The U.S. 4th Circuit Court of Appeals has struck down Maryland’s latest attempt to regulate drug manufacturers. With no federal legislation to address increasing prescription drug prices, many states have moved to address the problem on their own.
Some state measures, such as price transparency and price-gouging legislation, have been counterproductive. Others, such as banning gag clauses that prevent pharmacies from being transparent with their customers, are showing promise.
States care about high drug prices because the growth of prescription drug spending as a share of state Medicaid spending increased from 4 percent in 2013 to 25 percent in 2014, before declining to 6 percent in 2016. States are burdened by prescription drug spending volatility and its effect on balancing their budgets.
Before Maryland’s law was struck down, the Attorney General could require a justifying statement and records from a drug manufacturer if there is a 50 percent price increase for an essential off-patent or generic drug over a one-year period. Manufacturers found to be in violation could face a civil penalty of up to $10,000.
But the U.S. 4th Circuit Court of Appeals ruled that Maryland’s law violated the dormant commerce clause because regulating the retail sale of drugs in the state was indirectly regulating wholesale transactions that lead up to that sale. These transactions occur outside the state. Since only Congress can regulate interstate commerce under the commerce clause, states that pass similar legislation will run into the same legal troubles.
In addition to drug manufacturers raising prices, states must address the problems created by Pharmacy Benefit Managers (PBMs). PBMs negotiate drug prices with drug manufacturers on behalf of the insurer through a rebate system. The drug manufacturer pays the PBM a rebate to have its drug placed on a formulary list.
Formulary lists, utilized by most health insurance plans, include prescription drugs that health practitioners consider to be the most valuable. Drugs on these lists are also the ones that reach the pharmacy marketplace. If a drug is not on the formulary list, it is less likely to be prescribed, resulting in lower revenues for drug manufacturers.
This system of formulary lists incentivizes drug manufacturers to offer the PBMs larger rebates to place their drugs on the list. Ideally, a higher rebate should lower consumer costs. The PBMs keep a portion of the rebate and drug manufacturers get their drugs on the list. While rebates lower drug costs, the cost savings do not always accrue to the consumer.
Thus far, state legislation regulating PBMs has focused on banning gag clauses. Gag clauses, in contracts between PBMs and pharmacies, prevent pharmacists from revealing to patients that medication would cost less if paid out-of-pocket versus using insurance. The concern here is that patients are overpaying for prescription drugs because they are not aware of their options. Twenty states have enacted laws prohibiting gag clauses—ten this year alone.
A recent University of Southern California report sheds some light on the issue. The authors found that total overpayments in 2013 amounted to $135 million or $10.51 per insured patient. Overpayment refers to patient copayments that exceeds the total cost of the drug to insurers or PBMs.
Banning gag clauses is a form of transparency legislation. However, unlike legislation which focuses on price increase reporting, banning gag clauses makes the consumer aware of their price options, which leads to informed decision-making. This will lead to cost savings for consumers. States should continue to pass legislation prohibiting the practice.
Furthermore, it seems like this type of legislation is putting pressure on insurers to reform the rebate system. United Health Group, the largest insurer in the U.S., has recently announced it will start passing drug rebates to some of its customers. If other insurers follow suit and widen the scope of qualifying recipients, it can go a long way towards reducing drug prices for consumers.
State legislatures are less successful in using price transparency and price-gouging legislation to regulate drug manufacturers. Under price transparency legislation, drug manufacturers are required to report price increases of 10 percent or more over a certain period. Price-gouging legislation, on the other hand, allows states to take legal action and impose financial penalties on drug manufacturers who increase their prices substantially (percent varies) over a certain period.
Both measures are counterproductive. Transparency legislation, focused on price increases, is subjective. What is considered an excessive price increase can be difficult to determine, unless it is obvious, such as Mylan ratcheting up prices of the EpiPen in 2016.
Reporting requirements can lead to burdensome compliance costs for drug manufacturers without benefits. There is no derived benefit from price increase reporting, unless the state can do something about it. Some states have passed price-gouging legislation to deal with the issue, but this type of legislation can lead to violations of constitutional law.
Absent federal legislation, states will continue to push their own solutions. Their best solution so far has been banning gag clauses, which may lead to other reforms.
Isai Chavez is a contributor to Economics 21.
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