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THE PRESCRIPTION DRUG FAIRNESS FOR SENIORS
INDUSTRY MYTHS VS. REALITY
Prepared by the Minority Staff
Special Investigations Division
Committee on Government Reform
U.S. House of Representatives
April 2000
Industry Allegation: The legislation extends price controls to the pharmaceutical
industry.
The Facts: The Prescription Drug Fairness for Seniors Act (H.R. 664) does not impose
price controls on the pharmaceutical industry. Instead, the legislation ends price discrimination.
Under the legislation, companies can set their best price at whatever level they want. The goal of
the bill is to allow senior citizens access to prescription drugs at these same low prices.
Since drug companies closely guard their drug prices as trade secrets, the best publicly
available indicator of the industry's "best prices" are the prices that the industry charges the
federal government. For this reason, the bill requires the drug companies to make their drugs
available to pharmacies for resale to senior citizens at the lowest prices the drug companies
charge the federal government.
If a drug company refuses to extend its lowest federal prices to the senior citizen market,
the only consequence to the drug company is that the federal government will no longer buy
drugs from the company. In this way, the bill uses the buying power of the federal government
to end price discrimination and help seniors gain access to the drug companies' lowest prices.
The nonpartisan Congressional Research Service has concluded that H.R. 664 does not
set drug prices. According to CRS, the bill "would not establish a specific price at which
prescription drugs must be sold; the bill would require that prescription drugs intended for senior
citizens be sold to pharmacies at the best available government price."(1)
Industry Allegation: The lowest federal prices mandated by the bill are in effect
price controls because the prices are set by statute and are lower than the prices that
private-sector buyers must pay.
The Facts: The federal government buys its drugs under a multitude of programs. Some
of these programs (such as the Federal Supply Schedule (FSS), the VA Formulary, and the VA
"Blanket Price" Program) determine prices through voluntary negotiations between the federal
government and each participating manufacturer. Other programs (such as section 340B of the
Public Health Services Act) use statutory discounts. One government program (the Medicaid
drug rebate program) explicitly ties the statutory discounts for drugs participating in the
Medicaid program to the best private-sector prices, but is prohibited by statute from making this
"best price" information publicly available. Although these programs use different mechanisms
for acquiring drugs, their common goal is to obtain prices for the federal government that are as
low as those offered to the most favored private-sector purchasers.
It may be true, as the drug companies assert, that some private-sector buyers pay more for
their drugs than the federal government. The crucial question, however, is what are the prices
that the industry charges its most favored private-sector customers. The pharmaceutical industry
has never asserted that these most favored customers must pay more than the federal government.
Furthermore, GAO has confirmed that "federal supply schedule prices represent the best publicly
available information on the prices that pharmaceutical companies charge their most favored
customers."(2)
A recent study by the Department of Health and Human Services investigated
prescription drug pricing. This study found that although FSS prices are lower than the prices
that many private-sector purchasers pay for prescription drugs, there are probably "cases where
... third parties achieved prices below this FSS price."(3)
Industry Allegation: The legislation will force the pharmaceutical industry to
reduce research and development expenditures.
The Facts: Historically, there is no evidence to support the industry's claim that
preventing pharmaceutical companies from overcharging for their products reduces research. In
1984, Congress passed the Hatch-Waxman Act, which increased the availability of generic drugs
and provided more competition for brand name drugs. Before the legislation was enacted, the
pharmaceutical industry testified that, "the bill under consideration today could result in a decline
in scientific research and innovation."(4) According to the industry,
The bill's proposed restrictions . . . could have far ranging adverse effects on the
development of new technology in this country, including serious implications for
the future of university-based research and the emerging and vitally important
field of biotechnology research . . . Investment in private pharmaceutical research
is likely to decline and will no longer provide the kind of products that have
brought such an improvement in public health over the last 30 years.(5)
However, this legislation did not reduce innovation in the pharmaceutical industry.
Indeed, according to industry data, over the next five years pharmaceutical companies more than
doubled their investment in research and development, from $4.1- billion to $8.4 billion.(6)
In 1990, Congress passed legislation that created the Medicaid drug rebate, requiring drug
companies to reduce their prices for drugs sold to the Medicaid program. At the time, the
Pharmaceutical Manufacturers Association opposed legislation to reduce Medicaid drug prices
because "[i]ncentives for pharmaceutical research will be reduced."(7) This legislation, however,
did not reduce innovation in the pharmaceutical industry. Since 1990, pharmaceutical companies
again more than doubled their spending on research and development, from $8.4 billion in 1990
to $21.1 billion in 1998.(8)
Industry spokesmen have themselves conceded that the research and development
argument is a red herring. According to Jeffrey Trewhitt, a spokesman for the Pharmaceutical
Research and Manufacturers of America, competition within the drug industry will keep the
industry from reducing research and development: "Basically, companies are going to do
whatever they need to do to be able to have the money necessary to spend on research and
development, even if its $24 billion a year and still going up."(9)
Industry Allegation: If the legislation is enacted, the pharmaceutical industry
simply will not be able to afford to pay for high levels of research and development.
