A Conversation with Stephen W. Schondelmeyer

Drug and Health Care Spending — A Bubble That Will Burst Unless We Do Something

Interview by Peter Wehrwein

I am not an off-the-wall kook, says Schondelmeyer, a professor of pharmaceutical economics in the University of Minnesota College of Pharmacy and a member of the Managed Care Editorial Advisory Board. But he sees health care spending as unsustainable. Drug price increases above a certain amount should be reviewed and PBMs should be regulated.

Drug prices are in the news. Have they gone up or are they being talked about more?

I think the answer is yes and yes. They have gone up, and they are being talked about more.

I guess drug prices as a percentage of health care costs have gone up?

Let’s take that issue for a minute. Most people look at the [CMS] Office of the Actuary numbers on drugs and the health care pie. The Office of the Actuary does a great job of doing our estimates for us. They define carefully each piece of that pie, and there’s a piece that’s commonly labeled “prescription drugs.” Most people don’t bother to read that “prescription drugs” is really just outpatient retail prescriptions through community pharmacies. It doesn’t include drugs dispensed through hospital outpatient departments; drugs administered in the hospital; drugs administered in the physician’s office; drugs administered at home health agencies; or drugs administered through various other special providers.

Our health care pie is structured in a way that about half the drug spend is hidden, and it just so happens to be the part of the drug spend that is growing.

If one takes drugs through all channels—the other pieces of the national health care pie: hospitals, physician offices, dentist offices, nursing homes, home health, and the distribution and channels—drugs are about 20% of the health care dollar, not 10%.

So our health care pie is structured in a way that about half of the drug spend is hidden, and it just so happens that the part of the drug spend that’s growing the fastest is the part that’s not explicit. The part that’s hidden is the part that’s growing the fastest.

And that has to do with the increased use of so-called specialty pharmacy.

No, it’s not just specialty pharmacy. These are drugs administered in a doctor’s office. These are drugs administered in a hospital outpatient clinic.

They’re not even in the pharmacy benefit. They’re in the medical benefit of an insurance plan. And people don’t even realize it’s there, and yet, this accounts for one third to one half of all drug spend.

Where does one get that 20% number?

First of all, I find it appalling that we don’t publicly track it and report it.

I’ve been tracking it and looking for ways to identify the amount of drug revenue, again, not just drug company payments, but drug revenue and distribution costs in each of those pieces of pie. So, you look at the MedPAC reports on drugs in the hospital and the all-payer claims databases that Minnesota and several other states have.

In Minnesota I had the opportunity to work with our all-payer claims database. We have all medical claims and pharmacy claims. All health transactions. And I’ve identified all of the health transactions of Minnesota, which ones are drugs or drug-related, and added up the cost. And, in fact, in Minnesota in 2013, drugs accounted for about 20% of the total health care spend.

The answer is that researchers like you have to sort of go into databases and claw and scratch this information out....

Right. There’s no easy, quick-and-dirty way to do it or track it. This is a place where I think our government should develop a trend line that allows us to track total drug spend.

Pharma will come along and tell you, well, that’s not right; the number is really 14%. And what they’re saying is the amount of revenue drug companies get is only 14% of the health care dollar. They don’t want to take into account the supply and distribution costs—the wholesalers, PBMs, and other things that add on to that.

But as an economist, I’m interested in, at the end of the day, what’s the total amount of transactions, whether it’s for the drug product, its distribution, or administration.

What’s the net cost in the drug sector at the end of the day? It’s 20%.

Is that percentage of the drug spend increasing because of the nature of the drugs that are getting approved? Or does it have to do with companies jacking up prices?

The answer is yes and yes. You know, we have these wonderful new drugs, CAR-T drugs, that just came on the market. And I applaud them and their innovativeness, and they can add value to the marketplace. They are as close to a near-cure as we have, along with hepatitis C drugs. And I applaud them, but they came in at really unheard of prices—half-million dollars per patient. That’s just for the drugs, not the cost of administering them and the other health care.

So, on the one hand, these drugs are a great advance therapeutically, but it comes on at a price that really is—you can’t call that a market-based price. The price was offered and it’s sort of take it or leave it. Most insurance plans, Medicare, and Medicaid are apparently going to cover them.

I’m not criticizing these drugs, but we don’t have a market-based price structure to set that price.

The lack of a market-based price—is that especially pronounced in those hidden areas that you’ve described as opposed to the prescription drugs available through the community pharmacy?

