The public outcry and political scrutiny over the pricing policies of drug companies Valeant and Turing has amplified the national debate over high specialty drug costs.

To address the problem in a way that might actually improve things, it is important to recognize that not all high-priced drugs are created equal. Some are novel agents that enter relatively large markets at high prices, such as the Hepatitis C medication Sovaldi. Their prices are likely to remain high. Others, however, reflect older off-patent medications that were sold for years at low prices and have recently experienced large and sudden price increases, such as Daraprim. Both kinds of drugs cause distress for insurers and consumers, but they have very different implications for overall health care spending, and they require different policy solutions.

Expensive blockbuster medications can significantly raise overall health care spending and insurance premiums for a number of reasons. The high cost of Sovaldi, for example, is compounded by national guidelines that call for broader screening to detect disease among the general public and high need groups (e.g., prisoners), and by payment policies that require insurers like Medicare to cover them. Similarly, drugs such as the cholesterol-lowering medication Praluent will incur outsized costs due to the high prevalence of the conditions that they treat and the need for treatment to be long-term.

In contrast, some medications that have recently seen spectacular price increases reach smaller, low-volume markets and have a limited impact on overall spending. Many of these are "orphan drugs," medications designed to treat extremely rare diseases. Notable examples include Daraprim and Thiola before it, as well as two drugs that are driving the controversy around Valeant, Syrine and Cuprimine. Rodelis pharmaceuticals was set to execute large price increases for another orphan drug, cycloserine, until it was derailed by the outcry surrounding Daraprim.

Regulations create special incentives for the development of orphan drugs to encourage new treatments for rare conditions, but public policy has largely neglected the issue of massive price increases for these drugs once they are no longer new. Since the use of orphan drugs has not been large enough to affected payers' total costs, they in turn have not pushed back vigorously against high prices. This limited oversight has created an opportunity for companies such as Turing and Valeant to identify "underpriced" products and raise their prices.

Once a company, such as Turing or Valeant, acquires the right to sell an orphan drug, they can test the market by aggressively increasing prices with nearly no additional operating cost. If this strategy is met with either political outcry — as in the case of cycloserine — or movement of patients to other medicines, the companies can simply reverse course. However, if there is no pushback, they possess a largely unimpeded path to profits because of the small market size and limited competition. Valeant has practically made a business out of using this strategy on both orphan and non-orphan drugs, raising sticker prices on 56 of its medications this year alone.

Although the impact of orphan drug price increases on total health costs may be largely a nuisance for insurers, the effects can be tragic for patients with rare conditions and incomplete insurance coverage. Can market-based solutions help to curb these strategies and address the problem of old orphan drugs?

When economies of scale in manufacturing a drug are small enough, the prospect of profits should induce new sellers to enter the market with lower prices. This appears to be the tactic adopted by Imprimis pharmaceuticals, which recently announced that it would offer a compounded Daraprim alternative for $1/pill. Without FDA approval, however, the company can only offer the medication for specific patients on a case-by-case basis. More generally, Medicare has no economic leverage in these situations because it cannot refuse to cover an FDA approved drug or negotiate drug prices.

One alternative is to modify FDA rules to enable foreign suppliers to more easily enter markets that experience price surges. Another is to permit FDA fast-track approvals for generic versions of drugs that undergo significant price hikes. A third tack would be to permit large insurers (including Medicare) to enter into contracts with alternative drug producers for the entire volume of desired products. This would create a market large enough and revenues certain enough to be attractive to the drug companies, even if the original firm tried to undercut the price. Finally, because overall out-of-pocket insurance costs are already capped at $6600 for individual plans under the Affordable Care Act, orphan drug spending could be accounted for in existing out-of-pocket spending limits in insurance policies.

As public policy tries to catch up with the rising cost of new, expensive specialty drugs, what can patients with chronic conditions do to protect themselves from price surges? One strategy is to purchase an insurance plan with an affordable out-of-pocket maximum. Although they usually have higher premiums, such plans are available on the ACA insurance exchanges, as well as via many employer plans. Another strategy is for patients to ask their physicians about alternatives to orphan drugs that could be at particular risk for price spikes.

Hopefully, in time, the economic and political forces described above will drive drug prices back down to more reasonable levels. In the meantime, it pays for patients to understand and be proactive about spikes in drug pricing.

Joshua M. Liao, M.D., is an internal medicine physician and health policy fellow in the Division of General Internal Medicine at the University of Pennsylvania School of Medicine.


Editor's Note: Cross-posted on the Health Policy$ense blog of the Leonard Davis Institute of Health Economics of the University of Pennsylvania.

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