How Prescription Drugs Get Their Prices, Explained

Originally published by Newsweek.

After years of promising to repeal the Affordable Care Act, House Republicans last week introduced their replacement, the American Health Care Act, or AHCA. The proposed legislation has been ripped from both sides of the aisle due to concerns about increased insurance costs many people, particularly older Americans, may have to pay, as well as the potential loss of coverage that could result.

Missing from this debate about health care coverage has been any discussion of lowering the cost of care. The U.S. spends more than any other high-income country on health care. Prescription drugs account for about 17 percent of all health care spending; that’s more than $370 billion per year, again exceeding all other countries. This total is the result of not only the high number of prescriptions written but also the high cost of the drugs prescribed. President Donald Trump has vowed to lower drug prices but has not yet proposed any concrete approach for doing so.

Pharmaceutical companies often justify the cost of drugs as necessary to support the research and development, or R&D, of innovative treatments. If we want cures for devastating diseases, they say, we have to pay for them. But that explanation does not stand up under scrutiny. Research by the Tufts Center for the Study of Drug Development put the cost of developing a new drug at $2.6 billion. But that research was supported by the pharmaceutical industry, and the estimate has been questioned.

Shefali Shah has spent more than 15 years helping pharmaceutical companies navigate issues surrounding the cost of new medications. She has worked with biotech giants like Genentech, small biotechs bringing their first products to market and external consulting firms to pinpoint the magic dollar amount for a given medication.

Now an independent adviser, Shah spoke with Newsweek about drug prices: where they come from, who negotiates them and how they got so incredibly complicated.

What is the difference between pricing and reimbursement?

Pricing and reimbursement are entangled to some extent. Drugs may ultimately have several different prices, but the first one is the list price, which comes from the manufacturer. The list price is not necessarily the price that most people pay. In some cases, hardly anyone pays it. But the list price serves as the basis for many subsequent calculations.

Reimbursement is the amount the insurer pays for the drug, whether it’s a private insurer, Medicare or Medicaid. Typically, depending on the type of drug, the insurer pays either the physician directly, the drug manufacturer or an intermediary, such as a pharmacy benefit manager.

The PBM pays a heavily discounted price. Physicians buying the drug directly also receive a discount. So do wholesalers. None of these entities pays the list price.