The Long-Term Impact of Price Controls in Medicare Part D

by on February 6, 2017 at 2:30 am in Economics, Law, Medicine, Uncategorized | Permalink

There is a new paper on this topic, by Gigi Moreno, Emma van Eijndhoven, Jennifer Benner, and Jeffrey Sullivan.  The upshot is to beware price controls:

Price controls for prescription drugs are once again at the forefront of policy discussions in the United States. Much of the focus has been on the potential short-term savings – in terms of lower spending – although evidence suggests price controls can dampen innovation and adversely affect long-term population health. This paper applies the Health Economics Medical Innovation Simulation, a microsimulation of older Americans, to estimate the long-term impacts of government price setting in Medicare Part D, using pricing in the Federal Veterans Health Administration program as a proxy. We find that VA-style pricing policies would save between $0.1 trillion and $0.3 trillion (US$2015) in lifetime drug spending for people born in 1949–2005. However, such savings come with social costs. After accounting for innovation spillovers, we find that price setting in Part D reduces the number of new drug introductions by as much as 25% relative to the status quo. As a result, life expectancy for the cohort born in 1991–1995 is reduced by almost 2 years relative to the status quo. Overall, we find that price controls would reduce lifetime welfare by $5.7 to $13.3 trillion (US$2015) for the US population born in 1949–2005.

I would insist that we do not have good enough models of the innovation process to really understand the price elasticity of supply.  Nonetheless it is surely not zero, and under plausible assumptions the price controls are a bad idea.

We need a new rooftop chant: “Beware analyses that neglect supply elasticities,” to sweet cadences of course.  They should play that on AM radio as well.

For the pointer I thank the still excellent Kevin Lewis.

1 So Much For Subtlety February 6, 2017 at 2:34 am

Between $0.1 and $0.3 trillion is not chicken feed. Two years on average? In fairness they are mostly the sitting-in-front-of-TV-wetting-oneself years. Not exactly the best years of anyone’s life.

In the end I expect that the electorate is childish enough to want its drugs now and want them for free without giving a damn for the future. So what if new drugs don’t get discovered? Every abortion could be ending the life of the next Einstein. No one suffers from what could have been.

2 mulp February 6, 2017 at 4:50 am

Let’s increase NIH funding by $50 billion to $100 billion and have NIH fund human drug trials with the 25 best candidate drugs coming out of government funded research which if successful go to contract manufacturers with the drugs sold a cost of manufacturing.

A 10% success rate on drug trials would mean 2 new important drugs per year as cheap drugs once the pipeline is filled with 250 drug candidates in concurrent development based on a decade from early discovery to fully in mass production.

3 So Much For Subtlety February 6, 2017 at 5:06 am

Then scientists will sit around and do nothing. What incentive do they have to find an actual effective drug? They can spend their research grant as they please, and then claim that alas it failed clinical trials.

What is worse, drugs would not be discovered on the basis of effectiveness but political clout. We see this with HIV. Gays are loud and proud and not a little violent so they get more funding than prostate cancer.

Nor are the drugs any cheaper. It is just that the process of funding them is opaque.

4 Thiago Ribeiro February 6, 2017 at 6:25 am

Thankfully gay men don’t suffer from prostate cancer, it is a widespreade disease the way things already are. As a heterossexual man I was for researching prostate cancer treatments, but threats of gay violence made me change my mind about it and Elton John’s music. When will gay oppression stop?

5 dan1111 February 6, 2017 at 6:14 am

There are lots of options for criticising this paper. Poo-pooing the benefits of increased life expectancy does not seem like the optimal choice!

6 Dan Lavatan February 6, 2017 at 4:02 pm

I agree with the original poster, those people are better off dead. What’s more I don’t think there has been a useful drug invented since 1945. Everything was already found in nature and being used by people who lived where it grows.

7 So Much For Subtlety February 6, 2017 at 4:19 pm

Amusing. The interesting thing is how little progress there has been since the late 60s. Is there still room for new drugs anyway? Cancer is the obvious place but it is not clear new drugs are helping. Childhood cancers can be treated with success in a way that adult cancers cannot. What we are probably seeing is earlier detection – which looks a lot like longer life expectancy but isn’t the same thing. It may turn out heart disease is bacterial in the same ulcers are, but I see no evidence anyone is getting closer to working out the causes. What medicine does these days is keep us alive longer on machines. That is where the big spending is.

