Pricing and Reimbursement in
`U.S. Pharmaceutical Markets
`Faculty Research Working Paper Series
`
`Ernst R. Berndt
`MIT Sloan School of Management and NBER
`
`Joseph P. Newhouse
`Harvard School of Public Health, Harvard Kennedy School,
`and NBER
`
`September 2010
`RWP10-039
`
`The views expressed in the HKS Faculty Research Working Paper
`Series are those of the author(s) and do not necessarily reflect those of
`the John F. Kennedy School of Government or of Harvard University.
`Faculty Research Working Papers have not undergone formal review and
`approval. Such papers are included in this series to elicit feedback and
`to encourage debate on important public policy challenges. Copyright
`belongs to the author(s). Papers may be downloaded for personal use
`only.
`
`www.hks.harvard.edu
`Exhibit 1089
`ARGENTUM
`IPR2017-01053
`
`000001
`
`

`

`NBER WORKING PAPER SERIES
`
`PRICING AND REIMBURSEMENT IN U.S. PHARMACEUTICAL MARKETS
`
`Ernst R. Berndt
`Joseph P. Newhouse
`
`Working Paper 16297
`http://www.nber.org/papers/w16297
`
`NATIONAL BUREAU OF ECONOMIC RESEARCH
`1050 Massachusetts Avenue
`Cambridge, MA 02138
`August 2010
`
`Revised version to appear in Patricia M. Danzon and Sean Nicholson, eds., The Economics of the
`Biopharmaceutical Industry. The authors have benefited from discussions with Richard G. Frank and
`E. Mick Kolassa, but are solely responsible for the views expressed herein. This research was not
`sponsored. The views expressed herein are those of the authors and do not necessarily reflect the views
`of the National Bureau of Economic Research.
`
`© 2010 by Ernst R. Berndt and Joseph P. Newhouse. All rights reserved. Short sections of text, not
`to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including
`© notice, is given to the source.
`
`000002
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`

`Pricing and Reimbursement in U.S. Pharmaceutical Markets
`Ernst R. Berndt and Joseph P. Newhouse
`NBER Working Paper No. 16297
`August 2010
`JEL No. D4,I11,I18,L11,L65
`
`ABSTRACT
`
`In this survey chapter on pricing and reimbursement in U.S. pharmaceutical markets, we first provide
`background information on important federal legislation, institutional details regarding distribution
`channel logistics, definitions of alternative price measures, related historical developments, and reasons
`why price discrimination is highly prevalent among branded pharmaceuticals. We then present a theoretical
`framework for the pricing of branded pharmaceuticals, without and then in the presence of prescription
`drug insurance, noting factors affecting the relative impacts of drug insurance on prices and on utilization.
`With this as background, we summarize major long-term trends in copayments and coinsurance rates
`for retail and mail order purchases, average percentage discounts off Average Whole Price paid by
`third party payers to pharmacy benefit managers as well as average dispensing fees, and generic penetration
`rates. We conclude with a summary of the evidence regarding the impact of the 2006 implementation
`of the Medicare Part D benefits on pharmaceutical prices and utilization, and comment on very recent
`developments concerning the entry of large retailers such as Wal-Mart into domains traditionally dominated
`by large retail chains and the "commoditization" of generic drugs.
`
`Ernst R. Berndt
`MIT Sloan School of Management
`100 Main Street, E62-518
`Cambridge, MA 02142
`and NBER
`eberndt@mit.edu
`
`Joseph P. Newhouse
`Division of Health Policy Research and Education
`Harvard University
`180 Longwood Avenue
`Boston, MA 02115-5899
`and NBER
`newhouse@hcp.med.harvard.edu
`
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`

`I.
