Can Pharma handle pricing for value in this country?

by Daniel R. Hoffman, Ph.D.

Published May 21, 2013, 10:05 a.m. ET

All sectors in the health care business face major turning points within the next three years. This means the pharmaceutical industry and other manufacturers, together with providers such as physicians and hospitals, will operate in a different environment by the end of this decade. The important question is just how well each sector is preparing its course corrections to meet the new challenges.

What's behind these enormous changes that will remake health care businesses? Basically they can be summarized with the phrase, "value-based reimbursement." Stated in its simplest terms, value-based reimbursement (VBR) means that the large public and private payers have decided the price they're prepared to pay for any health care product or service will depend upon how much it improves outcomes and reduces overall costs. Although various countries and private payers may differ in their specific methods of applying VBR, a worldwide trend is making it the cornerstone of health care.

The impetus behind VBR lies in the fact that per capita health care costs are rising faster than overall economic growth and the disparity will get worse until some radical changes occur. Health care already accounts for 18% of GDP in this country and it will rise to 20% within the next few years. In a sluggish global economy, the need to devote increasingly larger proportions of a nation's wealth to health care remains simply unacceptable.

Anticipating the world of VBR, providers during the past few years have been remaking the fundamental ways they do business. Hospitals and physicians have been consolidating and preparing to abandon the fee-for-service model which served as their cornerstone for making money.

Providers know that the Affordable Care Act, passed in 2010 and scheduled for a full rollout next January, will bring them under VBR's standards by forcing them to share some of the risk with payers. Controlling health care costs made that inevitable because American medicine's fee-for-service system created a roadmap for inefficiency, spiraling costs and restricted access. Physicians, for example, weren't subject to the market factors of supply and demand because they could increase demand for their services simply by ordering more tests and procedures. Now, under VBR, what they're paid will depend on the patient outcomes their practice patterns produce and how much those practices reduce long-term costs.

At the same time health insurers have also been preparing to operate in a vastly different environment. These private payers know that they have been the objects of scorn in each of the last six presidential elections. They also know that the Affordable Care Act represents their last, good chance at keeping their beak in health care's trough, where they suck up thirty cents of every dollar.

Ever since the HMOs started expanding in 1970s, insurers have been claiming that they're worth this added cost to America's health care system because they can do more than government or anyone else to improve outcomes and control costs. So far it hasn't worked out that way. But by making it mandatory for everyone to obtain health insurance, Obama's weak-kneed health reform law put more control in the hands of insurers and effectively told them, "OK, here are the keys, now drive this thing."

Part of the insurers' responsibility means they have to enroll 30 million more people, bend the cost curve down and improve outcomes. Failing that, they will lose their justification for siphoning off such a hefty chunk of the health care bill.

Without a system run by insurers, the US would have to follow the rest of the world by moving to a government-administered health system. Payers know that and so they will use their power of the purse to squeeze providers and manufacturers to at least give the system the appearance of greater affordability.

Turning next to pharma, the drug industry has done less than providers or payers to deal with the new realities. Pharma simply loathes the sorts of changes that the US and Europe must make to both lower the cost and improve access. As one of the world's most profitable industries, if not the most profitable, it's understandable that pharma doesn't want to alter this country's current approach to health care because the US accounts for more than half its worldwide profits. Yet while pharma's intransigence is understandable, the status quo it seeks to preserve is neither realistic nor fair.

Then there's the fact that pharma has been able to successfully use lobbying, political muscle and payoffs to insulate itself from the socioeconomic forces affecting the other two sectors. Especially since the Bush Supreme Court has enhanced corporate control over American politics, pharma has not felt the need to remake its business model because the industry's leaders believe they can use readily available cash to prevent the tide from rising above their ankles.

For pharma the international movement to VBR means a day of reckoning is coming within the next three to five years. According to a 2011 study by the European Parliament, drug prices in the US, on average, are double those in Europe. Even the prevailing American values of cowboy capitalism that consider private enterprise as next to godliness cannot allow this runaway cost for drugs to continue.

Europe's national governments, particularly Germany, have already enacted stringent containment policies on drug prices. That leaves the US as pharma's last bastion of exorbitant profits. Since the political system here is bought and paid for, while the media are compliant with corporate interests, it will take a few more years for the public to recognize that they're behind the eight ball. But processes are in place for that recognition to occur.

Insurance premiums represent one source that will motivate consumers to clamp down on drug prices. As rising health insurance costs started to create unsupportable burdens on employers in the '90s, they began shifting increasing shares of it to their employees. At the same time, the overwrought Republican rhetoric about deficits has brought public attention to the fact that rising Medicare costs represent the biggest, single factor behind the federal government's ballooning budget.

Both trends will have the effect of making everyday consumers more disgruntled about paying too much for their medications. They will find it especially irksome when specific disparities come to their attention. For example, a diabetes pill with an average price of $1.50 in Europe costs $8.20 here. While people with insurance know they don't pay the full freight on those pills, it won't take long to figure out that such drug costs take money from their wallets in the form of increasing monthly premiums.

So while providers and payers are preparing for an inevitable future, pharma wants to operate as if it's still 1995. That's too bad because the future will require substantial changes and it will come soon, sooner than pharma's leaders want to admit.