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No. 4, October 2010
AARP, the huge organization of seniors and not-so-seniors (age fifty and up), has been publishing quarterly reports on the prices of branded drugs since 2005. The reports focus on the drugs most used by the elderly, and they invariably conclude that prices have been increasing much faster than inflation. The latest report, released on August 25, 2010, looked at the prices of 217 branded drugs. It found that, on average, prices increased by 8.3 percent in 2009 while the overall consumer price index declined by 0.3 percent. Remarkably, all but six of the 217 drugs registered increases. But this conclusion is misleading: after factoring in generic-drug prices–which AARP ignores–drug costs for the elderly are actually decreasing.
Key points in this Outlook:
The 8.3 percent average jump in drug prices in 2009 came in the wake of annual increases ranging from 6.0 percent to 7.9 percent from 2005 to 2008. For the entire 2005-2009 period, the cumulative increase in branded-drug prices was 41.5 percent, compared to 13.3 percent inflation for the economy as a whole. The report also estimated that for the average senior taking drugs for chronic conditions (which reflects most drugs used by seniors), the annual cost for a single drug increased from $1,049 in 2005 to $1,382 in 2009. Of course, most seniors only pay a small part of that because they have drug insurance, usually the Medicare Part D drug benefit. But what catches everyone’s eye are the total prices and costs.
When we learn that practically all branded-drug prices have been increasing year after year at well beyond the rate of inflation, the implication seems obvious: seniors have to pay more every year just to keep using the same drugs. That is certainly the impression that AARP intends to convey. But that impression is wrong: on the whole, the prices actually paid by seniors are failing to keep up with inflation by a wide margin–and this downward drift in real drug prices is accelerating. How can this be, given that the AARP reports always say just the opposite? The reason is simple: the AARP reports ignore the influence of cheap generic drugs.
Generics Change Everything
The AARP report lists price increases for branded drugs even when a generic version is available, which misrepresents the dynamics of the marketplace. After a drug patent expires and generics arrive, there are two prices for the same drug, one much cheaper than the other. The original brand usually stays on the market, with its price increasing like the prices of on-patent drugs. But the real action is with generics. The Hatch-Waxman Act, which governs generic entry, guarantees that the first generic will usually be priced only about 10 to 20 percent below the branded version. But that is only for six months; more generics soon enter the market, and prices often plummet. A report issued in May 2010 by the Kaiser Family Foundation notes that the average branded prescription cost about four times as much as the average generic in 2008 ($138 versus $35).
Which drug do Medicare patients buy–the expensive branded one or the inexpensive generic? They usually choose the generic, especially if it is a popular drug. The pharmacy benefit manager Medco reported that after the blockbuster antidepressant Zoloft went off patent in August 2006, 85 percent of new prescriptions were for the generic version by the end of the first week. This is typical of the work of energetic pharmacy benefit managers, who seek competitive advantage by cutting drug costs. When the sleep aid Ambien went off patent in 2007, Medco converted 97 percent of mail-order prescriptions and 77 percent of drugstore prescriptions to the generic version in the first week or so. One study showed that, on average, brands lose 86 percent of their market share within a year after patent expiration. These data, including the Medco reports, do not apply only to Medicare-patient prescriptions, but there is little reason to think that Medco and its competitors are any less effective in Medicare Part D plans.
This means that the AARP drug price reports, including the one released in August, are fundamentally misleading. As the latest report notes, when a drug goes off patent, the AARP analysis still uses the branded-drug price and pays no attention to the fact that essentially the same drug can now be purchased for far less. The AARP report suggests that keeping generics out of the analysis does not matter because if off-patent drugs were excluded, the average price increase would be slightly larger (8.7 percent instead of 8.3 percent). But that is beside the point, which is that most patients are saving hundreds of dollars each year by purchasing much cheaper generics instead of expensive off-patent but branded versions of many drugs.
The Influence of Generic Entry
The fact that AARP ignores generic entry makes a significant difference. We are in the middle of the greatest surge of blockbuster-drug patent expirations in history. For the pharmaceutical industry, the generic surge is a source of dramatic declines in revenues, profits, and payrolls. For consumers, it is a source of lower prices.