`
` Introduction
`
`
`
`
`The pricing and reimbursement of prescription drugs in the United States is
`
`important for at least two reasons. First, from the perspective of US consumers,
`
`prescription drugs constitute 12 percent of total U.S. health care spending (2008) or
`
`roughly two percent of GDP.1 Thirty-seven percent of this amount was tax financed, with
`
`the associated deadweight loss to finance that spending. 2 An additional 42 percent was
`
`financed through insurance, the bulk of which flowed through employer provided and
`
`subsidized insurance. The employer subsidies for this insurance cause distortions in the
`
`labor market with associated inefficiencies.3 Thus, the financing of pharmaceuticals in
`
`the U.S. is associated with various types of deadweight losses. Second, from the
`
`perspective of all consumers, the U.S. constitutes about 40 percent of the world
`
`pharmaceutical market. As a result, its pricing and regulatory policies materially
`
`influence world demand and hence the incentives of pharmaceutical firms to innovate.4
`
`
`
`In this survey chapter on pricing and reimbursement in U.S. pharmaceutical
`
`markets, we first provide background information on important federal legislation,
`
`institutional details regarding distribution channel logistics, definitions of alternative
`
`price measures, related historical developments, and reasons why price discrimination is
`
`highly prevalent among branded pharmaceuticals. We then present a theoretical
`
`framework for pricing of branded pharmaceuticals without and then in the presence of
`
`prescription drug insurance, noting factors affecting the relative impacts of insurance on
`
`prices and on utilization. With this as background, we summarize major long-term trends
`
`in copayments and coinsurance for retail and mail order purchases, average percentage
`
`discounts off Average Wholesale Price paid by third party payers to pharmacy benefit
`
`managers as well as average dispensing fees, and generic penetration rates, We conclude
`
`with a summary of the evidence regarding the impact of the 2006 implementation of the
`
`Medicare Part D benefits on pharmaceutical prices and utilization, and comment on very
`
`recent developments concerning the entry of large retailers such as Wal-Mart into
`
`domains traditionally dominated by large retail chains and the “commoditization” of
`
`generic drugs.
`
`
`
`
`
`
`
`
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`Berndt and Newhouse “Draft Handbook Pricing Chapter”
`
`II.
`
`Background: Legislation, Institutions and Historical Developments
`
`
`
`We begin with a brief background section that focuses on important U.S.
`
`legislative developments. This lays the groundwork for our later discussion of the
`
`marketing and pricing of generic and brand prescription drugs in the U.S. For the most
`
`part the U.S. generic drug industry approximates competitive conditions with price
`
`approaching marginal costs. As a result, we employ traditional microeconomic tools to
`
`describe the structure and pricing of that industry. We defer discussion of brand pricing
`
`in the presence of market power to later in this chapter. Next we outline the structure and
`
`distribution logistics of U.S. markets for pharmaceuticals, distinguishing roles and prices
`
`faced by providers from those of payers. Then, since any researcher focusing on the
`
`pricing of branded and generic drugs in the U.S. cannot avoid encountering the critical
`
`functions played by the misnamed Average Wholesale Price (“AWP”, aka “Ain‟t What‟s
`
`Paid”), we digress to provide background on the origins, history and evolution of the very
`
`important and sometimes misunderstood central role played by AWP in various segments
`
`of the U.S. pharmaceutical industry. We conclude this section with a discussion
`
`highlighting the demand and cost conditions facing biopharmaceutical manufacturers that
`
`make third degree price discrimination an attractive and widespread practice.
`
`A. Important Legislative Developments Affecting Drug Pricing
`
`The pricing of branded and generic drugs has long been a focus of controversy.
