In the quest to understand what drives higher medical costs in the US relative to other developed countries, a smaller — but essential — component is pharmaceutical drugs. In 2023 (the latest year with data from all OECD nations), Americans spent an average of $1,713/capita on prescribed and OTC drugs — much higher than the average of all other nations at $731/capita and $546/capita more than the next highest (Germany). As noted by Health System Tracker, per capita spending on prescribed medication grew by 69% in the US between 2004 and 2019, as compared to 41% on average in the OECD. The primary driver of this disparity is incentives within the US’s healthcare system to which all actors within the system respond.
As noted in a 2021 RAND Report, brand name drugs in the US were 3.44 times higher than in comparable countries, while generics were 16% cheaper — accounting for 84% of drugs sold in the US but only 12% of US spending on pharmaceuticals. The Hatch-Waxman Act of 1984 and the Biologics Price Competition and Innovation Act (BPCIA) of 2009 provide defined exclusivity periods of five years for new small-molecule drugs and 12 years for new biologics. The US patent system and drug-approval framework also allow companies to lengthen these monopolies by the process of “evergreening” — filing additional overlapping patents on different aspects of the drug, such as formulations, new uses, and dosing regimens — which can stretch the patent exclusivity well past the standard 20-year term for a patent. A 2023 JAMA study of 10 top selling prescription drugs analyzed the 1,429 patents and patent applications related to these drugs and noted that almost ¾ of patents were filed after FDA approval, with a median peak of applications 13 years after approval.
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 prohibited Medicare from negotiating prices on Part D plans. Consequently, private providers negotiated individually, which reduced potential negotiating power — until the 2022 Inflation Reduction Act which allows Medicare to negotiate prices on a small number of top-selling drugs. This contrasts with the bargaining power of other nationalized systems which either set price based on a cost-benefit analysis or which set a price ceiling on new pharmaceuticals — while having shorter exclusivity windows and lower utilization of generic drugs compared to the US.
Given the regulatory framework in the US, pharmaceutical companies can charge the maximum price that the market can bear once a treatment is approved and utilize the patent system to lengthen their exclusivity window to maximize their margins. Based on a 2020 JAMA study of S&P 500 companies from 2000 to 2018, the median net income (gross margin less expenses) of pharma firms versus non-pharma firms was significantly higher at 13.8% vs. 7.7%, while maintaining higher cash reserves than similarly sized companies in different industries. Pharmaceutical firms defend these practices and their margins by pointing at high R&D costs and the uncertainty of developing the next drug that will drive revenue. According to a 2022 Deloitte analysis, it costs roughly $2.3 billion to develop a successful drug, but when considering the entire R&D ecosystem (not just the successful drugs), this balloons to over $5 billion per successful drug.
Down the supply-chain from pharmaceutical companies, pharmacy benefit managers (PBMs) and insurers can also contribute to high consumer drug costs. A 2020 USC study noted that the PBMs demand large rebates (20-30% of a drug’s cost) from the manufacturer, with each dollar of rebate on average leading to a $1.17 increase in the list price of a drug. This rebate-driven structure can incentivize PBMs to prefer higher cost drugs with a higher rebate and “spread pricing” — charging insurers more for a drug than they reimburse the pharmacy and pocketing the difference, which works better when list prices are high. Given the vertical integration of certain PBMs with insurers (e.g. CVS/Caremark with Aetna, UnitedHealth with OptumRx) there is also the possibility of the integrated firm capturing rebate revenue while still passing costs to employers or patients. By contrast to the opacity in the US system, many other countries outlaw rebates and insist on transparent net pricing (often published in official registries) or fixed-price reimbursement.
Aiken is the director of Reporting and Analytics at RW Supply & Design. He has been a West Plains resident for the past 17 years after graduating from Grove City College in Pennsylvania with a Bachelor of Arts in History. Prior to living in the U.S., he grew up in Turkey and Germany.