The table displays AARP’s list of the twenty-five top-selling drugs in 2006–the same list that forms the basis for AARP’s comparisons between 2005 and 2009 prices. It also indicates which of those twenty-five drugs had generic competition in 2009, when that competition first appeared, and what the current branded and generic prices are for those drugs that were available as generics in 2009.
Eight of the twenty-five drugs were available as generics in 2009, and the disparity between branded and generic prices is striking; the average generic price is only 26 percent of the branded price (reflecting the 74 percent average discount). What does this mean for consumers? The only way to find out is to take into account two kinds of information that were ignored in the AARP reports: prices of the generic equivalents of branded drugs, and the extent to which patients switched from branded drugs to generics. Patient switching took two forms: from a brand to a generic equivalent and from one brand to a generic form of a different, but similar brand (such as from the branded, cholesterol-reducing drug Lipitor to the cholesterol-reducing generic Zocor). These are two different ways to save money. Clearly, this raises the possibility that the prices of drugs actually used by seniors have been declining instead of increasing.
In a recent paper, Ernst R. Berndt and Murray Aitken perform the necessary analysis to examine the influence of generic entry. Their paper surveys the impact of generic entry for the entire market since the 1984 Hatch-Waxman Act simplified the pathway for generic entry. One section looks at the same top-selling twenty-five drugs in 2006 that are listed in the table. The authors apply standard methods for constructing price indices, which take into account price declines when a generic appears, as well as consumer switching from brands to generic equivalents or from brands to generic versions of competing drugs. They conclude that between 2006 and 2009, the average price per prescription declined by 21.3 percent, compared to the AARP calculation that prices increased by 27.6 percent. The basic dynamic was simple: prices for individual brands did indeed increase as calculated by AARP, but those increases were more than offset by dramatic shifts toward generics. One must conclude that the AARP report and the headlines it generated were fundamentally misleading in the claim that seniors are paying more to use the same drugs they used in 2006. In fact, the opposite is true.
Drugs Will Get Cheaper in the Near Future
The surge in patent expirations and generic entry continues. Medco’s 2010 Drug Trend Report listed fourteen drugs that would go off patent in 2009, representing total 2008 sales of $14.3 billion. Of the seventeen drugs on AARP’s top-twenty-five list that were still under patent protection in 2009, one has gone off patent (Flomax, whose generic price is already 18 percent less than its branded price), five go off patent in 2011, and three more go off patent in 2012. Come 2012, only eight of the twenty-five drugs will still have patent protection. Given that eight off-patent drugs more than offset price increases in the remaining seventeen in 2009, we can expect seniors to pay much less than ever before for this twenty-five-drug market basket in 2012–when eighteen drugs will be off patent. If AARP continues to track drug prices by attending only to brand prices, the results will be even more absurd than they are now.
Does it matter that AARP publishes grossly misleading reports on drug prices? It matters a lot, for two reasons. First, the AARP reports suggest that something needs to be done to cap drug prices, such as explicit price controls or direct price negotiation by the Centers for Medicare and Medicaid Services (CMS). This ignores the fact that competition among drug benefit plans has made the Part D program much less expensive than anticipated. In congressional testimony in 2008, acting CMS administrator Kerry Weems noted that Part D spending in 2006 and 2007, the first two years of the program, was $28 billion and $41 billion, far less than the predicted spending of $43 billion and $62 billion. Forcing prices even lower would cut expected payoffs from developing new drugs for the elderly, which would cause great harm in the long run.
AARP’s strange method for tracking drug prices is also distressing because it obscures precisely what is most important. The fundamental dynamic of pharmaceutical markets–relatively high prices for the few years of patent life remaining after FDA approval, followed by many years of rock-bottom generics prices–is the prime force in the drug-development cycle that has so benefitted AARP members and will continue to do so if it is not dismantled by political forces. Instead of grandstanding on drug prices, AARP should help legislators and others maintain a sound understanding of true price dynamics. The easiest way to do that would be for future AARP reports to accurately state what has happened to drug prices in recent years. Those reports should factor in generic prices where applicable so that the average prices reported reflect the realities of the marketplace. The result would be drug price reports that make sense instead of causing mischief.
