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In September 2016, Mylan CEO Heather Bresch appeared before the

U.S. House Oversight Committee to address the controversial issue of rising prescription drug prices. Mylan was in the spotlight because of a dramatic 600 percent increase in the price of the EpiPen, a steroidal injector that treats severe and sometimes deadly allergic reactions. The rise in the cost of EpiPens was stunning. Priced at $100 for a two-pack in 2009, the same medication sold for over $600 by the fall of 2016. Members of the House of Representatives expressed their outrage over the surge in pricing for this important drug. Representative Elijah Cummings, from Maryland, accused the pharmaceutical maker of raising EpiPen prices "to get filthy rich at the expense of our constituents." Mylan CEO Bresch countered this criticism claiming that the price increases were necessary to ensure that Mylan could continue to invest in the research and development (R&D) necessary for new drug discovery, as well as improvements to existing products including the EpiPen.

The price increase for the EpiPen is hardly unusual in the U.S. drug market. Most drug makers added significant markups to the retail price of their compounds over the same time period. For example, AbbVie Inc. raised the price of the arthritis drug Humira more than 126 percent from 2011 to 2015, while Teva Pharmaceutical Industries Ltd. increased the price for its multiple sclerosis drug Copaxone by 118 percent over the same period. Data from National Health Statistics Group, summarized in the accompanying figure, illustrate that overall U.S. retail expenditures on prescription drugs grew steadily over the last 15 years. Between 2014 and 2015 prices increased 9.0 percent, to a total of $324.6 billion.1

Boosting the Bottom Line at Patients' Expense?

To be sure, price increases are an important way for drug company executives to increase profits and benefit their stockholders. Like most manufacturers, pharma giant Pfizer Inc. routinely raises prices for a large proportion of its offerings, including more than 133 of its products in 2015. Similarly, Merck & Co. raised its list prices by an average of 9.6 percent in 2016. In some cases, increases for just a single prescription can give a major boost to a company's bottom line. For example, Pfizer increased the price of its popular painkiller Lyrica by 51.7 percent over a three-year period. Analyst projections suggest that Lyrica will generate close to $5 billion in annual sales for Pfizer through 2019.2

While the increasing cost of medications certainly hit patient's pocketbooks, the consequences can be dire when sharp price increases impact lifesaving drugs. In one high-profile 2015 case, Turing Pharmaceuticals, headed by then CEO Martin Shkreli, acquired the drug Daraprim, a 62-year-old medicine used to treat a parasitic infection that can cause brain damage and death in infants and people with AIDS. Following the acquisition, Turing raised the price of Daraprim overnight from $13.50 to $750 a pill—a 5,000 percent increase! When asked by investors about the impact of the decision on the company's profits, Shkreli cynically wrote, "I think it will be huge .... So 5,000 paying bottles at the new price is $375,000,000—almost all of it is profit, and I think we will get three years of that or more. Should be a very handsome investment for all of us." While not illegal, the price increase prompted public outrage and Shkreli was subpoenaed to appear before the U.S. House Oversight Committee to answer questions about the move. While Shkreli resigned as the CEO of Turing later in the year, the company continues to resist numerous calls to reduce the cost of the medication.

While the price increases associated with Daraprim are extreme, there is little doubt that the widespread increase in prescription drug prices is making health care increasingly unaffordable in the United States. Indeed, some health care advocates are now arguing that price increases actually translate into poorer health outcomes and dangerous medical conditions because some patients can no longer afford to take drugs at their prescribed dosage.3

The High Cost of Drug Development

Bringing a new drug to market typically involves many years of very costly research, development, and testing by the pharmaceutical maker. Once a new drug is discovered and developed for human use, its safety and efficacy are evaluated by the U.S. Food and Drug Administration (FDA). As part of its evaluation, the FDA assesses the outcomes of three stages of clinical trials involving clinical researchers, doctors, and thousands of patients over several years. This process of discovery and testing can be very expensive with researchers estimating that the average R&D cost of developing a new FDA-approved medication was $2.6 billion (in 2013 dollars) over the last decade.4 Given these costs, it is little wonder that most pharmaceutical companies make enormous investments in R&D every year. Pfizer, for example, expensed over $7.5 billion in R&D in 2015 alone!

Drug development and testing are also exceedingly time consuming and risky. On average, it takes a successful experimental drug 15 years to go from lab to patient.5 Unfortunately, the vast majority of drugs that are developed actually fail to ever receive FDA approval for use. In a recent industry study of clinical trials between 2006 and 2015, only 9.6 percent of all developmental drugs successfully made it through even the first stage of clinical trials. Of those that succeeded in the first phase, only 30.7 percent ended up making it through the second set of clinical trials.6

Given this very high development expense, the FDA grants a period of market exclusivity from 5 to 12 years when a new patented drug is approved for patient use. During the exclusivity period, no competing low-cost or generic version of the drug can be sold in the U.S. market. While exclusivity gives the company a veritable monopoly on the marketing and pricing of the drug, executives and regulators agree that it provides pharmaceutical companies with a critical economic incentive to develop new drugs. This incentive is important for the stockholders of drug companies because they have to finance R&D expenses and they bear the costs associated with the duration and risk of drug development.