`
`Although Congressional attention to pharmaceutical pricing dates back further, a good
`
`place to begin is with the Congressional hearings conducted by Senator Estes Kefauver‟s
`
`Anti-Trust and Monopoly subcommittee between 1959 and 1962. These hearings dealt
`
`not only with the thalidomide tragedy in which many children were born with birth
`
`defects as a result of their mothers taking thalidomide for morning sickness during
`
`pregnancy, but also with allegations of pharmaceutical companies engaging in various
`
`questionable practices to realize excess profits. One writer describes the hearings as
`
`follows:
`
`“Witnesses told of conflicts of interest for the AMA (whose Journal, for example,
`received millions of dollars in drug advertising and was, therefore, reluctant to
`challenge claims made by drug company ads)…The drug companies themselves
`were shown to be engaged in frenzied advertising campaigns designed to sell
`trade name versions of drugs that could otherwise be prescribed under generic
`names at a fraction of the cost; this competition, in turn, had led to the marketing
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`Berndt and Newhouse “Draft Handbook Pricing Chapter”
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`of new drugs that were no improvements on drugs already on the market but,
`nevertheless, heralded as dramatic breakthroughs without proper concern for
`either effectiveness or safety.”5
`
`
`
`Kefauver‟s hearings led to enactment of the Kefauver-Harris Drug Act in 1962,
`
`also known as the Kefauver-Harris Amendments to the 1938 Food, Drug and Cosmetic
`
`Act. Among its numerous important provisions were that sponsors of New Drug
`
`Applications needed to document evidence of both safety and efficacy (not just safety),
`
`that informed consent was required of patients participating in clinical trials, that the
`
`sponsor file an Investigational New Drug application with the Food and Drug
`
`Administration before initiating human testing, that drug advertising be required to
`
`disclose accurate information about side effects, and provisions that stopped inexpensive
`
`to manufacture generic drugs from being marketed as expensive drugs under new trade
`
`names as new breakthrough medications, and that prevented the use of generic names that
`
`were obscure and difficult to remember, a practice that manufacturers allegedly employed
`
`to diminish generic substitution. It also mandated that a Drug Efficacy Study
`
`Implementation be undertaken to classify all pre-1962 drugs that already were on the
`
`market as either effective, ineffective, or needing further study.6 For our purposes here,
`
`the Kefauver-Harris Drug Act Amendments of 1962 are notable for clarifying
`
`distinctions between brand and generic drugs and regulating their marketing.
`
`Another important development of the 1960s was the 1965 passage of
`
`Congressional legislation adding Titles XVIII (Medicare) and XIX (Medicaid) as
`
`Amendments to the Social Security Act, which took effect in July 1966. At that time,
`
`however, Medicare covered only prescription drugs taken by hospital inpatients under
`
`Part A and physician administered drugs (typically injections) under Part B. Part D of
`
`Medicare which covered outpatient drugs taken orally -- small molecule drugs -- would
`
`not take effect until 40 years later in 2006.
`
`Also in the mid 1960s drug wholesalers envisaged a potential growth in demand
`
`for generic drugs, and a number of them, such as McKesson vertically integrated into
`
`manufacturing operations and began marketing their own generics. Part of the
`
`wholesalers‟ incentive to integrate into generic manufacturing and marketing arose
`
`because wholesaler margins were traditionally keyed to the price at which the
`
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`manufacturer suggested the wholesaler should sell, and to the extent generics were lower
`
`priced than brands, the prospect of manufacturers shifting their prescription drug mix
`
`toward generics implied a reduced gross profit margin for wholesalers. Contemporary
`
`industry analysts opined that the generic manufacturing and marketing window for
`
`wholesalers would, however, likely be a temporary one, as new specialized generic
`
`manufacturers entered the prescription drug market and marketed directly to the retail and
`
`hospital sectors.7 We discuss changing dynamics in drug distribution channels,
`
`particularly the impacts of information and communication technologies, later on in this
`
`chapter.
`
`A subsequent important legislative development was the Hatch-Waxman Drug
`
`Price Competition and Patent Term Restoration Act of 1984. It established the
`
`Abbreviated New Drug Application (“ANDA”) pathway that required only establishing
`
`bioequivalence with the reference drug (eliminating the need to establish safety and
`
`efficacy anew) and compliance with Good Manufacturing Practices.8 It specified that
`
`when a generic manufacturer submitted an ANDA and successfully established
`
`bioequivalence with the originator drug and complied with Good Manufacturing
`
`Procedures, the Food and Drug Administration (“FDA”) was authorized to approve the
`
`ANDA. For oral solid small molecules, along with ANDA approval the FDA assigns the
`
`generic an A (therapeutically equivalent) or B (drug not considered therapeutically
`
`equivalent) rating with the pioneer, thereby enabling pharmacists to substitute a generic
`
`for the brand prescription.9 It is worth noting that the FDA‟s A rating essentially grants
`
`complete interchangeabilty between brand and generic, or what economists would call
`
`almost “perfect substitutability” of the brand and generic.10 A weaker form of
`
`substitutability between different molecules occurs when, for example, payers (not
`
`necessarily the FDA) term two different molecules as being “therapeutically
`
`substitutable.”