I expect that much of that is due to thalidomide putting off researchers. Part of that is probably due to institutionalization – as medical research gets bigger and more regulated, more money goes to the older and more established researchers while real break throughs come from young men working alone.

At some point society will have to ask itself if keeping people alive on machines for longer is worth it.

8 TMC February 6, 2017 at 8:25 am

You’ll still have the last two years sitting-in-front-of-TV-wetting-oneself years. It will be ages Death-10 & 11 that are added.

9 So Much For Subtlety February 6, 2017 at 4:16 pm

Except those deaths won’t be added. They won’t be prevented. Fewer new drugs will be found so progress will be slowed. We will not forget the old drugs that do work.

10 Jeff L February 6, 2017 at 2:58 am

If there really are strong benefits to giving away rents to pharma, just subsidize new and more effective drugs directly. The combination of third party payer and IP granted monopolies is horribly inefficient. Prizes should create cleaner incentives than patents.

In our current second best system, there is obvious abuse of granted monopolies. Shkreli did all at once what other companies were spreading over many years, but both were collecting more rents just because they could. What policy should be used to address these obvious abuses if not price controls?

11 yo February 6, 2017 at 3:50 am

On which company’s payroll are these people?

12 mulp February 6, 2017 at 4:54 am

Goldman Sacks doing the m&a to match old legacy drugs with the politically connected pharma exec who with extract growing rents to inflate pharma share prices.

13 JFA February 6, 2017 at 9:37 am

Spell check: Sachs. How will the proletariat rise up if they can’t find the address to storm because you can’t spell?

14 Dan February 6, 2017 at 5:07 am

Tyler, all these people appear to be on the payroll expert witnesses for lawyers and lobbyists. I’m a lawyer, and a sometimes-lobbyist, so of course I think these people are the salt of the Earth, and I’d like to thank you for broadcasting their clearly disinterested research without any warnings regarding their conflicts of interest. I have no expertise or background that would give me the ability to independently evaluate their ideas, but then again neither do their clients or the policymakers, so who really gives a fuck.

15 Dan February 6, 2017 at 5:14 am

To be clear, I’m just saying this based on the authors’ LinkedIn profiles, so if someone wants to correct me, please go ahead and I will be forever grateful.

16 Bill February 6, 2017 at 9:01 am

Dan, My reaction as well, having worked with an economist at Pfizer.

One of the non-comparables with the VHA is that they centrally purchase, which means they create their own formulary, developed by druggists and physicians, which obviate the need for medical advertising to the patient and advertising and promotion to physicians.

Big savings in marketing costs.

17 JWatts February 6, 2017 at 9:52 am

“Big savings in marketing costs.”

A past example of the potential savings on marketing costs.

“We haven’t quite reached 42 years, but in another 7 years, we’ll be at the level of America, and after that we’ll go farther.” Nikita Khrushchev

https://en.wikipedia.org/wiki/Kitchen_Debate

18 Bill February 6, 2017 at 3:22 pm

JW,

Re your adoration of pharmaceutical marketing costs:

“Oliver also mentioned that nine out of 10 big pharmaceutical companies spend more on marketing than on research. León Markovitz of Dadaviz found and graphed those figures from healthcare research firm GlobalData in the graphic below. The amounts spent on sales and marketing are shown in orange, while the amounts spent on research and development are in blue.”

Here is the link to the WAPO article: https://www.washingtonpost.com/news/wonk/wp/2015/02/11/big-pharmaceutical-companies-are-spending-far-more-on-marketing-than-research/?utm_term=.51febbca16aa

19 JWatts February 6, 2017 at 5:03 pm

“Re your adoration of pharmaceutical marketing costs:”

I didn’t say that I adored pharmaceutical marketing costs, I just pointed out that they seem to be a significant component of capitalism. And I believe that zeroing them out would be a mistake.

It would be pretty easy to convince me that pharmaceutical companies spend way to much money on lawyers and marketers. But I don’t think the correct number for either is 0.

20 Bill February 6, 2017 at 6:22 pm

Who said it was.

