Academic journal article AEI Paper & Studies

Reforming Medicare Payments for Part B Drugs

Academic journal article AEI Paper & Studies

Reforming Medicare Payments for Part B Drugs

Article excerpt

June 2019

The rising cost of prescription drugs has been a focal point for debate in Washington and across the country. Policies affecting the market environment for prescription drug pricing must balance competing objectives. The public benefits from continued development of innovative new therapies, but access and affordability are major concerns. Policies that promote pharmaceutical innovation, such as patent protection and market exclusivity, increase the financial rewards to pharmaceutical research and development. They also reduce market competition, leading to higher prices for new drugs and higher costs for patients, insurers, and public programs. The challenge for policymakers is finding the balance between promoting innovation and promoting competition.

These issues are at the heart of recent proposals to change the way Medicare pays for drugs administered in physician offices and other outpatient settings. Such drugs, covered under Medicare Part B, are typically given to patients by infusion or injection or otherwise require medical supervision. (Medicare Part D covers drugs dispensed to patients through retail pharmacies.) Part B covers drugs used to treat a wide range of diseases, including cancer, rheumatoid arthritis, and macular degeneration.

Part B spending on drugs has risen rapidly in recent years, driven by growth in spending on biologics. From 2009 to 2016, spending grew at an average annual rate of 9.5 percent, compared to about 4 percent growth per year in total Medicare spending. The average price paid by Medicare rose at an average annual rate of 6.6 percent from 2009 to 2015 (after taking into account shifts in the mix of drugs used to treat patients, including the use of higher-priced drugs for treating the same condition) (MedPAC 2018).

The Trump administration has proposed a new payment framework for Part B drugs that would allow private vendors to negotiate prices with drug manufacturers. In addition, the administration would impose an upper limit on Part B drug prices under an International Pricing Index (IPI) Model. The IPI is based on prices paid in other developed countries for the same pharmaceutical products that Part B covers. As explained below, the IPI methodology is used to allocate payment reductions across drugs in the index to achieve overall program savings, but the level of savings is not tied to international prices.

Although Medicare Part B accounts for a relatively small share of the prescription drug market, changes to its payment methodology could set a precedent that the rest of the market might adopt. Proposals to revamp Medicare's payment methodology should be evaluated for their impact on both Medicare and the pharmaceutical market more broadly.

The Broader Context for Pharmaceutical Pricing

Three aspects of the pharmaceutical market are central to the way drugs are priced (Newhouse 2004). First, the fixed costs for getting a product to market, including the research necessary to develop it and obtain approval from the Food and Drug Administration, are high. Second, the market is notoriously risky. Many product development efforts fail. Third, once a drug is approved and production begins, the marginal cost of producing an additional unit of the product is generally quite low relative to the product's overall fixed costs.

As a consequence, the prices manufacturers charge must be high enough to compensate investors for the fixed costs of product development, cover the losses from investments that did not lead to a marketable product, and provide an appropriate risk-adjusted rate of return on invested capital. If the return on investment in drug development falls too low, capital will move naturally to other markets with higher returns.

Limited competition and the prevalence of third-party payment contribute to the rise of drug prices. Patents and regulatory hurdles make it costly for other companies to develop alternative therapies and can substantially delay market entry for lower-price competitors. …

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