Yes and no. You’re right that each has a different market dynamic. Drugs like the CAR-T therapies, they come in at a really high price, and then may not increase much in price over time. If you start at a half-million dollars per course of therapy, you don’t have to raise your price much for a while. You started pretty high up on the mountain.

But other drugs in other settings that didn’t start as high up the mountain as CAR-T are also raising their price. Sometimes it’s the price at market entry that’s the issue. Sometimes it’s the price of a drug and its change in price over time.

I think part of what we’re seeing in the pharmaceutical marketplace is a lot like what we see in other industries when they’re faced with dramatic uncertainty. The pharmaceutical marketplace keeps hearing rumbles that maybe Congress—or maybe this or that president—is going to do something about drug prices.

When that uncertainty is there, that doesn’t result in those drug companies slowing their rate of growth in price increase. In fact, it accelerates it because they realize there’s uncertainty ahead, and we could be facing price controls or market-based criteria that put pressure on us more than we have right now. So, while we can, we’re going to raise our prices. We’re going to move up the mountain in terms of price levels, so that if we do get pressed or regulated in terms of pricing, we’ll be starting from a higher place on the mountain. So, uncertainty feeds this.

What other sectors have this dynamic—grabbing as much profit as you can in advance of regulation?

Sometimes it’s in advance of regulation; sometimes other market uncertainties. What happened with gasoline prices as we had these hurricanes in Texas? Prices went up.

Do you think Part D coverage has been a factor in the increasing amount of money spent on drugs?

Yes. When you expand coverage and you don’t do anything to manage or control or improve the cost structure in the market, you’re going to see more money spent.

Is there anything that you see in the way Part D is designed where it could be redesigned in a way to push-back on drug costs or price?

Sure. Part D is administered through—I forget how many—about 2,000 business entities across the country. Now, imagine if I was the CEO of a company like Best Buy here in the Twin Cities, and I go to each of their store managers and say, “Look, you’re each on your own. We want each of you to negotiate the best price you can with Samsung, and with each of the electronics manufacturers. Each of you negotiate the best price you can, but we’re not going to buy corporately and centralized, and we’re not going to negotiate better prices for you.”

That’s the way we set up our Medicare program. We’ve set up 2,000 business entities that offer Part D drug plans nationwide. We’ve told each of them, “Go negotiate your best deal with the drug companies.” But we’re not going to negotiate using the leverage in aggregate of all of the Medicare programs as a single entity.

We set it up to be a marketplace mechanism, but we said, “Don’t use any of the tools of the market.” It doesn’t work. This is like Adam Smith’s invisible hand, expecting it to work while we put handcuffs on it.

Don’t they have power through the formulary?

That doesn’t negotiate prices. And the formulary is driven by each of the 2,000 plans. Again, are you going to get the best price at a Best Buy store if each store negotiated its own prices? No, you’re not. That’s what we’re saying. So, you’re telling me that 2,000 formularies are going to get a better price than Medicare as a whole, negotiating prices? I don’t think so.

I’m thinking about various factors that have come into play coincidental with rising drug prices and cost. It seems that there’s been a concentration of market power in fewer PBMs. I was reading this morning that CVS, Optum, and Express Scripts control 80% of the market? Do you think some of what we’re seeing as far as drug prices are concerned could be attributed to PBMs and their market power? And maybe their secret deals, discounts, and rebates?

Well, I want to say up front that PBMs are an important part of our pharmaceutical marketplace. They provide many valuable services. But, they also have some hidden behaviors that are detrimental to the market. And PBMs are not subject to regulation like insurance companies. There’s no oversight body for PBMs in the marketplace. Nobody is holding them accountable for their behaviors in the marketplace. Other than employers.

But I work for many different employers and consulted for them, and even the best of employers don’t have the staff, the wherewithal, the ability to make fully informed decisions with how they interact with PBMs because it’s such a complex marketplace and difficult to sort out what the net effect of various behaviors are. And many behaviors are hidden. Rebates account for about one third of all the money we spend on drugs these days. The top dollar line we spend on drugs, about one third of it goes back in rebates. That’s the equivalent of employers and individuals and the government giving drug companies a loan for a third of their revenue, and then, waiting a year to collect it back, interest free.

And the PBMs get administrative fees on top of that. They make far more from their fees from manufacturers than they do from their clients.

If you make more from the upstream supply source, the manufacturers, than you do from your downstream client, whose interest are you going to serve? Don’t think too long about it.

