POLICY BRIEF

Reducing U.S. Prescription Drug Spending: Comparing

Alternative Policies for Price Control, Utilization Management,
and Industry Regulation.

Prepared by Alexander Cohen, MSW

December 2010

Boston University School of Public Health

Department of Health Policy & Management
Culminating Experience Project for PM 755 – The Shape of Health Care Delivery

For comments, questions, or more information, please contact:

Alexander (Sandy) Cohen
E-mail: scohen11@bu.edu
Phone: (617) 358-5531
Overview: The continuing trend of unsustainable increases in U.S. prescription drug spending can be attributed to the
absence of price controls or competitive market conditions for medications, persistent growth in drug utilization, and
insufficient government regulation of the pharmaceutical industry. Proposed policy options with legitimate potential for
lowering prescription drug spending are available that would do so without limiting medication access. Assessing their
potential benefits will enable health care payers and policymakers to select changes that will secure the long-term
availability and affordability of prescription drugs.

Problem Scope: Health care industry stakeholders are familiar with the trends in growth of total U.S. health care
expenditures (HCE). Total health care spending in 1990 was estimated to be above $714 billion, and by 2008 had more
than tripled to $2.3 trillion (Kaiser Family Foundation
[KFF], 2010a). While the 322% rate of increase in
Table  1:  Comparing  annual  increase  in  Rx  
Spending  and  HCE   HCE during this period has been staggering to health
care payers, cost growth has been significantly greater
Spending  Increase  above  last  year    

%  Change  Rx   %  Change  HCE  

within the pharmaceutical sector. 1990 spending on
20.0%  
prescription drugs in the U.S. totaled $40.3 billion,
15.0%  
and grew rapidly to $234.1 billion in 2008—an
10.0%  
increase of 584% (KFF, 2010b). This rate of growth
5.0%  
is nearly double that of total HCE growth since 1990.
0.0%  
1991  
1992  
1993  
1994  
1995  
1996  
1997  
1998  
1999  
2000  
2001  
2002  
2003  
2004  
2005  
2006  
2007  
2008  

Table 1 (left) shows the relative annual growth in

spending on prescription drugs compared to overall
*Centers  for  Medicare  &  Medicaid  Services,  2010   HCE. Comparatively, the U.S. appears alone among
industrialized nations in having this heightened level of pharmaceutical spending, with Europeans spending only two-
thirds as much per capita on medications as Americans (Lakdawalla et al., 2009).

Spending in this sector has been a key contributor to the

overall growth in health care spending during this period, Table  2:  U.S.  Rx  Spending  as  %  of  HCE,  
1990-­‐2008  
expanding its share of HCE from 5.6% in 1990 to over
12.00%  
10% in each year from 2003 to 2008 (see Table 2). With
10.00%  
this expansion, prescription drugs have become the 3rd 8.00%  
most costly sector of our nation’s health care system, 6.00%  
behind only hospital care (31% of HCE) and physician 4.00%  
2.00%  
and clinical services (21%). As researchers and
0.00%  
policymakers continue to acknowledge the need for 1990  1992  1994  1996  1998  2000  2002  2004  2006  2008  
comprehensive health care reform to curb system-wide
*Centers  for  Medicare  &  Medicaid  Services,  2010  
costs, the extreme growth of pharmaceutical spending
should include U.S. prescription drug policy as an essential component of future reforms.

Root Causes: The forces behind the recent prescription spending growth can be roughly reduced to four primary factors:

1. Significant increases in medication prices (Avorn, 2010a; KFF, 2010b; Maheras, 2010).
Reducing U.S. Prescription Drug Spending 1
 
 2. Expanding growth in prescription drug access and utilization (Avorn, 2010a; 2010b; KFF, 2010b).
3. The industry’s marketing expenses and effects (Avorn, 2010a; Maheras, 2010).
4. Ineffective and insufficient government regulation of industry practices (Avorn, 2010a; Outterson & Kesselheim,
2009; US-GAO, 2009).

Prices: Medication prices in the U.S. have received substantial attention for many years, particularly with international

comparisons where prices in other countries tend to be significantly lower (Frank, 2004; Quon, Firszt, & Eisenberg, 2005).