I am indebted to Gabriel Sudduth of the AEI staff for research assistance, including the compilation of the data in the table. I remain responsible for all errors.
John E. Calfee ([email protected]) is a resident scholar at AEI.
1. Stephen W. Schondelmayer and Leigh Purvis, Rx Price Watch Report: Trends in Retail Prices of Brand Name Prescription Drugs Widely Used by Medicare Beneficiaries, 2005 to 2009 (Washington, DC: AARP, 2010), available at www.aarp.org/health/drugs-supplements/info-08-2010/rx_price_watch.html (accessed September 15, 2010); and Duff Wilson, “AARP Says Brand-Name Drugs Up 8% in 2009,” New York Times, August 25, 2010.
2. The 217 drugs were the bestselling drugs in 2006 in the AARP Medicare Part D plan. The five-year average was for the 207 drugs that were marketed continuously from 2005 to 2009. Prices came from ThomsonReuters MarketScan Research Databases. All averages were sale-weighted using the AARP Medicare Part D sales data for 2006.
3. AARP also publishes reports on generics prices. But those reports just track generics prices without comparing them to branded prices or noting the impact on prices actually paid by consumers as they switch from branded to generic drugs.
4. Food and Drug Administration, “Generic Competition and Drug Prices,” available at www.fda.gov/AboutFDA/CentersOffices/CDER/ucm129385.htm (accessed September 15, 2010).
5. Janet Lundy, Prescription Drug Trends (Menlo Park, CA: Kaiser Family Foundation, May 2010), 3, available at www.kff.org/rxdrugs/upload/3057-08.pdf (accessed September 15, 2010).
6. Medco, 2007 Drug Trend Report (Franklin Lakes, NJ, 2007), 9, available at http://medco.mediaroom.com/file.php/129/2007+DRUG+TREND+REPORT.pdf (accessed September 15, 2010).
7. Medco, 2008 Drug Trend Report (Franklin Lakes, NJ, 2008), 10, available at http://medco.mediaroom.com/file.php/162/2008+DRUG+TREND+REPORT.pdf (accessed September 15, 2010).
8. Murray Aitken, Ernst R. Berndt, and David Cutler, “Prescription Drug Spending Trends in the United States: Looking beyond the Turning Point,” Health Affairs 28 (2008): w155.
9. Stephen W. Schondelmayer and Leigh Purvis, Rx Price Watch Report: Trends in Retail Prices of Brand Name Prescription Drugs Widely Used by Medicare Beneficiaries, 2005 to 2009, 3.
10. Murray Aitken, Ernst R. Berndt, and David Cutler, “Prescription Drug Spending Trends in the United States: Looking beyond the Turning Point”; and Medco, 2010 Drug Trend Report (Franklin Lakes, NJ, 2010), 42-43, available at http://medco.mediaroom.com/file.php/187/2010+DRUG+TREND+REPORT.pdf (accessed September 15, 2010).
11. Ernst R. Berndt and Murray Aitken, “Brand Loyalty, Generic Entry and Price Competition in Pharmaceuticals in the Quarter Century after the 1984 Waxman-Hatch Legislation” (NBER Working Paper 16431, National Bureau of Economic Research, Cambridge, MA), available at www.nber.org/papers/w16431.pdf (accessed October 25, 2010). They used the same source for price data as the AARP reports did, although other sources could be more accurate.
12. Medco, 2010 Drug Trend Report, 5.
13. Medco, 2010 Drug Trend Report.
14. U.S. House of Representatives, Committee on Oversight and Government Reform, Testimony on Medicare Drug Benefit, 110th Cong., 2d sess., July 24, 2008, available at www.hhs.gov/asl/testify/2008/07/t20080724a.html (accessed October 25, 2010).
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