Costly cures: the US drug pricing conundrum
Rising drug prices have been thrust into the limelight by the US presidential nomination campaigns. We look at the implications for the healthcare industry in light of this increased scrutiny.
Rising drug prices have triggered something of a political explosion during the US presidential nomination campaigns. Perceived by some as a vote-winning tactic, the discussions have nonetheless shone a spotlight on the prices set by drug companies and paid by health insurers, hospitals and government health schemes. There are concerns that key drugs are becoming unaffordable and inaccessible, even for the insured and relatively affluent.
Stepping aside from the radical price hikes imposed by companies such as Turing and Valeant, we sought to understand what the impact of a regulatory clampdown on drug prices might mean for the pharmaceutical industry and its stakeholders.
Figure 1: Why are prescription drugs so expensive?
Of the 73% who say the cost of prescription drugs is unreasonable, these are the reasons they give:
Source: Kaiser Family Foundation Health Tracking Poll (conducted June 2-9, 2015)
Figure 2: Branded prescription drug prices are rising
Source: Express Scripts 2015 Drug Trend Report
We summarise our research and views below:
1. Financial impacts
Pricing restrictions could impact a firm’s earnings-per-share, or its share price. For example, Morgan Stanley predicts a 4% impact on 2017 earnings-per-share from pricing restrictions, (regulatory or other; Morgan Stanley Research, October 2015). Hilary Clinton’s tweet in 2015 following Turing’s excessive price hike brought share prices in the biotechnology sector down by 4%. Employers and insurers are also affected, many of whom may start to transfer some of the increased costs to consumers, via higher monthly premiums or rising co-payments, or may simply exclude the expensive drugs from their lists.
2. Dual pressure for drug companies
Currently there is no regulatory “cap” on drug prices. In theory prices should be controlled by market mechanisms, for example through drug companies providing rebates (a type of discount) to insurance companies. The chart below shows a widening gap between the net price provided to insurers and pharmacies once rebates have been taken into account, and the headline list price, which is the price of the drug if paid out of pocket. It is this list price that has been rising, due to several factors but partly to compensate for the increasing pressure to provide rebates. For drug companies, this signals pressure at both ends of the price spectrum. Furthermore, there is little evidence to show that patients are benefiting from the increased rebates.
Figure 3: High list prices versus falling net prices
Source: Morgan Stanley Research, April 2016
3. Major regulation is far off the mark
The campaigns of both Democratic nominee Hilary Clinton and Republican nominee Donald Trump have both proposed some regulatory tweaks to pricing structures, such as allowing Medicare (the government health scheme for the elderly) to negotiate prices directly with drug companies, which has been met with criticism. In addition, a trial is already underway to shift doctors to a value-based payment model. But in reality, any major federal change will be difficult to achieve in the near- to mid- term, due to congressional barriers and more pressing campaign priorities. Consequently, any near-term requirements on drug companies are likely to be state-wide rather than federal. Indeed, state initiatives that are already being discussed include improving transparency on pricing structures and applying partial caps.
4. Companies are struggling to tackle the debate
Drug companies are generally resistant to either increased transparency or regulatory change, arguing firstly that pricing structures already take into consideration many complex factors, such as research and development (R&D) costs, availability of other treatments, impacts on patients and ability to reduce other healthcare costs. Secondly, they contend that regulatory action would change the whole healthcare and insurance industry, with drug pricing just one part of a broader challenge. Some companies appear more proactive than others. For example, a major pharmaceutical has trials underway for “pay for indication” (where a drug is priced according to its effect on different tumours), and “pay for performance”. Again, these face various challenges such as who to reimburse, how physicians would respond, and incompatibility with the pricing structure adopted by Medicaid (the government scheme for those on low incomes).
5. Uniqueness will pay; transparency will help
Companies that have limited innovation in their portfolio and pipeline, or whose strategy has relied on price hikes without incremental R&D investment, are the obvious losers – this is already well known by the market. Those with lower US exposure will also obviously be less sensitive to any limitations on US price hikes – again, this already appears to have been factored in by the market. The key differentiating factors for other companies will be uniqueness and transparency. Uniqueness encompasses factors such as better innovation, a higher proportion of sales from new products, and exposure to therapeutic areas that are hard to replicate. Transparency focuses on clearer patient outcomes and proactive communication on the pricing debate. Such companies have a better chance of shielding themselves from restrictions on price rises and negative public opinion.
Regardless of political outcomes, we believe the healthcare industry as a whole will have to address increased scrutiny and pressure on pricing. As long term shareholders, we continue to engage with healthcare companies to understand their position, exposure, and response to these issues.
Important information: The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors. Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.