U.S. prices have not only been high relative to other nations, but have also independently become more expensive from

year-to-year. Between 2000 and 2008 alone, 416 brand-name drugs experienced “extraordinary prices increases” (U.S.

Government Accounting Office [US-GAO], 2009), which are defined as price increases of more than 100% at a single

point in time. These 416 medications, comprising about 0.5% of all brand-name medications dispensed in the U.S. during

this period, more than doubled in price overnight. The average annual price growth of all prescription drugs from 2000 to

2009 was 3.6%; about 44% greater than the corresponding price growth (2.5%) for all items (KFF, 2010b). Translated

into actual dollars, the average U.S. retail prescription price nearly doubled from $38.43 in 1998 to $71.69 in 2008.

The U.S. has historically relied on market conditions to determine prices. However, the pharmaceutical industry’s

patent-based system neutralizes any chance for market-based price control during the life of the patent by precluding

others from producing equivalent products. Dr. Jerry Avorn (2010a) of Harvard Medical School explains, “The U.S. is

the last industrialized country where pharmaceutical companies can set any prices that they want.” This power of price

setting is made possible by this proprietary environment that lacks any competition. Manufacturers’ ability to create their

own retail prices has been repeatedly identified (Maheras, 2010) as a key factor driving the unchecked growth in prices

charged to Americans. During this time of major price and spending growth, the pharmaceutical industry remained as the

most profitable industry in the U.S. from 1995 through 2002, and among the top 5 each year since (KFF, 2010a).

Drug access and utilization: While medication prices have been steadily increasing, the amount of medication being

prescribed and consumed in the U.S. has risen even more substantially. The total number of prescriptions provided in the

U.S. increased a total of 39% from 1999 to 2009, from 2.8 billion to 3.9 billion annually (KFF, 2010c). This increase over

the past decade has been accompanied by population growth of only 9% (KFF, 2010d), which indicates that the increase

in medication use was not simply driven by an increase in the number of American residents. In fact, the average number

of retail prescriptions per capita increased from 10.1 in 1999 to 12.6 in 2009 (KFF, 2010c; KFF, 2010d). Therefore,

nationwide use of prescription drugs increased 25% during this period, when controlling for population growth.

2 Alternative Policies for Price Control, Utilization Management, and Industry Regulation
 
 One factor often identified to explain this trend is the general ‘aging of America’ (Avorn, 2010a, 2010b). As

individuals age, their health needs become more complex, with Medicare beneficiaries commonly experiencing multiple

chronic conditions at the same time (Umans & Nonnemaker, 2009). Additionally, the increasing prevalence of insurance

benefits for prescription drugs has made medication access easier and more affordable for a great number of Americans

(KFF, 2010b). The greatest contributor to expanded insurance coverage was the Medicare Prescription Drug,

Improvement, and Modernization Act of 2003, which established a voluntary Medicare benefit (titled ‘Part D’) for

outpatient medications that went into effect January 1, 2006. The Kaiser Family Foundation (2010e) reports that, as of

February 2010, 27.7 million Medicare beneficiaries (60%) were enrolled in a Part D plan. Additionally, by 2009, nearly

all workers (98%) covered by an employer-sponsored insurance plan had a prescription drug benefit (Claxton et al., 2009).

Marketing: One area where American drug manufacturers have great freedom, relative to their international counterparts,

is marketing to physicians and directly to consumers. The U.S. is still the only developed country in the world, along with

New Zealand, that allows such direct-to-consumer advertising [DTCA] (Avorn, 2010a; WHO, 2009). Research findings

suggest that DTCA increases pharmaceutical sales, helps to avert underuse of medicines, and may also lead to overuse of

marketed medications (Donohue, Cevasco, & Rosenthal, 2007). Thus, the first ten years of the U.S. experiment with

DTCA showed us that this type of marketing does influence prescription and consumption, driving up costs and possibly

introducing health hazards through unnecessary medication use.