`
`B. Pricing of Generic Drugs
`
`As noted above, the traditional microeconomic theory toolkit is mostly sufficient
`
`for analyzing generic drug pricing. For the most part one can view generic drug
`
`manufacturers as operating in competitive markets, taking the price of generic drugs as
`
`given, and facing no buyer with monopsony power.
`
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`For most small molecule pharmaceuticals (i.e., most tablets or capsules), the
`
`process of undertaking clinical trials to establish bioequivalence and meet ANDA
`
`requirements is inexpensive relative to establishing efficacy; estimates range from $2-5
`
`million.11 With entry being relatively inexpensive and the regulatory pathway open and
`
`clear, one would expect extensive generic entry following patent expiration, with price
`
`eventually falling to marginal cost. Indeed, that is what numerous researchers have
`
`found. Frank and Salkever [1997], Reiffen and Ward [2005], Atanu, Grabowski,
`
`Birnbaum, Greenberg and Bizan [2006], and Berndt, Mortimer, Bhattacharjya, Parece
`
`and Tuttle [2007] all find that price and the extent of generic entry are jointly determined.
`
`Reiffen and Ward also report that generic price continues to fall as the number of generic
`
`entrants increases up to five or so, but thereafter levels off. A common finding from the
`
`literature is that the number of generic entrants increases with the size of the branded
`
`molecule market (measured in dollars) prior to the loss of patent protection; generic entry
`
`of oral solids tends to be more extensive than that of injectables. Scott Morton [1997,
`
`1999] considers various aspects of generic entry decisions in detail, and finds that generic
`
`firms tend to specialize in the therapeutic classes in which they have previous experience.
`
`Three notable exceptions to envisaging the generic drug industry as being
`
`competitive with price approximating marginal cost are worth noting, each involving
`
`some aspect of market power. First, under the terms of the Hatch-Waxman Act, before or
`
`after submitting its ANDA, a generic manufacturer who successfully prevails in
`
`challenging the brand innovator‟s patent claims can be granted 180 days of exclusivity
`
`during which time no other ANDA holder for that molecule/strength can market its
`
`product. This is typically called a Paragraph IV entry.
`
`With no further ANDA entry permitted for a period of 180 days, the market for
`
`that particular molecule/strength becomes a duopoly, with the branded and single generic
`
`as competitors. In such a duopoly environment, the price of generics is generally only
`
`10-20% below that of the brand.12 A variant of this occurs when the branded
`
`manufacturer enters into an agreement with a generic manufacturer (other than the
`
`successful Paragraph IV entrant) to market the molecule/strength under the branded
`
`product‟s original New Drug Application (not an ANDA). This has been dubbed
`
`“authorized generic entry”, and it enables the branded company to continue pricing its
`
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`branded product high after loss of patent protection, and rather than ceding all generic
`
`sales to the single successful Paragraph IV entrant, it can share generic revenues with its
`
`collaborating “authorized generic” entrant in a triopoly environment for up to 180 days.13
`
`Following the 180 day Paragraph IV exclusivity period, generic entry tends to be
`
`substantial, with generic prices falling sharply. The presence of authorized generic entry
`
`does not appear to adversely impact the extent of subsequent generic entry post-180 day
`
`exclusivity, although it might do so in cases where the size of the potential generic
`
`market is small.14
`
`A second exception involves what is called “branded generics”. For example, a
`
`common feature observed in antidepressant markets in the 1980s following loss of patent
`
`protection was primarily branded manufacturers other than the original patent holder
`
`entering with similar strength (or with the off-patent molecule in combination with other
`
`molecules) therapeutic formulations but branded with other than the generic name. 15
`
`Branded generics attempt to differentiate themselves from both the original branded
`
`patent holder and other generic entrants, and charge prices in between the generic and the
`
`original brand. While not particularly successful in the last few decades, branded
`
`generics may be rejuvenated in the context of biosimilars, as we discuss next.
