US PRICING AND DISTRIBUTION

Although one often hears references to the "price of a medicine" in the United States, this is really an oversimplification, since for any given medicine there are a wide range of prices. At the high end, retail prices vary not only by city, but among local pharmacies. At the low end, free medicines are delivered as samples and through patient assistance programs.

GOVERNMENT PROGRAMS

In between full retail and free, prices range widely, influenced by the patient's insurance status and other factors. The lowest prices are generally paid by government programs such as Medicaid and the Veterans' Health Administration (VHA). Under Federal law, state Medicaid programs receive a 15.1% discount off the average manufacturer price (AMP) or the "best price" at which the company sells a medicine to any private sector customer in the United States, whichever is lower. AMP is the proprietary price at which the manufacturer sells the medicine to wholesalers, while Average Wholesale Price, or AWP, is a published "list price" compiled by industry analysts. A frequently cited source for AWPs is the Red Book, published by the Medical Economics Company, the same company that publishes the Physicians' Desk Reference.

Many Medicaid programs use a "Preferred Drug List" to exert pricing pressure on manufacturers. Drugs that aren't discounted below the minimum price may be excluded from the list and thus can only be prescribed with prior authorization from the state Medicaid agency. This imposes a level of administrative burden that can act as a powerful deterrent against physicians prescribing an expensive medication, ultimately hurting sales of the drug.

The VHA receives discounts that are similar to Medicaid's, although the formula is different. In addition, the VHA uses a bidding process for the "closed classes" of its National Formulary system to secure prices below those that are legally required. Securing coverage by the VHA for medicines excluded from its closed classes is even more difficult for physicians than obtaining prior authorization for a drug from Medicaid.

Medicare currently pays only for a limited number of outpatient prescription drugs -- mostly cancer chemotherapy agents, administered as intravenous infusions in a clinic or doctor's office. However, new Federal legislation has created a limited and voluntary Medicare prescription drug benefit for all Medicare enrollees, starting in 2006. In addition, for 2004 and 2005, this law included transitional prescription drug discount cards and, for low-income Medicare beneficiaries, a $600 annual subsidy. The law also changes Medicare's methods of paying for the medicines it already covers. Specifically, before 2004, Medicare reimbursed the doctor or clinic 95% of the Average Wholesale Price (AWP), a system that has been repeatedly criticized in government reports for over-reimbursing doctors and clinics. Starting in 2004, Medicare's reimbursement amounts for some of these medicines decreased to 8085% of AWP and in the future may be subject to "competitive acquisition program" pricing.

Although the new law precludes the Federal government from dictating prices or formularies, there will likely be pressure in the long run for the government to reduce the prices it pays for prescription medicines, just as it currently does for all healthcare products and services. Expensive biotech medicines may find themselves particularly vulnerable to this pressure, since the government may represent a large part of the U.S. market for these drugs, particularly if they are used primarily by the elderly and if private plans manage to avoid providing Medicare prescription drug coverage to the high risk/high cost patients using these therapies.

Overall, there will likely be considerable uncertainty over the next 5-10 years about how Medicare will price or pay for medicines, particularly new medicines, within the new benefit. Clearly, the government's continued leveraging of its legal and buying powers to minimize spending will have significant pricing implications for pharmaceuticals. The effect on drug sales depends, in part, upon whether lower prices can be offset by increased usage due to expanded insurance coverage for millions of Medicare beneficiaries.

How the changes in Medicare will ultimately affect seniors' prescription drug coverage and use will depend upon Congressional modifications to the new law, the Federal government's implementing regulations, the rate at which seniors enroll in the new benefit (inasmuch as it may initially prove of only limited value to them) and employers dropping or modifying their retiree coverage in response to the new law.

PRIVATE MARKET

In the private insurance market, discounts and rebates vary by company and medicine, with the Medicaid "best price" often creating a floor for markdowns. Contracts frequently provide for variable discounts depending on a drug's market share, rather than strictly on the volume of units purchased. Private insurers can affect a drug's market share by using prior authorization, formularies, and financial incentives. Private payers create financial incentives for patients by placing medicines in "tiers" requiring different co-payments. For example, a plan might require that patients make co-payments of $10 for generics, $20 for "preferred" medicines, and $40 or 50% of the cost for "non-preferred" medicines. Within some plans, if a medication is not "on formulary" it is classified as non-covered or "excluded," requiring patients to pay 100% of its cost. Health plans and insurance companies may also create financial incentives for physicians to use certain medicines. Particularly in staff-model health systems, these incentives can take the form of risk sharing, bonus pools, or other systems where the physician is partially responsible for the total cost of prescription drugs used by their patients.

One effect of the new Medicare pharmaceutical benefit law is to make Medicare beneficiaries more attractive to private managed care plans. Early trends indicate that managed care plans are boosting their pharmaceutical benefit and lowering premiums for Medicare beneficiaries, with the likely effect of increasing enrollment. This will place a greater percentage of the pharmaceutical market under the restrictions of managed care plans.

By establishing incentives for physicians, prior authorization policies and formularies create de facto pharmaceutical expenditure-control programs. Therefore, when formulating a compelling pricing argument, a biotech company needs to appreciate each customer's internal budgetary operations and incentives for cost control. Those with direct pharmacy spending budgets will probably be more stringent in imposing limits on drug prices and usage. Health systems that take a more integrated approach may view pharmaceutical expenditures within the context of overall healthcare spending and recognize, for example, that spending more on drugs may reduce hospitalization costs. Generally, vertically integrated health systems, such as staff-model HMOs, tend to have more integrated budgetary approaches and are thus more open to cost-saving arguments for expensive biotech products. Yet, a system that includes both physician groups and hospitals must still pay for the fixed cost of maintaining hospitals and may not derive savings from a new drug's ability to prevent hospitalizations.

A private health insurance system may also rely on a thirdparty company, called a pharmacy benefit manager (PBM), to develop and manage formularies, negotiate discounts, and manage prior authorization processes. (Integrated health systems like HMOs and the VHA may have their own internal PBMs.) In some cases, PBMs have their own internal financial incentives that can affect pharmaceutical usage.

None of these market pressures are likely to remain static. Most programs, whether private or governmental, change their pharmacy systems and contracts every year in response to new approvals of branded and generic medicines and other events. The resulting changes in prices and sales volume for individual medicines can be dramatic.

FOLLOW THE MONEY

Complex behind-the-scenes financial transactions paralleling the distribution chain also affect potential drug revenues. As a general rule, the manufacturer receives 7075% of the retail price of a medicine, 5% goes to the wholesaler, and 20-25% percent to the pharmacist. These revenue distributions can be influenced by rebates and discounts, as well as by the individual payment policies of different payers. For example, companies pay state Medicaid programs a quarterly rebate: 15.1% of either the AMP or the best price to private purchasers in the US. Additionally, the Federal rebate formula increases this percentage if the company has raised its price by greater than the Consumer Price Index. Because of the retail markup on drugs, pharmacies have traditionally been able to offer discounts (usually 10%) to seniors who lack prescription drug coverage. Some payers try to drive down their retail payments for medicines to near the pharmacist's actual acquisition costs, while compensating pharmacists with a higher dispensing fee. A biotech company should "follow the money" to understand how economic incentives influence the various links of the distribution chain.