Due to the expense of successful marketing campaigns, the bulk of pharmaceutical promotion is performed by the

more expensive, brand name medications. This suggests that the effect of marketing on medication use has even greater

proportional effects on industry spending, because patients are primarily increasing their use of more costly drugs. In

addition to the common belief that DTCA drives up U.S. prescription drug spending (Avorn, 2010a; Donohue, Cevasco,

& Rosenthal, 2007; Maheras, 2010), it seems reasonable to conclude that manufacturers alter prices to recoup their

marketing expenses rather than accepting reduced profits. Thus, the industry’s promotional expenses are likely passed on

to consumers through higher charges, contributing to further growth of U.S. pharmaceutical spending. Estimates of 2004

promotional spending by U.S. drug companies vary considerably, from a very conservative $27.7 billion (IMS Health,

2005) to $57.5 billion (Gagnon & Lexchin, 2008).

Insufficient Government Regulation: There are several examples of poorly regulated industry practices that contribute to

increased spending and may also be detrimental to medication access or quality. Perhaps the most significant gap in U.S.

Reducing U.S. Prescription Drug Spending 3

 
federal policy contributing to pharmaceutical spending growth is the absence of regulations for setting drugs’ retail prices.

Similarly, there are no regulations that set allowable limits for price increases, as evidenced by how often medications

have ‘extraordinary price increases’ (US-GAO, 2009). The industry’s promotional activities, which have proven to affect

consumption and spending, are also under-regulated. Specifically, ‘data mining’ is still legal, though this exchange of

information occurs without doctors’ consent or knowledge. With ‘data mining’, pharmaceutical companies purchase data

on individual physicians’ prescribing behavior (much of it directly from the AMA) to inform how they direct promotional

activities, targeting providers that offer the greatest potential for raising sales of specific drugs. Also, while few states

have required drug or medical device manufacturers to report gifts and other promotions given to medical providers

(Maheras, 2010; Pew Prescription Project, 2010), a new provision in the 2010 Patient Protection and Affordable Care Act

(Section 6002, Physician Payments Sunshine Provision) will require such reporting beginning January 1, 2012.

Final examples of poorly regulated behaviors include drug repackaging and “patent trickery” (Avorn, 2010a). An

investigation by the U.S. Government Accountability Office (2009) found that about half of the 416 recent extraordinary

price increases were for drugs purchased from manufacturers or wholesalers, repackaged, and then resold in smaller

packages (at the inflated prices) to health care providers. While guidelines do exist for the process of drug repackaging

(see U.S. Pharmacopeia, General Chapters: 1146), there does not appear to be any existing standard for pricing

repackaged drugs. This leaves them vulnerable to large price inflation that will be passed on to patients. Another study

(Kesselheim, Fischer, & Avorn, 2006) investigated the additional costs to Medicaid of extending the intellectual property

rights for three medications through one method of ‘patent trickery.’ These delays were the result of an industry process

known as ‘evergreening,’ when manufacturers try to extend patents by patenting peripheral features of their products.

This is not a legitimate premise for extension, and serves primarily to delay generics during litigation. For these three

drugs, the average patent extension was 26 months, and the cost to Medicaid alone was $1.5 billion from 2000 to 2004.

Policy Implications: The root causes of the current pharmaceutical spending problem lead to the following implications

for the direction of pharmaceutical policy:

1) Free market conditions do not exist in the U.S. pharmaceutical industry to control prices.

2) The U.S. must develop policy mechanisms for effectively controlling medication prices.

3) The U.S. must ensure that achieving lower prices does not negatively affect patients’ medication access.

4) Cost savings may only be possible through policies that reduce industry profits, which will be strongly resisted.

4 Alternative Policies for Price Control, Utilization Management, and Industry Regulation
 
 5) Collaborating with other nations to design policies may meet U.S. goals and increase security of global health.

Policy Options: The policies currently regulating the activities of the pharmaceutical industry have proven ineffective at

balancing the power of manufacturers, patients, and government. Of particular interest in this Brief are current U.S. and

State approaches to price control, utilization management, patent laws, and Medicare benefits. To aid the reader with

organizing and analyzing this material, a table has been created to chart examples of problematic policies. This table (see

Appendix A) provides an overview of how and why the policies have been ineffective, notes confusion and controversy

that surround the policies, and provides cost estimates when available. This is not an exhaustive source of all U.S. and

State policies that affect pharmaceutical sector spending. Examples of topic areas that are not included are policies

pertaining to promotional activities, physician education, transparency of industry negotiations, and the widespread

systems for payment and delivery of all U.S. health care. With the interrelatedness of all health care sectors, reviewing

every variable in U.S. health care that affects prescription spending is beyond the scope of this Brief.

