What Is Increasing the Cost of Generic Drugs? (Part II: Regulatory and Legal Reasons)

Policy Reports | Health

No. 373
Wednesday, October 07, 2015
by Devon M. Herrick

Compared to the funds spent on doctors and hospitals, prescription drug therapy is a bargain. Generic drugs are especially inexpensive, accounting for 88 percent of drug prescriptions filled but only 28 percent of expenditures on drug therapies.

Executive Summary

The average price of a brand drug falls by about 80 percent or more within a year after it faces competition from generics. Whereas the average cost of a name-brand prescription was $268 in 2011, it was only about $33 for a generic drug.

Intense competition usually holds generic drug prices in check. Oddly, during the past few years many generic drugs that have been on the market for decades have suddenly become expensive. In 2014, the price of more than one-fourth of generic drugs rose 10 percent to 100 percent or more. In other cases, old generic drugs have becomes scarce and hard to procure. The following are some of the regulatory and legal reasons drug prices are rising. 

Slow FDA Approvals Reduce Generic Competition. Over the past five years, the U.S. Food and Drug Administration (FDA) has approved an average of 400 to 500 generic drugs annually. But this is only a fraction of the applications received. The FDA still has a backlog of about 4,000 applications, with an average time to approval of more than two years.

Quality Compliance on Aging Production Lines. Old drugs are often made on aging production lines. These are sometimes shut down for maintenance or are stopped after the manufacturer is warned by the FDA that the facility is out of compliance with current good manufacturing
practices. According to the FDA, much of the problem of sterile generic injectable drugs that are in short supply is the result of poor quality compliance.

The FDA’s Unapproved Drugs Initiative. Thousands of drugs predate the approval required under the 1938 Food, Drug & Cosmetics Act — many were grandfathered but never officially approved. The FDA wants these cheap drugs off the market and replaced with more costly “approved” versions from drug makers willing to conduct clinical studies to determine the safety and effectiveness of the drugs — the standard for approval under the 1938 act.

Pay-for-Delay. So called pay-for-delay is a negotiated agreement whereby the patent holder compensates the ‘first-filer’ to delay a patent challenge for an agreed upon length of time. The Federal Trade Commission believes pay-for-delay costs consumers $3.5 billion annually due to higher drug costs.

Generic Substitution Laws. Pharmacists and pharmacies are governed by state laws and state
regulations. The degree to which states allow pharmacists to substitute cheaper generic drugs for brand drugs varies from one state to the next.

How Not to Deal with Rising Drug Prices. Barriers to competition in all forms ultimately hurt consumers,
employers, insurers, drug plans and taxpayers. If prices rise, consumers pay through higher premiums, higher taxes or lower wages. Today, most health plans include some drug benefits. Insurers and employers often hire Pharmacy Benefit Managers (PBMs) to administer drug plans. PBMs use a variety of techniques to control costs for their clients and enrollees. PBMs encourage enrollees to use cost-effective alternatives, such as generic drugs. They also negotiate with pharmacies and assemble preferred pharmacy networks to mitigate the problem of rising prices. When price volatility impacts local pharmacies, politicians often attempt to insulate drugstores and local business from the pain this causes. In the process, state lawmakers often make the situation worse. The following are some harmful regulations that should not be used to deal with rising drug prices.

Banning Efficient Pharmacy Networks. Increasingly, health plans and PBMs reduce premiums by negotiating and contracting with qualified pharmacies offering competitive prices. Some state legislatures have passed any willing pharmacy regulations that restrict the right of health plans to contract with exclusive narrow networks. 

Restricting Mail-Order Pharmacies. PBMs often use discounts and lower cost-sharing to encourage
beneficiaries to use convenient, low-cost mail-order pharmacies. Many state legislatures have tried to ban the use of financial incentives to reward consumers for using mail-order.

Restricting Maximum Allowable Cost (MAC). The wholesale cost of generic drugs can vary tremendously
from one manufacturer to the next. So-called MAC price lists are a tool health plans, drug plans and insurers use to place an upper payment limit on what the plan is willing to reimburse for a given drug. Without a limit, pharmacies would have little reason to hold down costs since they could pass the higher cost onto drug plan members. More than a dozen states have laws restricting some aspect of maximum allowable cost (MAC) lists.

How to Lower America’s Drug Bills. Generic drugs are inexpensive when there is competition, but less
so when markets consolidate and the FDA lacks the resources to quickly process competitors’ applications
to produce generic drugs. The FDA needs to clear the backlog of applications and allow competition to
flourish. This, in turn, would alleviate some of the price hikes caused by market consolidation in both drug
manufacturing and distribution. Finally, states need to resist pleas from local constituents to pass perverse
regulations designed to protect local business (and pharmacies) at the expense of competition.

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