`
`A third potential exception to generic or patent expiration follow-on markets
`
`being approximated as competitive with price close to marginal cost involves biologics,
`
`as distinct from small molecules. Prior to 2010 there was no procedure for generic entry
`
`of biologics, now dubbed “biosimilars.” Section 7002 of the 2010 health care reform
`
`legislation (the Patient Protection and Affordable Care Act), however, established the
`
`authority for the licensure of biosimilars, which are intended to provide price competition
`
`for the original biologic; it granted the original biologic 12 years of market exclusivity.
`
`The term biosimilar rather than generic drug is used not only because biologics
`
`are considerably larger and more complex molecules than are synthesized small
`
`molecules, and tend to be more challenging and costly to manufacture,16 but also because
`
`their larger size and complexity implies possibilities of their surfaces folding in different
`
`ways, thereby not blocking receptor sites as uniformly as synthesized small molecules.
`
`Hence, characterizing them analytically and establishing bioequivalence between the
`
`original biologic and an attempted follow-on biologic entrant raises difficult scientific
`
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`issues and challenges with important economic implications. In particular, because of
`
`greater manufacturing costs and complexity, difficulties in establishing bioequivalence
`
`and meeting other regulatory requirements, it is widely anticipated that the extent of
`
`follow-on biologic entry subsequent to loss of patent protection will be considerably less
`
`than has historically been observed with chemically synthesized small molecules.17 A
`
`consequence of this is that biosimilars are unlikely to experience the same degree of price
`
`competition following loss of patent protection as brands that A or B-rated bioequivalent
`
`small molecules have encountered in the US.18 Instead, as the 2010 health care reform
`
`legislation is implemented, one will likely see competition from something akin to
`
`“branded generics,” products that are less than perfectly substitutable with the branded
`
`biologic pioneers, but nonetheless positioned to act as possible therapeutic equivalents.
`
`Hence, price declines of biologics following loss of patent protection are likely to be
`
`notably smaller than have occurred historically with generic small molecules.
`
`C. Distribution Channel Logistics and Pricing
`
`Before initiating our discussion of the supply prices of branded drugs, we believe
`
`it useful to outline several logistical and transactional aspects of biopharmaceuticals, both
`
`generic and brand, including use of a variety of distribution channels. Observed prices of
`
`even the same biopharmaceutical will differ in various transactions simply because the
`
`drug pathway involves distinct distribution channel transactions.
`
`It is important to distinguish consumers, providers and payers. We designate
`
`providers of pharmaceutical products as those entities that actually purchase and take
`
`both title and physical possession of biopharmaceutical products, either directly or
`
`indirectly providing them to consumers. Providers include retail and mail order
`
`pharmacies, various wholesalers, hospitals, and physician offices that administer
`
`medicines (typically by intravenous, infusion or injection). In comparison, payers such
`
`as health care plans, pharmaceutical benefit managers, most group purchasing
`
`organizations and employers, typically do not take title to and physical possession of drug
`
`products, but instead reimburse providers for the purchases they or their beneficiaries
`
`have made. Despite their name payers do not actually purchase drugs, and the prices
`
`involved in the transactions in which payers engage are not the purchase prices of drugs
`
`from manufacturers or wholesalers.
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`Brand manufacturers of small molecules sell their drugs primarily to certain
`
`providers, particularly wholesalers and chain warehouses, and have relatively limited
`
`direct sales to hospitals, retail and mail order pharmacies, and physician offices.19 The
`
`price at which brand manufacturers sell to wholesalers and chain warehouses is generally
`
`the Wholesale Acquisition Cost (WAC), a published list price, minus a few percent
`
`discount for prompt payment and other incentives. In turn, wholesalers sell branded small
`
`molecules to retail and mail order pharmacies, usually at the present time at a few percent
`
`above their WAC, and at a 15-20% or larger discount off of what is known as the
`
`misleadingly named Average Wholesale Price (“AWP”).20
`
`Wholesalers face different markets for branded and generic drugs. They can
`
`purchase branded drugs only from a single manufacturer, whereas they can purchase
`
`most generic drugs from many manufacturers. As a result, they can create price
`
`competition among the various generic manufacturers of a particular small molecule.
