While Trump’s threat of getting rid of rebates that drug companies pay third party agents has many breathing a sigh of relief, this battle against drug prices may be far from over.
As a general rule anyway, kickbacks aren’t permitted, although for some reason the pharmaceutical industry often doesn’t follow general rules.
The prescription drug industry, in the United States in particular, is a huge industry of course and there’s lots of money to go around for everyone, including deals that have companies that serve as intermediaries in negotiating drug prices for insurance companies receiving “rebates” for their services.
How this works is that a company will negotiate a certain price with a pharmaceutical company for their clients and be compensated for this directly by the pharmaceutical company instead of the client. These are called rebates but they amount to what we would normally call kickbacks, and kickbacks are not market efficient and just add to the cost of what ends up being sold as a result.
It is odd that insurers don’t deal with pharmaceutical makers directly, and we are not talking about small companies here but huge ones, and given the importance of pricing to their business, negotiating their own prices would both make sense and be something that they would be fully capable of doing on their own without the need for third party agency.
If an agent negotiates a price for you, having the price that you pay include direct compensation to the agent by the vendor will add to the cost of the product no matter how you slice it, and especially will when this level of compensation is out of your hands, as is the case with these rebates.
If the third party gets compensated by the vendor, this also may affect their incentive to bargain in complete good faith, as they are essentially in cahoots with the vendor here and can even be said to work for them instead of who are supposed to be their actual clients. Drug companies can even charge more and share this extra with the third party, and they probably do get to charge more than they would otherwise under this sort of arrangement.
When you have a market as large as the United States, we would normally think that, if anything, costs would be lower in such a market, as more volume generally means more efficiency and certainly more bargaining power.
When we consider that the price charged for pharmaceutical drugs is much higher in the United States than in other countries, this just doesn’t make sense, unless the system in the U.S. is just that broken. As it turns out, it is that broken, and the existence of these kickbacks is just one of the problems that raise prices far higher than elsewhere.
The U.S. Market Is Unregulated, and Higher Prices Are What Happens
The biggest thing that the U.S. lacks is an effective system of regulation, and the fact that companies can get away with so-called rebates like this speaks loudly to the utter lack of effective regulation that we have, because this is one of the first things that would be addressed.
The U.S. is the world leader in political lobbying though, and the health care industry has some very deep pockets and somehow has managed to use their power to keep profits very high and avoid the constraints that they face elsewhere, and they are more than happy to just keep things just as they are.
When the President of the United States wants to get rid of these rebates and he ends up giving up on the idea, as Donald Trump just did, we get an idea of what he might be up against here. On the other hand, perhaps he gave this up because he has an even better idea, and that sure looks like the most reasonable explanation right now.
In other industries, this sort of rebate system would not be permitted and people could even go to jail over it, but the health care industry in the United States is in a special category here, in an almost untouchable one it seems. We even have a nice-sounding name for this, pharmacy-benefit managers, although who really benefits from this isn’t made so clear, and it’s the pharmacy-benefit managers who are managing benefits to themselves at the expense of consumers ultimately.
Companies who offer these services, some pretty big companies such as Cigna, CVS Health, and UnitedHealth Group, are no doubt breaking out the champagne over this new development, in victory.
President Trump, who has been expressing his desire to do something to address the huge gap in drug prices between the U.S. and other countries, may not have given up the war yet, and in fact, it is likely about to be escalated, where he may be looking at going after the pharmaceutical companies directly now.
This other idea of his is an even better one actually, and if successfully implemented, may serve to cull any excesses that may be happening down the pipeline. If we limit prices on what drugs can be sold at, if we in other words set caps that are aligned with what these things cost in other countries, there may no longer be room for this extra money changing hands because the pharmaceutical companies will likely want or need to keep the full wholesale price to themselves and there may not be anything left to share.
If Prices End Up Being Pegged to Those in Other Countries, That’s an Even Better Fix
It may actually be that Trump ended up realizing this and especially getting the fact that this is a much bigger stone and both problems may be addressed in throwing this bigger one. Setting a cap on prices is actually the only real solution to this mess as this would regulate away the excesses charged to Americans that people in other countries do not have to pay, which is the problem itself.
At this point, if drug companies still want to pay pharmacy-benefit companies a percentage of their sales, it would be their own profits that they are sharing, rather than what goes on now, with their marking up the cost of their merchandise to accommodate this. If they can’t mark it up anymore, this problem becomes solved as well.
Trump has already put forth the idea of using an International Pricing Index, or IPI, to price drug costs in the U.S. While the benefits issue really wasn’t a concern to drug companies at all, as they could still price their products the same way and let those downstream worry about the effects of this, and suffer the consequences if the scheme was scrapped, if the IPI comes into effect, that will be another story altogether.
President Trump is very much in favor of the free market, more so than politicians usually are, but the much higher cost of drugs in the U.S. is not a matter of the free market speaking, it is actually what happens when the free market does not do what it is supposed to. The health care industry overall doesn’t resemble a free market very much anyway, and there are reasons why we need regulation over and above whatever the market will bear, because we grant monopolies to these drug companies and that surely needs to be closely supervised.
Demand for drugs is very inelastic already, meaning that if you need something to either stay alive or maintain a minimal quality of life, price is much less of an object and usually isn’t one at all. There may not be any substitute for a certain drug, and companies can charge pretty much whatever they want for it as they have no competition whatsoever while their monopolies remain in effect.
When we combine a monopoly with extreme inelasticity, and we add in the fact that while people may not be able to afford such high prices, their insurance companies can and do come to their rescue, this is nothing remotely close to a free market economy, and may be as far from it as we could possibly get.
The main reason why it is cheaper to buy the same drugs in other countries is that these countries regulate drug prices, but the United States has thus far chosen not to. This all results in much higher profits for pharmaceutical companies and a much higher cost to consumers, and this is not a situation that we should be happy with unless you own shares of drug companies that is.
We will have to see how successful Trump is in making drug price regulation a reality in the U.S. and bring these prices in line with what is being charged elsewhere, where people have regulators step in on their side to protect them from excessive profits that they do not have the power to deal with themselves. If there ever were a justification for regulation, this would clearly be one.
The stocks of drug companies took a real hit Thursday on this news though, as would be expected, and Trump hasn’t even come out and told us that he will be going down this road for sure yet. All he really said so far is that “we have some very big moments coming up, I think, over the next week.”
The speculation at this point is that this big moment will be an announcement that he is serious about bringing the prices of drugs in line with the ICI, or some similar plan that may at least bring us closer to these numbers. The language he used did tell us that this is a work still in progress though, which suggests that he’ll be consulting with others about this first, and may run up against the power of the drug companies that this would target.
We’ll have to see how this comes out and who comes out ahead, and if the intention to do this ends up being made, just how far Trump can take this fight. This is a lot bigger issue than the 3-4% loss that drug stocks took Thursday though, so the market is only pricing this in a little so far, but if this ends up getting done, expect a whole lot more.