Patient Protection and Affordable Care Act provisions: Several policy changes were included in the 2010 PPACA

that may affect the pharmaceutical industry and its spending (Avorn, 2010a; KFF, 2010b; Maheras, 2010). Although the

trend during the past 15 years has been towards near universal availability of prescription drug benefits, it is now expected

that medication coverage will be included in the minimum benefits package that will soon be developed. The AARP and

other consumer advocates are excited about the provision that will begin now to shrink the infamous ‘Medicare doughnut

hole’ to a 25% co-payment level (down from 100%) by 2019. The Physician Payments Sunshine provision is a disclosure

law between teaching hospitals and the pharmaceutical/medical device industries that is generally based on a transparency

model developed in Massachusetts. Starting in 2012, manufacturers will be required to report any payments or gifts over

$10 they’ve made to physicians and teaching hospitals. This provision aims to provide patients with greater knowledge of

the relationships that pharmaceutical companies have with their doctors and hospitals. The legislation will also begin

imposing an annual fee on brand-name manufacturers with sales that exceed $5 billion, open the door for an increase in

the Medicaid mandatory rebate, provide funds for “Academic Detailing” (Avorn, 2010a) pilots, and makes changes to

some drug labeling requirements (KFF, 2010b).

Policy Recommendation: Numerous options have been explored for innovative policies that would reform the U.S.

pharmaceutical industry (see Hoadley, 2005, for complete analysis). A fair sample of the research has been consulted to

explore why current policies have failed to address the root causes of increasing prices, greater consumption, widespread

Reducing U.S. Prescription Drug Spending 5

 
marketing, and ineffective regulation. While cost-sharing and utilization management policies have been the most

frequent approach, a review of their outcomes determined that patient’s exposed to these policies experience more

difficulty accessing medications, eventually leading to more adverse events and higher total health care spending

(Goldman, Joyce, & Zheng, 2007). Additionally, while much attention and support has been given to lifting the FDA’s

ban on prescription importation, this approach is complicated because it will involve global cooperation to stabilize

markets (Lakdawalla et al., 2009), and evidence of the potential cost savings are unreliable and unimpressive (CBO, 2004;

KFF, 2010b). Policies that will reform Medicare Part D benefits may presently demand more attention due to the higher

prices charged to Medicare patients (Outterson & Kesselheim, 2009), the emergence of Medicare as a leading prescription

payer, and the demographic trends of aging and longevity. Furthermore, while there is a great need for reducing waste in

industry marketing and patent manipulation, the issue of controlling retail prices appears to offer greater savings potential.

Considering the research reviewed, input from field experts consulted, and the current environment for cost savings

potential, this Brief suggests that the U.S. federal government aggressively pursue high-impact price control policies.

Namely, it is recommended that:

1. Congress remove the “non-interference” clause from the Medicare Modernization Act.

2. Institute the mandatory rebate system used for Medicaid prescription benefits for all Medicare Part D plans.

3. All public payers (State and Federal) should substitute the Average Wholesale Price (AWP) with the Federal

Supply Schedule (FSS) in calculating ceilings for their payments on brand name drugs.

4. The Centers for Medicare & Medicaid Services (CMS) should return all Americans eligible for both Medicare

and Medicaid to the receiving their prescription drug benefits through Medicaid plans.

Institute of Medicine’s 6 Aims of Improvement: If implemented, these policy recommendations will achieve system-

wide improvements that align with the IOM’s published aims for health care innovation:

Safe: By targeting savings through price control as an alternative to utilization management approaches, the prescription

drug sector will move away from limiting patients’ access to prescribed medications as a means of cost reduction.

Effective: All of the policies recommended have already demonstrated great success by achieving lower prices and

spending on medications in Medicaid, the Veteran’s Administration, and other private benefit plans.

6 Alternative Policies for Price Control, Utilization Management, and Industry Regulation
 
Patient-centered: These recommendations will foster improvements that advance patient-centered interests by making

medications more affordable and available to consumers, without endangering drug quality or access.

Timely: By shifting cost-saving policies away from utilization management, this area of health care services would rely

less on practices that interfere with timely care, such as prior authorization, fail-first and step therapy protocols.