`
`Large retail chains also buy directly from generic manufacturers, pitting one generic
`
`manufacturer against others to obtain the lowest generic price. As a result, gross profit
`
`margins for both wholesalers and large retail chains are larger for generic than branded
`
`small molecules.21
`
`In contrast, many biologics are administered via injection or infusion by health
`
`care providers (i.e., physicians and nurses), rather than being patient self-administered
`
`oral tablets or capsules purchased from retail or mail order pharmacies. As a result,
`
`manufacturers of branded biologics sometimes sell directly to hospitals and physician
`
`offices rather than to the wholesalers to which the branded small molecule manufacturers
`
`usually sell. Firms known as “specialty pharmaceuticals,” however, often provide
`
`wholesaler-type intermediary services between biologic manufacturers and providers.
`
`Although the practice is not as firmly ingrained as it is with branded small molecules,
`
`biologic manufacturers generally sell products to the specialty pharmaceutical firms at a
`
`slightly discounted WAC, and often at slightly higher prices to the providers who are
`
`buying directly.
`
`Over the years a variety of intermediary services for all drugs have increasingly
`
`been provided by pharmaceutical benefit managers (“PBMs”). Services provided by
`
`PBMs include benefit design and contracting with manufacturers for third party payers
`
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`(insurers, employers, governments); pharmacy network formation; real time prescription
`
`benefit eligibility certification and claims processing; formulary management and rebate
`
`negotiations with manufacturers, payers and pharmacies; drug utilization screening and
`
`review; operation of mail order pharmacies, and other functions. Although PBMs are a
`
`critical component of the third party drug benefit system, in general they do not directly
`
`purchase prescription drugs from manufacturers, take title or physical possession of the
`
`product, or provide the drug product to the patient. Rather, they are best viewed as
`
`intermediary payers. If, however, the PBM owns a mail order pharmacy, as large PBMs
`
`do, then the PBM‟s mail order pharmacy may perform provider services directly to
`
`patients.
`
`Because of the multitude of agents involved in pharmaceutical transactions, a
`
`variety of ex post reconciliations and “true ups” occur. One of these is the chargeback.
`
`It arises because, as noted above, few brand manufacturers sell directly to providers,
`
`instead distributing their products primarily via wholesalers. Suppose that a
`
`manufacturer negotiates with a third party payer (“TPP”) or group purchasing
`
`organization (“GPO”), which does not take title to the product, a discounted price that is
`
`below the price the manufacturer charged the wholesaler. Pharmacies contracting with
`
`the TPP or members of the GPO purchase from the wholesaler at the contractually agreed
`
`on TPP/GPO price. The chargeback is the difference between the manufacturer‟s price
`
`charged the wholesaler and the manufacturer‟s contract price with the TPP/GPO and
`
`makes the wholesaler whole. Typically the wholesaler submits chargeback requests to
`
`the manufacturer on a regular basis, and the manufacturer transfers the invoiced
`
`chargeback to the wholesaler via electronic data interchange.
`
`In addition to chargebacks, various forms of rebates are common in
`
`pharmaceutical transactions. Manufacturers contracting with TPPs/GPOs and PBMs
`
`often have market share or absolute number/dollar provisions that provide financial
`
`incentives for the TPPs/GPOs/PBMs to meet certain targets. e.g., a 10% of WAC rebate
`
`if brand x attains 40% of all dispensed prescriptions in a given, well-defined therapeutic
`
`class, and 15% if it attains 50%. Depending on the extent to which targets are attained or
`
`exceeded, manufacturers pay these organizations rebates. Since whether such target
`
`thresholds have been reached can typically only be determined retrospectively, these
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`rebates (or at least a portion of them) are paid ex post at regular intervals. PBM contracts
`
`with network pharmacies often contain similar rebate provisions, as do PBM contracts
`
`with TPPs.22
`
`To this point we have not dealt with prices paid by consumers, be they completely
`
`cash paying uninsured or the much larger number of consumers whose insurance covers
`
`drugs. Regarding the latter, TPPs have attempted to constrain rising pharmaceutical
`
`expenditures by exerting financial pressures on the patient, altering cost-sharing
`
`provisions between the insurer and the insured consumer. Initially drug insurance
`
`involved the insured‟s paying a copayment (a fixed dollar amount, usually for a month‟s
`
`supply) or a coinsurance rate (a fixed percentage of the total cost) irrespective of the
`
`specific drug bought. Drug insurance also involved the insurer‟s establishing a
`
`formulary, which was simply a list of drugs covered by the insurer. Formularies could be
`
`open or closed. Open formularies essentially cover all drugs approved by the FDA,
`
`whereas closed formularies cover only a subset of FDA approved drugs; for those drugs
`
`not covered, the insured must pay the full pharmacy price.
