The Washington PostDemocracy Dies in Darkness

The perils of value-based pricing for prescription drugs

How do you determine the value, and the price, of life-saving medication?

(Elise Amendola/AP)

As pharmaceutical companies emerge from congressional hearings unscathed, pointing to exciting new medicines and the high cost of research and development (R&D), the question remains: How will society pay for the escalating costs of prescription medicine?

While the lifesaving implications of many medications are remarkable, the costs are equally breathtaking. In February, for example, Medicare released a proposal to cover the expensive CAR-T cancer drug. These treatments can cost $1.5 million per treatment.

To address paying these high costs, drug companies have proposed alternative payment mechanisms, such as health care loans (HCLs) or drug mortgages that would distribute the high upfront cost of a drug over several years. As anyone with a credit card knows, however, the debt can quickly escalate and, eventually, it comes due. These proposals would do little to solve the underlying problem of massive costs.

In a surprising twist, however, one approach is drawing support from across the political spectrum: value-based pricing. This concept suggests that a product’s price should be based on the value that the customer perceives from a product. The focus on customer perception makes value-based pricing particularly handy for industries in which demand can be driven through emotion, such as fashion.

As adapted to the pharmaceutical industry, value-based pricing attempts to measure the quality and quantity of life generated by a drug. But how are these values derived? The scientific field itself lacks a straightforward method of determining what would count as evidence of value. Would improvement after one month of therapy justify a highly expensive drug? If the patients receive some benefit, but their lives are extended by only a few months, would that be sufficient?

Just as significant are the deeper issues we need to confront before embracing such ideas. Economically, basing price on value does nothing to reduce the efforts by drug companies to manipulate the rewards of the system — it might even make things worse. And morally, a value-pricing system brings us face-to-face with questions regarding the actual worth of the very medical innovations on which we now depend as a society.

Consider, for example, the marginal cost of making a drug in the factory, which is quite low. In fact, as explained by Neeraj Sood at University of Southern California, the gross profit margin for pharmaceutical companies is 76 percent on brand-name drugs. Of course, the cost of producing the medicine in the factory is only a small piece of the overall drug manufacturing puzzle. Profits and patents form the pillars of an incentive structure that is critical for fostering innovation.

Developing these medications is time-consuming and costly, and their value — their ability to save lives — is in some ways immeasurable, as we can glimpse from a look back in history. Actress Vivien Leigh, whose performance opposite Clark Gable in “Gone with the Wind” earned an Oscar, died of tuberculosis in 1967. The type of tuberculosis she most likely contracted would be treated today with antibiotics. And although penicillin was the first successful treatment for tuberculosis, new resistant strains are a reminder of the importance of continued pharmaceutical innovation.

Similarly, the author of “Pride and Prejudice,” Jane Austen, probably died of Addison’s disease, an adrenal gland disorder that is treatable today. Although Thomas Addison identified the disorder in a monograph in 1855, it would be more a century before synthetic corticosteroids were developed, which now form the basis of treatment.

R&D for such treatments — including creating the medication, stabilizing it for mass production, going through extensive clinical trials and obtaining approval from the Food and Drug Administration — takes time, patience and money. Patents then protect this investment, as companies would be unlikely to invest in such an arduous process if the resultant drug could be immediately copied.

But R&D costs have long been over-projected by the drug industry. As the former CEO of GlaxoSmithKline commented, the billion-dollar price tag for drug development is “one of the great myths of the industry.” It includes inflated development costs, and such studies have cherry-picked the most expensive drugs to develop, ones that account for only about 20 percent of new drugs.

Some of those studies also throw in figures such as opportunity costs — that is, projections of what the company could have done with its money if it had not engaged in research. It is a little like saying, “Even though I paid $100 for a sport coat, I’m claiming it cost $2,000. Because if I hadn’t bought the sport coat, I could have bought a share of Google stock that might have skyrocketed in value.” That is a puzzling way to measure what a company spends on R&D.

Additionally, companies frequently argue that the “cost of producing a drug” should include the cost of failed attempts to produce other drugs. This argument is used to justify the various ways in which companies extend their patent protection, lengthening their periods of monopoly pricing. Including the cost of failed attempts is a strange concept, however, when the patent system is designed to reward success. Specifically, the question for patentability is not how much work you put into an invention but whether the invention actually works.

This notion is rooted in the Constitution itself and has been used to reject such quixotic patent applications like perpetual motion machines and cures for baldness. Quite simply, the U.S. Constitution gives Congress the power to confer patents for “limited times” to useful inventions that represent sufficient progress in their art. This is true historically for medicines, as with every other type of patented invention. The original groundbreaking formulation for insulin earned a patent in 1923, while a patent for whitening the skin by applying whole milk was rejected in 1939 because, to no one’s surprise, it simply did not work.

Yes, we want to incentivize innovation, but a patent is not a participation trophy. Inventors do not get a patent for the inventions they tried and failed to create. Similarly, the reward they receive from a patent should not include compensation for those other failures.

Along with these economic issues, the value-based pricing concept brings some pressing moral questions to consider. As one commentator explained, for example, the value to me of giving my child a polio vaccine may be $1 million per dose, because it would be worth that to avoid my child succumbing to polio. But such pricing is both utterly impractical — the U.S. health-care system would collapse if each vaccine cost $1 million per dose — and would defeat the purpose of eradicating the disease. Polio plagued millions before 1955, including former president Franklin D. Roosevelt and Senate Majority Leader Mitch McConnell, but today the basic vaccine is routinely given to American children at an affordable cost.

Indeed, everything we do with pharmaceuticals may have value, but can we afford all that, particularly when our ability to value life and comfort is subject to such irrationality? Before we slide headlong into value-based pricing, we should think carefully about the impact of this approach. Specifically, in contemplating value, society should think in terms of what I would call “cumulative value”: If the national budget for drug spending is a certain amount (or an average budget for per-person drug spending is a certain amount), how much of that amount does it make sense to spend on this particular advance? Otherwise, if value is open-ended and has no sense of total upper boundaries, we could value ourselves into budget oblivion.