I’m not against PBMs. I’m just saying the market is structured in a way that we have reverse, perverse economics. And the PBMs and drug companies get together and agree in their context that rebates are proprietary and confidential, and we can’t disclose them.

So, we talk about value-based health care, but we tell the physician, “We can’t tell you the net price.” We tell the pharmacists we can’t give them the net price. We tell the patient we can’t give them the net price. We tell the employer we can’t give them the net price.

I assume that you are in favor of the various pieces of state legislation that would force PBMs to disclose some of their rebate and discount deals with manufacturers.

We need some kind of disclosure, but frankly, many of the state proposals I see are so poorly written that they simply add administrative cost, and they won’t functionally change the information that people have available and use. A lot of states require disclosure to someone at the state government, and it will be held proprietary and confidential. So, what have we gained?

Do you think there ought to be PBM regulation—some national agency regulating PBMs?

At some level, I think there may be a need for some type of regulatory body, because frankly, what you see in the health care marketplace—and in the drug space in particular—is once you have some disclosure rules in place, if you don’t ask the right things or report the right things, it doesn’t help. And second, even if we get them to report certain things and they’re helpful for a year or two, they will create new streams of revenue and new perverse payment systems that fall outside of what they’re required to report, so that it distorts it again.

So, I think ultimately what you need is a body that is overseeing them that can adapt with the marketplace. Don’t get in the way when they’re doing good things to help the health care outcomes of the public, and they’re helping to do it at reasonable cost. But raise questions when the cost is not reasonable, or when they’re taking capital out of the market without improving health care.

A few years ago I interviewed Steve Miller. He talked about how Express Scripts got tough with Gilead and managed to cut the price of the hepatitis C drugs because of its bargaining power. It was fairly persuasive. Do PBMs do some good stuff like that? Get prices down through their negotiating power?

Well, they can. There are times that they do. But there are also things that they either tolerate or create that add cost that we don’t know about, too.

What are you thinking of?

I think one is PBMs adding spread on top of the cost of generics. They pay a network pharmacy $25 per generic prescription. They turn around and bill the employer $40 for that. Most employers don’t know that. Most employers didn’t intentionally agree to that. And yet, that adds to the cost structure in the marketplace.

PBMs also have preferred networks. Often the preferred networks actually cost the employer more than the nonpreferred networks. But they think they’re going to get a better deal from it.

Or PBMs push or require mail order. We assume that mail order is cheaper, but it’s not. There are times when we can find that the cost of mail order prescriptions is higher than what the same prescription would have cost at retail. So, there are examples where PBMs develop revenue streams from behaviors that are hidden, and that cost the client more rather than less. And clients often are not able to discern that.

Give me an example of either the mail order or non-preferred network being more expensive?

I’d rather not. I’d encourage you to go look at the National Community Pharmacist Association. They have a PBM website.

Let’s talk about value-based pricing, which is held out as a way to respond to drug prices and cost. I like the definition that Anna Kaltenboeck and Peter Bach used in an opinion piece for Stat: value-based pricing links a drug’s price to a transparent measure of its benefit. Do you think that’s a good definition?

Well, I think that helps. As long as it’s truly transparent. And transparent to everyone, not just selective audiences, again, like the state agency, or just the employer, but we can’t tell the physician. Or just the physician, but we can’t tell the patient. We have to look at what they mean by “transparent.”

Here’s my first reaction to value-based pricing: You’re exactly right. One needs to have definitions to anchor the discussion, because without that, you can easily be talking about totally different things and think you’re agreeing. To a health system trying to provide the most health care they can with the limited resources they have, “value” means basically what Peter Bach is describing—delivering the same or greater outcome for equal or lower price. So, how much you’re getting for the money you’re spending.

But if you turn it around for a corporation, a hospital, a health system, a drug company, their goal is to make profit for their investors, for their stockholders. To stockholders, what does value mean? Value means getting the most return for the money they’ve invested. It has nothing to do with outcome and health care.

In my reading about value-based pricing—the Bach version, if you will—there are a couple flavors. One is outcomes-based pricing—the drug company is only going to get paid if the drug produces a certain outcome. But one criticism is that companies will just jack up the price from the start. Is that a problem with outcomes-based pricing?