21 JWatts February 6, 2017 at 11:26 pm

You said: ” which obviate the need for medical advertising to the patient and advertising and promotion to physicians.”

That certainly sounds like zeroing out marketing costs. Feel free to correct the point, if you don’t mean zero.

22 Jan February 6, 2017 at 6:03 am

1) Most serious proposals floating around now are for Medicare direct negotiations, not price controls. Every other rich country has some version of this.

2) If Medicare negotiated drug prices, most estimates put program savings at >$10 billion year. This paper’s estimate of a low of $100 billion for the 1949-2005 cohort seems way, way off. http://blogs.wsj.com/pharmalot/2015/07/23/u-s-could-save-up-to-16b-if-medicare-part-d-negotiated-prices-paper/ The key is that the government would also need to be able to set some fort of formulary (with lots of exceptions in cases of patient need) to have any leverage with drug companies.

3) What are their assumptions that lead them to conclude there is a 25% reduction in new drugs? How does that affect their estimate of 2 years reduced life expectancy? Their assumption should be that truly innovative therapies, like the recent hep C drugs, would still come to market because they save lives and payers will be willing to cover them, but that many me-too drugs offering no or marginal benefit do not come to market, because fewer payers will cover them. If they don’t make these assumptions, their estimates are not

4) I would not surprised if this paper were directly or indirectly funded by industry. Even if not, the authors’ firm serves mainly pharma clients and it was founded by one of the most pro-industry economists in the drug space (Philipson). That doesn’t make it wrong, of course, but it needs a lot of scrutiny.

It appears the purpose of the study was to model a very extreme version of Medicare payment changes paired with some extreme and blunt assumptions about innovation and patient outcomes in order create a price controls straw man. Then they attempted to make it seem that nothing good can come of our Medicare efforts to get better prices on drugs.

23 JWatts February 6, 2017 at 11:50 am

“4) I would not surprised if this paper were directly or indirectly funded by industry.4) I would not surprised if this paper were directly or indirectly funded by industry.”

So?

Did you question the funding source for the study’s saying that Medicare would save more than 16 billion per year? If that study was funded by the US government, does that imply it’s invalid?

If you always assume that government studies are de facto valid and industry studies are de facto invalid, you aren’t remotely objective.

24 Jan February 6, 2017 at 12:05 pm

Funder is always a consideration, but especially when a business interest has stake or thinks it has a stake in the outcome. I don’t assume that any study is valid. Bias is real!

25 Jan February 6, 2017 at 12:09 pm

Also, the $16 billion study wasn’t funded by government, in case you were wondering. And it wasn’t funded by industry either. It’s one of various estimates that have been published on this topic.

26 Daniel Weber February 6, 2017 at 3:46 pm

Aetna is bigger than most European countries. How come Aetna can’t get the same price discounts?

27 Jan February 6, 2017 at 3:55 pm

Two reasons:
-To get price concessions insurers must be willing to walk away from the negotiation table and not cover certain drugs; they don’t really do this because their competition is other US insurers who will cover those drugs; pissed off patients will not want to sign up for Aetna because of a crappy formulary and go to their competitors, so insurers end up pretty much covering everything

-Health care itself costs so much more here in the US than other countries (largely driven by our high prices for doctors and hospital care) that 10-15% of overall costs going to drugs seems like a drop in the bucket, so we don’t focus on solving that problem; truth of the matter is we have both a huge health care spending problem and a huge drug spending problem; Americans as a society refuse to accept a larger gov role in driving down costs and they also refuse to accept any rationing of care, even if it is based on value

28 Turkey Vulture February 6, 2017 at 4:23 pm

Why would either of these issues be substantially different if the Government were negotiating instead?

29 Jan February 6, 2017 at 4:50 pm

Like I said, Medicare would have to set a formulary to have leverage in negotiations. Otherwise, almost mo point in doing it. That means some level of rationing. But it would also be negotiating on behalf of many more people than a single insurer, so it would get better discounts.

30 JWatts February 6, 2017 at 5:08 pm

“Why would either of these issues be substantially different if the Government were negotiating instead?”

Burly men with guns.

31 Bill February 6, 2017 at 4:58 pm

Jan,

All good points.