Efficient: By implementing the FSS as a uniform system for all public payers, bureaucratic complexity will be reduced

for the payment and price negotiation of medications covered by public insurance plans.

Equitable: By granting Medicare the same rights to negotiate drug prices as every other payer in the U.S., Medicare

beneficiaries will experience greater benefit parity and will no longer be subjected to unequal medication costs.

Implementation and Dissemination: The following steps should be incorporated into implementation and dissemination

of these policy changes in accordance with IOM’s 10 Rules for Redesign (noted alongside each item):

1) Education on medication access and payment options will be made easily available to Americans through prominent

internet and office-based media (Transparency is necessary; Knowledge is shared and flows freely).

2) Surveys of Medicare beneficiaries will request feedback about their medication access and spending, and whether new

policies align with their needs, values, and preferences (Patient is the source of control; Care is customized to patients’

needs and values).

3) Establish quarterly interagency meetings to discuss implementation barriers and lessons learned to improve outcomes

and consistently seek to reduce waste (Cooperation among clinicians is a priority; Waste continuously decreased).

4) All CMS staff and medical providers reimbursed by CMS or VA will be anonymously surveyed quarterly or bi-

annually to measure attitudes toward new policies, ideas for improvement, and feedback on patient needs (Needs are

anticipated; Knowledge is shared and flows freely).

5) Hold an annual conference on pharmaceutical policy to disseminate new research data, provide States with an

opportunity to learn from each other, and allow transfer of feedback from State-level experiences to federal

policymakers (Knowledge is shared and flows freely; Cooperation among clinicians is priority; Decision-making is

evidence based).

Reducing U.S. Prescription Drug Spending 7

 
Sources consulted or recommended

Avorn, Jerry, MD. (2010a). Telephone interview with the researcher on 27 October 2011.

Avorn, J. (2010b). Medication use in older patients: Better policy could encourage better practice. The Journal of the
American Medical Association, 304(14), 1606-1607.

Centers for Medicare & Medicaid Services. (2010). National Health Expenditures by type of services and source of funds,
CY 2008-1960. CMS, Baltimore, MD. Available from:
https://www.cms.gov/NationalHealthExpendData/02_NationalHealthAccountsHistorical.asp#TopOfPage.

Claxton, G., DiJulio, B., Finder, B., Lundy, J., McHugh, M., Osei-Anto, A., Whitmore, H., Pickreign, J., & Gabel, J.
(2009). Employer Health Benefits: 2009 Annual Survey. The Kaiser Family Foundation, Menlo Park, CA, and
Health Research & Educational Trust, Chicago. Available from: http://ehbs.kff.org/pdf/2009/7936.pdf.

Congressional Budget Office [CBO]. (2004). Would prescription drug importation reduce U.S. drug spending? CBO
Economic and Budget Issue Brief, Washington, DC. Available from: http://www.cbo.gov/doc.cfm?index=5406.

Congressional Budget Office [CBO]. (2008). Budget options volume I: Health care. CBO, Washington, DC, 236 pages.
Available from: http://www.cbo.gov/ftpdocs/99xx/doc9925/12-18-HealthOptions.pdf.

Donohue, J.M., Cevasco, M., & Rosenthal, M.B. (2007). A decade of direct-to-consumer advertising of prescription drugs.
New England Journal of Medicine, 357(7), 673-681.

Frank, R.G. (2004). Prescription drug prices. New England Journal of Medicine, 351(14), 1375-1377.

Gagnon, M-A., & Lexchin, J. (2008). The cost of pushing pills: A new estimate of pharmaceutical promotion expenditures
in the United States. Public Library of Science Med, 5(1), 29-33.

Gellad, W.F., Schneeweiss, S., Brawarsky, P., Lipsitz, S., & Haas, J.S. (2008). What if the federal government negotiated
pharmaceutical prices for seniors? An estimate of national savings. Journal of General Internal Medicine, 23(9),
1435-1440. Available at: http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2517993/.

Goldman, D.P., Joyce, G.F., & Zheng, Y. (2007). Prescription drug cost sharing: Associations with medication and
medical utilization and spending and health. The Journal of the American Medical Association, 298(1), 61-69.