`
`Drug benefit cost-sharing provisions have evolved over the last two decades, with
`
`the key innovation being to charge the customer different amounts for different drugs.
`
`When drug insurance was first introduced, the consumer typically paid the same
`
`coinsurance rate for any drug, but now the price paid by the customer depends on which
`
`“tier” the drug is placed. The first tiered plans typically had two tiers, but as we come to
`
`in Section IV, now there are usually three or even four. In such an arrangement, generic
`
`drugs will typically be on the lowest or cheapest (to the consumer) tier. When a customer
`
`brings a prescription for a generic drug on the first tier to the pharmacy, the customer
`
`pays the pharmacy a relatively small amount, say $10 for a 30-day prescription. The TPP
`
`or its PBM pays the pharmacy the remaining cost of the drug and a dispensing fee.
`
`Relatively few benefit plans have many branded drugs on their first tiers, although
`
`occasionally a formulary will have an off-patent brand on the first tier.
`
`Depending on the result of negotiations among the manufacturer and the PBM or
`
`TPP, for a given therapeutic class of drugs (e.g., anti-depressants) the insurer has one or
`
`more preferred brands on the second tier. A customer presenting a prescription to a
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`pharmacy for a branded drug on the second tier faces a larger copayment, say $25 for a
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`30-day prescription, with the TPP or its PBM picking up the balance.
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`Brands for which the TPP or PBM was unable to negotiate a favorable price (from
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`its perspective) are placed on the third tier. To incentivize customers and their
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`physicians to substitute away from these non-preferred brands, copayments for third tier
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`brands are considerably higher than for the second tier, say, $50 for a 30-day
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`prescription. Finally, certain very costly drugs, such as the oncology and rheumatoid
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`arthritis biologics that can cost thousands of dollars per month, may be placed on a fourth
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`tier. Even if the lower three tiers have increasingly higher copayments, the fourth tier, if
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`the plan has four tiers, almost always has a coinsurance rate, perhaps 20-30%.
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`A relatively recent innovation involves prescriptions for maintenance drugs
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`(drugs used to treat chronic rather than acute or episodic conditions). TPPs and PBMs
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`now incentivize customers to obtain such drugs via mail order in 90 day prescriptions by
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`making the copayments for 90 day prescriptions less than three times the 30 day
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`copayment, often twice the 30 day copayment.23 Another, even more recent innovation is
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`to reduce cost sharing amounts for specific drugs (or specific classes of drugs) to
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`encourage compliance and potentially reduce hospital and physician costs. We discuss
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`this development below.
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`D. The Long-Lived, Ubiquitous but Misnamed Average Wholesale Price
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`In almost all brand drug transactions, reference is made to a “price” called the
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`Average Wholesale Price (“AWP”). Although the role of AWP as a reference or
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`benchmark price from which various discounts are taken is critical for contracting in
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`these markets, the AWP is sometimes misunderstood, in part because it is neither an
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`average nor a wholesale price.24
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`D.1
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`The Creation and Evolution of Average Wholesale Price
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`We now digress, initially to discuss the creation and evolution of the Average
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`Wholesale Price “AWP”) as a reference or benchmark for the pricing of numerous
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`pharmaceutical transactions. Following Congressional passage of the federal Medicaid
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`enabling legislation in 1965, the various states were required to develop beneficiary and
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`reimbursement practices, subject to approval from the Health Care Financing
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`Administration (“HCFA”, now the Centers for Medicare and Medicaid Services,
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`“CMS”). At that time, numerous small wholesalers ex