The same is true with physicians services: doctors who did not bid to get into a network at a lower price complain about how patients are denied the right to choose their physician, but, in fact, you can pay more to go out of network. Similarly, doctors like to push “Any Willing Provider” statutes as a way to get minimize HMO and third party payer negotiation, as the threat of exclusion is diminished under AWP legislation.

32 Turkey Vulture February 6, 2017 at 4:29 pm

I think private insurer discounts are ultimately constrained by the kinds of pricing regulations and policies that the government here tends to adopt.

From what I’m familiar with, they often take the form of paying particular attention to the best price that someone gets in the private sector. If that is the case, then when Aetna is trying to negotiate with a pharma company, the pharma company is taking not only any revenue losses from lowering Aetna’s price into account, but also revenue losses that may result of this affects their best price or whatever metric is used to determine pricing for government entities. So their buying power might tend to be less consequential than you’d expect it to be.

33 Todd Kreider February 6, 2017 at 7:31 am

“As a result, life expectancy for the cohort born in 1991–1995 is reduced by almost 2 years relative to the status quo. Overall, we find that price controls would reduce lifetime welfare by $5.7 to $13.3 trillion (US$2015) for the US population born in 1949–2005.”

This is my point about junk economics: economists extrapolating decades, and in this case more than a century into the future to come up with meaningless figures. Anyone born in the 1965 to 2005 group (and probably earlier) can easily live to over 150, where a 27 year old today would be 87 in the year 2067. These authors are assuming they know both what medical technology can do between 2030 and 2130 as well as the approximate cost – even if relative. I forget how to say “garbage-in, garbage-out” in Latin.

In 2007, economists at the CBO estimated rising health care costs out to 2085 (!) and explained away technological advances over the 21st century as likely to increase costs as they had in the 20th century. I later learned that they strongly objected to extrapolating that far out into the future and wanted to stop at 2025, which would also be wrong, but at least not a joke.

This is where the health pills come in. It isn’t that far away where a pill can slash the incidence of type 2 diabetes by 30% and not too much further from 100%. Great reductions in cancer, heart disease and Alzheimer’s disease aren’t that far away either on the 21st/22nd time scale the authors mention.

34 TMC February 6, 2017 at 8:35 am

This why I always include fusion into my energy calculations. Kind of a snarky answer, and you do have some good points, but counting on remedies that have been 10 years in the future for the past 50 years doesn’t help that calculation.

35 Todd Kreider February 6, 2017 at 9:03 am

They have not been 10 years in the future for the past 50 years. I realize it takes some modicum of effort for these economists to look up the medical science trends, although some has been widely reported for many years. These authors know that their colleagues, who they have to impress

Do you think that four economists in 1977 studying the computer market when The Commodore PET and the Apple II came out could give good cost estimates to what the U.S. will spend on computers in 2017 to say nothing of 2077? These authors are telling is that they can within a narrow range out just as far.

Anyway, MR readers should be able to spot a joke paper (or book) where issues like supply elasticity are not all that interesting due the absurdness of the “study”.

We have already seen ridiculous extrapolations with tuberculosis and how many iron lungs will be needed by 2000, AIDS deaths by 2000 etc but economists never seem to learn. Or rather, they have no incentive to learn.

36 Todd Kreider February 6, 2017 at 9:07 am

The above should be: “These authors know that their colleagues, who they have to impress to get published, also think 2037, 2077 and 2107 diet, supplements and treatments will look pretty much like today.”

37 dan1111 February 6, 2017 at 9:14 am

What are these “medical science trends” that lead you to confidently claim we are on the brink of drastically cutting back major diseases? I’m a medical researcher, and I don’t know what you are talking about. What is this type 2 diabetes pill you mention?

Of course there are (always) promising developments that might lead to some real improvement in the near future. And in the next 50+ years, it’s quite likely that the burden of at least some disease is going to be significantly lessened. But these specific advances you predict have no basis that I know of. And the consensus of the health community is quite strongly that we should prepare for a continued rise in healthcare costs

38 Todd Kreider February 6, 2017 at 2:54 pm

First, while I do think we are on the brink of significantly cutting back many diseases, that is, within 5 to 10 years and “drastically” within 10 to 20 years, these economists aren’t just going out to 2037 but out to 2077 and 2107 when one born in 2005 will be just 102. There is nothing reasonable about this type of projecting.