Innovation or Gaming the System

While market exclusivity provides pharmaceutical companies with an important economic incentive to develop new drugs and improve existing medications, many of these same companies attempt to game the exclusivity rules through maneuvers commonly known as "hard switching" and "evergreening."

Hard switching happens when a manufacturer discontinues the sale of a drug immediately before the end of its exclusivity period and replaces the drug with a new, market-exclusive compound. In many cases patients are prescribed the new medication before the lower-cost generic medication hits the market. If patients are unaware and never informed of the availability of generic versions of the older drug, they will continue to use the more expensive brandname medication.

Evergreening occurs when a pharmaceutical company makes small changes to a drug before the end of its exclusivity period in an effort to gain a new patent and a new exclusivity period. Typically these changes involve modifications to a medication's dosage or form of release. Drug makers claim that the alterations improve the efficacy of the medication and typically promote the new higher-priced product as superior to the older version. Critics of evergreening, however, argue that the majority of these changes are trivial and yield only minor benefits for patients, while allowing pharmaceutical makers to continue to charge exorbitant prices for equivalent drugs.

Can Consumers Fight Back Against High Drug Prices?

Like any product, drug prices are determined by supply and demand. While consumers may have a number of alternative options when they purchase a car or a gallon of milk in the grocery store, patients typically face far fewer options when they purchase medications as an individual or through one of many forms of medical insurance.

There are often many drugs to choose from when treating common conditions. For example, a "statin" lowers cholesterol in the body and is one of the most commonly prescribed medicines in the United States today. Given the high demand for the product, many pharmaceutical companies have developed their own branded statin including Pfizer (Lipitor), Astra Zeneca (Crestor), and Merck (Zocor), and there is a variety of very low-cost generic versions of these drugs available on the market today.

On the other end of the spectrum, exclusivity rules and a lack of viable alternative medications can severely limit a patient's options. In the most extreme cases, patients with rare conditions must rely on pharmaceutical companies to develop so-called "orphan" drugs. Under the 1983 Orphan Drug Act (ODA), drug companies producing orphan treatments expected to be used by 200,000 patients or less can qualify for additional exclusivity, special tax treatment, and R&D grants to incentivize research for these relatively small populations. Once a treatment is developed, however, the lack of competition can leave patients vulnerable to price increases. For example, in 2015 Valeant Pharmaceuticals raised the price of Cuprimine, a drug to treat an extremely rare malady known as Wilson's disease, by 400 percent to $26,189 for the annual treatment.

To many it seems that consumers are at a distinct disadvantage in the prescription drug market. In many other countries, however, drug prices are negotiated by government health programs that have effectively curbed the increases observed in the U.S. market. Since the government programs are the only large buyers, they can drive hard bargains with manufacturers and the savings for consumers can be huge. For example, a recent report by CNN noted that the monthly prescription price for the common acid reflex drug Nexium costs $215 in the United States but just $23 per month in the Netherlands.7 These low prices have driven many U.S. consumers to try to fill their prescriptions outside of the United States, typically in Canada and Mexico, although U.S. law prohibits pharmacies and people with prescriptions from filling their orders over the border.

For the majority of Americans, drug prices are negotiated indirectly through their insurers that have a limited ability to constrain surging prices. The Medicare and Medicaid programs are the largest insurers of patients in the United States, covering more than 125 million people. Federal law, however, prohibits the U.S. Centers for Medicare and Medicaid from negotiating drug prices with the pharmaceutical companies.

Private insurers have some options available to reduce excessive drug pricing. One tool at their disposal is the requirement that a patient receive prior authorization from the insurer before receiving coverage for a given prescription. While prior authorization can cause some drug makers to think twice about exorbitant charges, the practice is under fire by state attorneys general who contend that the threat of nonauthorization for expensive drugs is inconsistent with an insurer's obligation to cover the medical needs of the insured.

Insurers also rely on drug formularies and tiered co-payments by patients for medications to moderate pharmaceutical costs. Drug formularies are the lists of drugs that a health insurer agrees to pay for, at least partially, for a given medical condition. In setting the formulary, health experts try to provide access to effective but lowcost drugs. In many cases this means providing access to generic rather than brand-name drugs for the same indication. Higher patient co-payments reduce drug affordability for consumers, reducing the demand for certain drugs. The effect of co-payments on demand, however, is limited by state laws that cap out-of-pocket expenses by the insured.

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