April 3, 2014

The Strange and Very Expensive World of Prescription Drugs

Marc Joffe

Principal Consultant, Public Sector Credit Solutions
Summary

Prescription drugs account for about 10 percent of U.S. health care costs-or 1.8 percent of GDP. This does not include the cost of otherwise unnecessary medical appointments to obtain prescriptions and the time wasted at pharmacies waiting for prescriptions to be filled. By relaxing the prescription drug restrictions and reforming the patent system the government can unlock the competitive forces that drive prices down and empower individuals to avoid unnecessary, expensive medical services.

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Like many male baby boomers, I am in the process of saying goodbye to my hair. To extend the farewell, I decided to take Propecia, a prescription drug that combats male pattern baldness. But delaying the inevitable has substantial costs-costs that are exaggerated by our nation's Byzantine prescription drug system.

Although Propecia's side effects are generally minimal and readily found on the web, getting the drug requires a doctor's visit. Further, many physicians won't renew prescriptions without periodic follow ups. The result can be numerous consultations, paid for by private or government insurance, merely for the purpose of obtaining permission to buy a vanity pill.

At my local pharmacy, Propecia costs $3 for each 1 milligram (mg) pill-a daily dose implying an annual cost of over $1,000. Since that cost is well beyond the reach of many, lower cost workarounds have appeared. For example, I can buy a generic version made in Argentina for about half the cost. Since Argentina is not a signatory to the Patent Cooperation Treaty, Merck cannot readily enforce its U.S. patent there.

But even bigger savings are available at my local pharmacy. There I can buy a generic version of another Merck drug that contains the exact same active ingredient, Finasteride. This generic version of Proscar-a remedy for enlarged prostate-costs only 30 cents per pill. Because the pills contain 5 mg of Finasteride, instead of the 1 mg recommended for baldness, I can use a pill cutter to break the pill into quarters, reducing my cost per dose to a mere eight cents.

So I can get the same active ingredient from the same pharmacy for either $3 per milligram or less than eight cents per milligram. In normal markets, such imbalances tend to disappear fairly quickly because they create arbitrage opportunities. Unfortunately, the pharmaceutical market is anything but normal-and thus irrational pricing reigns.

Proscar (5 mg) was first patented by Merck for treating enlarged prostate in 1992. It came off patent in 2006, which was also when the Food and Drug Administration permitted competing drug manufacturers to market generic alternatives. Propecia (1 mg) received a separate patent in 1997, not because it was a new substance, but because Merck proved that a lower dose of Finasteride could solve a different medical issue-hair loss. This second patent just ended in 2013, so the process of cost reduction through generic competition is just starting.

Irrationally priced Finasteride is a relatively minor contributor to the high cost of prescription drugs. Acid reflux medications are a much bigger game. With annual revenue of $6 billion, AstraZeneca's Nexium ranked number two on the list of top selling prescription drugs in 2013. But this pharmaceutical blockbuster is just a "me-too" medication.

In 2003, the FDA approved a request by AstraZeneca to reclassify Prilosec, its original acid reflux treatment from prescription to over-the-counter (OTC) distribution. The FDA usually reclassifies drugs from prescription to OTC only after the manufacturer files a New Drug Application requesting the change. Since Prilosec lost patent protection and became vulnerable to competition from low-cost generic drugs, it made business sense for AstraZeneca to make Prilosec available on an OTC basis.

At about the same time, the company introduced Nexium. The company's sales force began encouraging physicians to prescribe Nexium-instead of recommending Prilosec-at a cost per dose several times higher than the OTC alternative. Marketing claims aside, Prilosec and Nexium are very similar molecules that produce very similar results. The crucial difference is that Prilosec has lost patent protection and Nexium still has it. The stated benefit of dispensing drugs through a prescription process is that it reduces the risk of patients using the medications improperly. But, if Prilosec and Nexium are basically the same, why should one be sold over the counter and the other be available only by prescription?

Nexium would be somewhat less expensive if a pharmacist did not have to dispense it. Since the dangers of Nexium self-medication are similar to the risk of consumers' direct purchases of Prilosec, it is hard to see the social benefit of restricting the manner in which Nexium is dispensed.

A larger question is whether Nexium should have even received patent protection in the first place. By legally prohibiting competition from generic alternatives, drug patents (and FDA exclusivity periods) lock in high prices for newer medications. While it is argued that patent restrictions provide a social benefit by encouraging research into new lifesaving drugs, it is clear that many drug patents do not provide such a benefit.

Nexium is just one of many me-too drugs that generate large pharmaceutical industry profits but have had only marginal pharmacological benefits. Other examples include the erectile dysfunction pills that followed Viagra and the additional cholesterol-reducing statins that came on the heels of Lipitor.

Prescription drugs account for about 10 percent of U.S. health care costs-or 1.8 percent of GDP. This does not include the cost of otherwise unnecessary medical appointments to obtain prescriptions and the time wasted at pharmacies waiting for prescriptions to be filled. By relaxing the prescription drug restrictions and reforming the patent system the government can unlock the competitive forces that drive prices down and empower individuals to avoid unnecessary, expensive medical services.