Some advances: 1) stem cell therapies that have shown great promise in helping if not yet curing those with disabilities from strokes, heart attacks, blindness, etc. 2) IBM Watson 3) gene therapy 4) immunotherapy for cancer where 5) $1000 genome sequencing will help. 6) potential health pills like metformin, rapamycin and Nicotinamide Riboside (NR) = a type of vitamin B3 that can reduce the incidence in hearat disease and cancer as pharmaceuticals try to improve on these. We should know about NR within a few months as human trial results are announced and published.

39 JWatts February 6, 2017 at 11:51 am

“This is my point about junk economics: economists extrapolating decades, and in this case more than a century into the future to come up with meaningless figures”

+1 century of bad extrapolation

40 TomW February 6, 2017 at 7:47 am

Wouldn’t a better question be: in this model, what would the supply elasticity need to be in order to make the policy break even? I know I’d find that much more informative than this lifetime welfare analysis.

Also, as others have noted, “compared with the status quo” might not be the relevant comparison (is there any economic theory that says the distortionary & opaque pricing schemes the industry uses now are efficient?) And to consider only one alternative (what they call a VA-style approach) is an awfully limited way of examining the problem.

41 AlanG February 6, 2017 at 8:45 am

Tyler, you are overlooking how inefficient the current Part D program is. Currently the various plans that provide Part D coverage negotiate with Pharmacy Benefit Managers (PBMs) discounts for the pharmaceuticals that they will offer to Medicare patients. The PBMs take a cut of the discount because, lo and behold, that’s how they make money. The discounts are pretty much like trade secrets and most patients are unaware of how the system works other than one important fact. Evey year pricing of drugs changes in the plans and patients must examine the Part D programs to see which one offers the best pricing for the drugs that they take. As you know utilization of Rx drugs is higher among seniors than any other age group so this pricing inefficiency (not to mention the time spend looking at Part D plans on an annual basis) is magnified.

Let’s say the government negotiated the EXACT same price as a PBM with the manufacturer, the price to the consumer would be lower by the amount of the discount that is otherwise gobbled up by the PBM. What’s wrong with this? There is no price price differential to the manufacturer but the consumer pays less. Win/Win, correct?

42 AlanG February 6, 2017 at 9:03 am

One more thing to add and of course I’m not spending $40 to read a paper that is probably quite wrong with a lot of assumptions; anyone who claims that drug development would be imperiled because of price controls is just wrong. We’ve seen that price controls in virtually every other country in the world has had no impact and total volume sales of pharmaceuticals in these countries is much higher than in the US. A lot of years I ago I was talking with a CEO of a top 10 pharma company about price controls and the impact on research and he said that price controls in Europe were having no impact at all on R&D operations.

43 TMC February 6, 2017 at 9:52 am

Price controls can work for half the world as long as the other half picks up the R&D tab. Every extra pills costs a penny to make. Once everyone does it, it will effect R&D. We do need to figure a way to spread the costs over a larger group though.

44 JWatts February 6, 2017 at 12:17 pm

I’m leery of this paper, because I think the the mortality statistics into the future are probably not very predictable. But price controls will absolutely effect total R&D and overall supply.

45 Bill February 6, 2017 at 9:06 am

Tyler,

Let’s have truth in advertising in headlines or at least some care.

Direct negotiation by a purchaser, or indemnitor who creates a formulary, is not price controls.

It is negotiation by a buyer who seeks competition among competing sellers who bid for the business.

46 Post-Truth Politics February 6, 2017 at 1:29 pm

Good point. But what about the Libertarian right of capitalists to price gouge the consumer forever, with the sky as the limit? 🙂

47 Sure February 6, 2017 at 9:08 am

The big thing that goes missing in the debates about pharma prices are the actual costs of the alternatives. Lifetime treatment costs for Hep C, without liver transplant, are around $100,00. Pharma cures are priced around $80,000. Rather than do the basic math that $80,000 is not only a straight up 20% lifetime savings (excluding transplants), and perhaps even noting that patients typically liked to be cured of chronic diseases, we get side tracked by how much the drug company pays to produce this wonderful drug.