Well, I would frame it a little differently, but I think it is the same basic issue. Let’s assume that the value-based description and definition you’ve brought forward from Peter Bach is what we’re talking about. Drug companies only bring up value-based pricing if they intend to raise the price. I’ve never heard a drug company asked to talk about value-based pricing to reduce the price. So, basically, they’re operating from a one-sided hypothesis—our drug is worth more, and you should be paying us more. And then it’s down to, “How much can we get out of you.” Have you ever seen one try to lower the price with value-based pricing?”

I’ve only seen it in the context of when they’ve already set a high price.

I was surprised that the CEO of Novartis made a statement, something to this effect: We had intended to charge seven or eight hundred thousand dollars for this drug [Kymriah], and we decided to come on the market at $475,000. So, is that value-based pricing, that they came in at $475,000 versus $700,000? Is that value-based pricing? No. That’s just, “We took a lower price than we thought we were going to take before.” But neither price is justified. We don’t know that either of them is right. And they haven’t provided any information to justify it.

Here’s the other problem with value-based. Value-based says, “Basically, what is the value of the effect this drug can have in the marketplace to a patient”? Let’s say this drug saves a person’s life. Now, Peter, if I asked you what your life is worth, and I asked you to get a concrete dollar value in mind, you’ll pick a number.

There are systematic ways of examining this with QALYs, right?

No, no, but that isn’t what they—I’ll get back to that.

So, you pick a value, and I’ll ask you how much you have in your bank. When I do that exercise almost everyone thinks they’re worth more than they have in terms of personal resources. So, how are we going to pay for health care if we all think....

Well, that’s a function of the people you hang around with. If you hang around with people who lived in North OaksNorth Oaks is an affluent Twin Cities suburb., or whatever…

Well, I hang around with all crowds, and I make that point to all crowds.

The point is that if you’re sitting in the ER, having a heart attack, you don’t sit up and say, “Wait, how much is this going to cost?” We don’t make value-based decisions in health care because it’s about life and death and we aren’t rational when we think about that.

Here’s the second thing. Let’s assume that a person’s thinking and they realize, OK, this may or may not prolong my life; I’ll have a better quality of life, maybe, maybe not. How much is that worth? Often in those econometric studies that use QALYs, they all assume that optimal care would have been delivered and paid for, and this drug will save this much off of what optimal care would have cost without the drug. But, we don’t have the resources to pay for optimal care for everybody in society to begin with. So, by definition, that escalates the cost above the resource structure that we have in society. Follow that?

Yeah, I do, but to me, you’re throwing the baby out with the bath water. It seems that you could crunch numbers with QALYs and take data from the largest clinical trial available, or even some real-world evidence results, and you figure this drug, you know, is worth three QALYs, which we tend to price at about $200,000, and you arrive at a price. You could enforce some systematic, rational thinking on drug prices in an ICER-type way.

I agree we need to encourage rational thinking on drug prices. I applaud ICER for what they do, but I think there are fundamental issues, even in their method. What is the value of a QALY? And if you look back at the history, it’s not particularly well grounded in terms of either resources available in society, or the basis on which that QALY is set. And then, how do you escalate that over time? So, what is a life worth? And I don’t think there’s a....

Insurance companies don’t put their own money into paying for somebody else’s health care. The payer is either the individual person or an employer.

In terms of you asking me how much my life is worth, that’s not who is being asked the question. It’s the payer that’s being asked the question.

But who pays for health care? Insurance companies don’t pay for health care. Yes, they process transactions, but insurance companies don’t put their own money into paying for somebody else’s health care. They take money out with each transaction. The payer is either the individual person, or an employer on behalf of an individual in lieu of giving them salary; or government by taking taxes from individuals. But you are the payer.

Yeah, but it all gets put into the meat grinder of our social and political and economic arrangements, you know, we pay a lot in this country for health care.

But if we don’t break that cycle, it won’t change. My worry is we’re going to hit a point where we will have a crash-and-burn, and we’ll have to answer the question: Is this health system too big to fail? Is this drug company too big to fail?

I think the resources flowing into health care without rational, economic decision making, it’s a bubble that’s going to burst at some point in the not-too-distant future.

You’ve pointed out that these prices are way out of whack. How do you push back against these private entities’ pricing things the way they are?

I think that’s a relevant and appropriate question—how do you push back? Because now, we have a system where when a new drug, whether it’s a new molecular entity or just a new combination, comes on the market, basically, it has to be covered by our Medicare and Medicaid programs. And for all practical purposes, it has to be covered by most commercial insurers, or they might be subject to lawsuits from their employees and covered lives, saying, “Hey, you took care of their problem, but not mine. Why am I paying insurance? You’re supposed to cover everything.”

