Executive Summary: How Medicare's Drug Pricing Can Hurt R&D

Report Health Care Reform

Executive Summary: How Medicare's Drug Pricing Can Hurt R&D

January 12, 2009 4 min read Download Report

Authors: Laura Summers and Cheryl Smith

Given the sheer enormity of the growing Medicare program, Members of Congress and the new Administration should realize that any decisions they make regarding Medicare drug pricing could have an enormous impact on pharmaceutical research and development. This in turn would affect the quality of care for the baby boom genera­tion, parts of which will begin retiring in 2011.

Before 2003, the federal Medicare program made no provision for a prescription drug benefit. That changed with the implementation of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Also known as the Medicare Modernization Act (MMA), this legislation autho­rized the introduction of Medicare Part D, an entitlement prescription-drug benefit for Medicare recipients. MMA represented the largest addition to the federal entitlement program since The Great Society.

MMA included a provision prohibiting the Secretary of the Department of Health and Human Ser­vices (HHS) from "interfering" in the private negotiations between drug manufacturers and the prescription-drug plans (PDPs) that deliver the Medicare benefit. MMA further stipulated that the Secretary not require a particular formulary or institute a price structure for the reimbursement of cov­ered drugs under the Medicare program, though it did not prevent private PDPs from doing so.

The current law prohibiting the federal government from directly "negotiating" or setting drug prices for the Medicare Part D benefit is a topic of fierce congressional debate. While some argue such measures would relieve the financial strain on the federal budget, others maintain the residual effect would be counterproductive, as such measures have the potential to reduce pharmaceutical profits and stifle medical innovations, which, they claim, would ultimately save money and lives. Research shows that new and more effective drugs can substantially reduce disabilites from chronic disease, securing savings in federal programs that provide assistance to these patients, while improving the quality of their lives. This would especially be the case with the costly and devastating diseases of aging, such as Alzheimer's.

Alzheimer's and Entitlement Costs. Alzheimer's disease (AD) affects millions of Americans every year. In 1990, slightly more than 10 percent of the U.S. population aged 65 or older suffered from Alzheimer's. Using the same 10 percent ratio, the prevalence of Alzheimer's disease today would be around 3.7 million. Because of the aging baby boom generation and increasing portion of the population age 65 and older, however, studies estimate the number of Alzheimer's patients in the U.S. will have doubled from 1995 to 2015, and will have tripled from 2000 to 2040.

The individual cost of caring for an Alzheimer's patient can range anywhere from $18,400 annually for a patient with mild symptoms to $36,100 per year for a patient with severe symptoms. These rep­resent conservative estimates, and do not take into account the enormous financial and economic burden of informal care given to Alzheimer's patients by family members, neighbors, and friends.

With the retirement of the baby boomers, the ranks of Alzheimer's patients will continue to swell to unprecedented numbers in the coming years; likewise, the cost of care is also predicted to continue to rise. In tandem, these trends present a unique and troubling picture for federal entitlements. This demographic evolution, the so-called graying of America, represents enormous, unsus­tainable costs with respect to the Medicare and Medicaid entitlement programs.

The Right Policy. For Medicare, the right policy is to preserve the market-based pricing that ensures not only the continued availability of drugs to treat diseases of aging, but also encourages critical research and development that could reduce these costs in the future.


Scientific research to develop delay-onset drugs for disease is extremely risky in terms of anticipated success and expected return. Pharmaceutical com­panies are more likely to invest in projects that yield the highest expected return--an expectation which is determined by how likely those projects are to succeed and increase consumer demand. In this case, the increasing demand for delay-onset drugs is driven by pending demographic shifts. Given this demand expectation for new drugs, pharmaceutical firms have been willing to invest in less-promising projects (such as delay-onset) in addition to the projects they believe will succeed. Funding for such ventures comes, in part, from profits yielded by Medicare Part D sales. Given a reduction in profits, a reduction in innovation is sure to follow. Clearly, the public pricing scheme used to pay for drugs invented and developed in the private market strongly affects the level of innovation.

In addition to affecting innovation, extending the "negotiation" power has a high potential to affect private prices. When government provides private firms with a large part of their returns from innova­tion, pricing policy is not innocuous. As discussed, public pricing is based solely on reference pricing, with private pricing serving as the scale. Were Medicare "negotiation" to be statutorily permitted, the private "best prices" against which public prices are benchmarked, would no doubt increase. In addition, guaranteeing "below average" prices for federally procured drugs when public purchases constitute nearly half the market share would be mathematically impossible without seriously raising the price for privately procured pharmaceuticals.

Price setting by the Secretary of Health and Human Services on behalf of Medicare Part D beneficiaries is politically attractive, but it is bad health policy. It is rife with potential hazards. Without question, pharmaceutical revenue--and R&D as a function of total revenue--would be reduced. The potential for numerous and varied residual effects on the treatment of disease, progress in reducing costly morbidity, and reductions of the quality of care for the next generation of retirees is--or should be--of even greater concern.

Cheryl S. Smith is a Strategic Plan Development Manager for Health System Reform for the State of Utah, and a former Health Policy Fellow at the Center for Health Policy Studies at The Heritage Foundation. Laura L. Summers is a recent graduate of Brigham Young University with a Master's in Public Policy.


Laura Summers

F.M. Kirby Research Fellow in National Security Policy

Cheryl Smith