Frankly, I am a big believer that skill follows incentives. We should create extremely strong incentives for better pharma to lure the best and brightest minds into the game. To that end, I am game for pretty much anything that makes it more lucrative to develop useful drugs than to be an investment banker.

48 WC Varones February 6, 2017 at 9:12 am

We need to allow drug reimportation, or insist on MFN pricing.

We are going broke bearing the cost of drug development for the entire free-riding world.

49 JFA February 6, 2017 at 9:52 am

One thing that I was surprised Tyler did not comment on (given his proclivity for pointing out the Great Stagnation) is that the model the authors use assumes future drugs will have the same distribution of productivity as past drugs. This will most likely not obtain due to research having diminishing returns (i.e. finding drugs of the same effectiveness gets harder), so this the numbers in the paper are probably wildly overstated. The authors also don’t account for the cost to citizens (in terms of immediate reduced welfare) who have to fund these drug purchases.

But while we’re on the topic, how about this for a policy reform: create several cost effectiveness (in terms of dollars/life-year saved) levels; the most cost effective treatments get covered full stop; then you increase people’s share of the cost with each cost-effectiveness cut-off. I mean, I don’t know about you, but I’m tired of my money going to give someone’s 78-year-old granny expensive cancer drugs just to get a couple of extra months. As Margaret Atwood’s short story title says, “Torch the Dusties.”

50 Turkey Vulture February 6, 2017 at 10:03 am

Seems like a lot of questionable stuff in there. I will just point out that it might not even be the case that the current form of price regulation leads to lower revenues/profits for the pharma companies across the totality of US market sales. These pricing policies may lead to elevated private sector prices, as any based on “best pricing” reduce the incentive to aggressively compete on price in the private sector. The policies may also create potential coordination points that facilitate oligopolistic coordination and elevate prices.

51 asdf February 6, 2017 at 10:11 am

Only Tyler could think that a market in which one side isn’t allowed to negotiate is a free market.

52 steve February 6, 2017 at 10:26 am

The 2 years of life expectancy just from a minor drop off in new drugs is not even remotely believable.

Steve

53 Cyril Morong February 6, 2017 at 11:14 am

“We need a new rooftop chant”

How about this one?

We don’t need more regulations, We don’t need more price controls, No Socialism in the courtroom, Hey, White House (or Congress), leave us all alone

54 wd40 February 6, 2017 at 11:26 am

At present, Europe and most of the rest of the world pays less for medicine than the we do in the United States. By giving the US government more bargaining power, the end result will be lower prices for medicine in the US and higher prices in Europe. That is, when more parties get the discounted price, the discounted price goes up.

55 JWatts February 6, 2017 at 1:22 pm

“.. the end result will be lower prices for medicine in the US and higher prices in Europe. ”

Yes, but also probably less R&D spending overall. Which I’m ok with, but it’s a negative that needs to be acknowledged.

56 Post-Truth Politics February 6, 2017 at 1:33 pm

“Beware analyses that neglect supply elasticities.”

LOL, somehow, I don’t think that phrase will catch on very well. Marketing is obviously not Tyler’s field. Need something easier to understand and remember, something smooth and flowing as it rolls off the tongue.

57 GoneWithTheWind February 6, 2017 at 2:21 pm

Everyone knows that drug prices in the U.S. are held artificially high so that drug prices in other countries can be held artificially low. It was intended to be a good thing a humanitarian act. But times changed and many new drugs were discovered and many new drugs are very expensive. So it is time to end it. It won’t be pretty though.

58 Bill February 6, 2017 at 6:25 pm

Do you really believe that the unwillingness to negotiate lower drug prices was a humanitarian act so that other poor countries like England and Germany could have lower prices?

59 AlanInAZ February 6, 2017 at 7:21 pm

Paper should be edited to read “reduces the number of new copy-cat drug introductions by as much as 25% relative to the status quo.” Today most spending on biomedical research is outside the US and expanding rapidly in Asia, funded largely by governments. This paper is probably total BS and I certainly will not pay to read it.. Good way to prevent scrutiny – put it behind paywall.

60 Jackson Layers February 9, 2017 at 10:17 am

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