So, we have a marketplace where if you get FDA approval, saying your drug is better than placebo, which is all FDA is authorized to evaluate, you get on the market, and you have to be covered, and the drug company can set whatever price they want. And, we don’t have any meaningful ways to push back on price.

So, how can you do that? I’m not saying we should go to price regulation in an overt sense. I do think we need a price accountability structure. That would be if the threshold price of a new drug is above a certain level, or if an existing drug raises its price more than a certain threshold level, that should trigger a review by some kind of rate regulation body that reviews and holds the drug company accountable in a meaningful way.

We need some kind of bona fide rate regulation review body that can meaningfully evaluate the information presented by drug companies, and come to a rational conclusion of whether this is justified or not. And then, use ICER-type techniques with some refinement and change.

If the regulation body doesn’t agree with the drug company on the price, the drug company can still market that drug at whatever price they want to charge. But the leverage is that body could say, “If this price exceeds the value that appears appropriate, then this drug doesn’t have to be covered under Medicare, or Medicaid, or under commercial insurance plans.” Consumers are welcome to pay cash.

Is there any model for what you’re talking about in another country, or in another part of the American economy?

Yeah. It’s close to the Canadian patent medicine price review board, but I would extend it not only to patent medicines, but also to generics.

Do you have a sense that this is a little bit of Neverland thinking on your part?

Well, it is, but I think continuing to pay the prices we are experiencing in the pharmaceutical market is pretty much a Neverland, also.

You were quoted in a couple stories about websites are trying to do with drug prices what Expedia and others have done with airline prices—aggregate and allow easy comparison. Do you see it accomplishing much?

I think there’s a fundamental difference. Those sites often focus on and take advantage of copay coupons in the marketplace. They don’t always focus on the net cost to the full cost to the consumer. If I’m shopping for airline prices, my employer doesn’t buy my airline tickets for vacation. I have to pay the full cost of that. But if I’m shopping for a prescription, and I get a copay coupon online that reduces my copay from $50 to zero, I think I’m saving money. But if that prescription ends up costing my employer $600 instead of $50, all I’ve done is fool myself into thinking I’m saving money when actually I’ve increased the cost structure for health care of my employer, and next year, they raise my premiums on health care, increase my cost share, or they have less money to give me in salary.

I got a good deal, but maybe it’s not good for the system in general.

But even for the person, it’s not good. I would remind people that premiums are out-of-pocket costs just as much as copays are. They just happen at a different time.

People don’t notice their premium cost.

They don’t. That’s my point. It doesn’t mean it’s not a cost. It just means we don’t incorporate that in our decision making. So, it’s easy to fool some of the people most of the time.

I’m really not trying to be an off-the-wall kook. I’m trying to help us step back and evaluate the basic assumptions we’re making about this marketplace, and about how cost, value, and drugs work. And I think we’ve all gotten locked into a certain framework and failed to step back and see how out of alignment it is with a market-based system. This is not a market-based system.

What would you call it?

It’s a protected monopoly.

I think people have noted that drugmakers are afforded monopoly power.

But then Congress says we want to keep drugs as a free market. How can you make that statement when we also admit that it’s a monopoly-based system? Too incredible. We have this cognitive dissonance. It’s this, but this, and yet, they’re incompatible. We haven’t resolved that. So, I’m not sure we fully comprehend that.

On the editorial pages of the Wall Street Journal they say one of the responses to this situation is speedier FDA approval, with the notion that that would lead to more competition. That’s sort of what Gottlieb is pushing, I think.

It is. I think it helps with the margins, but speedier approval doesn’t bring a new generic company into the marketplace for a very small niche generic product that’s marginally profitable to begin with. And when generic drug companies have consolidated, we have fewer of them. Speedier approval doesn’t make more people come into that market.

What about biosimilars? They were the ACA answer to the biologics. They were supposed to bring generic-like pressure into this market, right?

Well, they were supposed to, but we’ve implemented biosimilars by adding a four-digit code at the end of the biosimilar name that makes it a unique proprietary name, even though it’s called a non-proprietary name. So, we’ve done things structurally in the regulation of biosimilars that have pretty much neutered out the market power that biosimilars could bring. Yes, we’ll see 10, 15, maybe 20% reduction price of biosimilars. But we won’t see 70, 80, 90% reduction price like we’ve seen with traditional drugs and generics.

The transcript of this interview has been edited for length and clarity.

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