Hoadley, J. (2005). Cost containment strategies for prescription drugs: Assessing the evidence in the literature. Prepare
for the Kaiser Family Foundation, March 2005. Available from: http://www.kff.org/rxdrugs/7295.cfm.

IMS Health. (2005). Total U.S. promotional spending by type, 2004. Available from:

Kaiser Family Foundation. (2010a). U.S. Health Care Costs: Background Brief. Available from:
http://www.kaiseredu.org/Issue-Modules/US-Health-Care-Costs/Background-Brief.aspx.

Kaiser Family Foundation. (2010b). Prescription Drug Costs: Background Brief. Available from:
http://www.kaiseredu.org/Issue-Modules/Prescription-Drug-Costs/Background-Brief.aspx.

Kaiser Family Foundation. (2010c). Kaiser Family Foundation calculations using data from IMS health,
http://www.imshealth.com (Press Room, US Top-Line Industry Data, 2008).

Kaiser Family Foundation. (2010d). Kaiser Family Foundation calculations from U.S. Census Bureau,
http://www.census.gov.

Kaiser Family Foundation. (2010e). Medicare: A Primer. Available from: http://www.kff.org/medicare/upload/7615-

03.pdf.

8 Alternative Policies for Price Control, Utilization Management, and Industry Regulation
 
Kazis, Lewis, MD. (2010). Interview with the professor on 4 November 2010. Boston.

Kesselheim, A.S., Fischer, M.A., & Avorn, J. (2006). Extensions of intellectual property rights and delayed adoption of
generic drugs: Effects on Medicaid spending. Health Affairs, 25(6), 1637-1647. Available from:
http://content.healthaffairs.org/content/25/6/1637.full.

Lakdawalla, D.N., Goldman, D.P., Michaud, P-C., Sood, N., Lempert, R., Cong, Z., de Vries, H., & Gutierrez, I. (2009).
U.S. pharmaceutical policy in a global marketplace: Reducing copays tends to be a robust and welfare-improving
policy, while imposing price controls risks high costs in the hope of a relatively modest benefit. Health Affairs,
28(1), w138-w150. Available from: http://content.healthaffairs.org/content/28/1/w138.full.

Maheras, Georgia, Esq. (2010). Telephone interview with the person on 2 November 2010.

Outterson, K. & Kesselheim, A.S. (2009). How Medicare could get better prices on prescription drugs: Increased
formulary flexibility and value-based pricing are among the options that should be considered in the context of
health reform. Health Affairs, 28(5), w832-w841. Available from:
http://content.healthaffairs.org/content/28/5/w832.full.

Pew Prescription Project. (2010). Federal Reporting Requirements on Payments to Physicians: Impact on State Laws.
Prepared for the Pew Health Group, November 2010. Available from:
http://www.prescriptionproject.org/tools/initiatives_factsheets/files/Sunshine_State-Impact.pdf.

Quon, B.S., Firszt, R., & Eisenberg, M.J. (2005). A comparison of brand-name drug prices
between Canadian-based internet pharmacies and major U.S. drug chain pharmacies.
Annals of Internal Medicine, 143, 397-403.

Umans, B. & Nonnemaker, K.L. (2009). The Medicare Beneficiary Population: Fact Sheet. AARP Public Policy Institute,
Washington, DC, 4 pages. Available from: http://assets.aarp.org/rgcenter/health/fs149_medicare.pdf.

U.S. Government Accountability Office (GAO). (December 2009). Report to Congressional Requesters: Brand –name
prescription drug pricing: Lack of therapeutically equivalent drugs and limited competition may contribute to
extraordinary price increases. U.S. Government Accountability Office, Washington, DC, 36 pages.

U.S. Pharmacopeia. General Chapters 1146: Packaging Practice—Repackaging a Single Solid Oral Drug Product into a
Unit-dose Container. Available from: http://www.pharmacopeia.cn/v29240/usp29nf24s0_c1146.html.

World Health Organization (WHO). (2009). Direct-to-consumer advertising under fire. Bulletin of the World Health
Organization, 87(8). Available from: http://www.who.int/bulletin/volumes/87/8/09-040809/en/index.html.

Reducing U.S. Prescription Drug Spending 9