead Sciences expects to have a gross-to-net discount of 46%, more than double the 22% it ended 2014 with.
Without competition from AbbVie, Gilead Sciences could have told insurers to "take it or leave it" with the current price, and most insurers would have been forced to accept the price. Viekira Pak is arguably inferior to Harvoni, but that doesn't really matter, because at some point, it makes more sense to pay AbbVie for an inferior product and deal with complaints from members.
What investors should look for
The threat of government intervention in drug pricing is pretty minimal, and even if Democrats and Republicans could come to some compromise, the ideas won't have much of an effect on drug pricing.
With the biggest concern being competition, investors should focus on truly innovative companies and avoid drugmakers with me-too drugs that don't offer any advantage over current treatments. Take Vertex Pharmaceuticals (NASDAQ:VRTX), for example. The drugmaker has the only two cystic fibrosis drugs -- Kalydeco and Orkambi -- approved to fix the underlying problem rather than just treat the symptoms, and it has more in clinical development. Vertex Pharmaceuticals won't be competition-free forever, but its head start, combined with the fact that different mutations that cause cystic fibrosis require different drugs, make Vertex Pharmaceuticals a good choice in a market where competition puts pressure on drug prices.