The Facts: There is no support for the industry's assertion that it could not afford its
research and development budget if the legislation were enacted. While the pharmaceutical
industry currently spends $17 billion annually on research and development,(10) it spends $11
billion annually on advertising and marketing(11) and reported $26.2 billion in profits in 1998.(12) Its
operating profit margin is 28.7% -- nearly three times higher than the profit margin of other
manufacturers of branded consumer goods.(13) Even if the legislation had the effect of reducing
industry revenues, the industry could afford to maintain or even increase its spending on research
and development.
While the industry's research and development expenditures are relatively large as a
percentage of revenue, they are not high as a percentage of profit when compared to other large
U.S. companies. For example, Ford's expenditures on research and development in 1997 were
equal to 90% of its profits, whereas Merck's expenditures on research and development were
equal to only 37% of its profits.(14)
This industry assertion of reductions in research also assumes a decrease in drug industry
revenues - an assumption that is not shared by independent analysts in the securities industry.
Reducing prescription drug prices will lead to an increase in the volume of sales, as seniors that
were previously unable to afford prescription drugs would now be able to afford their
medications. According to a recent Merrill Lynch analysis:
Volume increases could overwhelm negative pricing impact. It is important to
remember that a reduction in prescription drug prices, both with or without
associated prescription benefit coverage, is likely to be associated with price
elasticity and increased utilization (especially for Medicare recipients that currently
have no drug coverage).(15)
Industry Allegation: The legislation does not guarantee lower prices because
pharmacies, not drug companies, are responsible for the high retail markups paid by
senior citizens.
The Facts: At the retail level, the pharmacy market is highly competitive: if consumers
are unhappy with the prices charged at one retail outlet, they can buy their prescription drugs at a
different outlet. This competitiveness guarantees that pharmacies will pass on to senior citizens
the benefits of any lower prices for prescription drugs. According to a leading academic expert,
Professor Stephen W. Schondelmeyer, the head of the University of Minnesota's Department of
Pharmaceutical Care and Health Systems:
Once a patient is on a given prescription medication, the patient becomes a price
competitive consumer. . . . Any discounts passed on to community pharmacies will be
passed on to the consumer, or payor, of the prescription because of the competitive retail
environment."(16)
The analyses by the minority staff of the Committee on Government Reform demonstrate
that the legislation will be effective: lowering prices that pharmacies pay for prescription drugs
will lower retail prices for seniors. The studies compare the retail markup due to pharmacies
with the total markup paid by retail customers. They find that drug companies, not retail
pharmacies, are responsible for the significant differential between the prices paid by retail
customers and the prices paid by the drug companies' most favored customers. The analyses
find that while the average retail price differential is over 100%, pharmacy markups account for
only 22% of the price paid by retail customers. This indicates that it is drug company pricing
policies, not pharmacies, that are responsible for the high prescription drug prices paid by
seniors.
Industry Allegation: The legislation does not address the problems with Medicare.
It fails to provide seniors with what they really need: complete coverage for prescription
medicines.
The Facts: The ideal solution for seniors would be to enact a Medicare drug benefit -- a
solution supported by many members of Congress. Questions have been raised about the price
tag of this benefit, however. A comprehensive Medicare drug benefit has been estimated to cost
$20 to $40 billion annually.(17) In July, the Clinton administration announced a plan to provide
prescription drug benefits for all Medicare recipients.
The Prescription Drug Fairness for Seniors Act is an intermediate step that reduces drug
prices for seniors without costing the federal government anything. It will measurably improve
the quality of life for senior citizens by lowering the price of prescription drugs by as much as
40%. A senior citizen spending $150 a month on prescription drugs could save over $700
annually under the legislation.
It is ironic that the pharmaceutical industry criticizes the legislation for failing to provide
a comprehensive Medicare drug benefit. Although the drug companies now say that they support
the inclusion of prescription drug benefits in private-sector Medicare HMOs, they continue to
resist including prescription drug coverage as a universal Medicare benefit. As the New York
Times recently reported, "drug companies are gearing up to fight any plan for the Government to
provide prescription drugs as a basic benefit in the traditional Medicare program."(18) In July, the
same companies began a "multimillion-dollar" advertising campaign designed to fight efforts to
reduce prescription drug prices for seniors.(19)
1. Congressional Research Service, The Cost of Prescription Drugs for the Uninsured
Elderly and Legislative Approaches, 17 (Nov. 24, 1999).
2. Letter from William J. Scanlon, Director, GAO Health Financing and Public Health
Section (April 21, 1999).
3. Department of Health and Human Services, Report to the President: Prescription Drug
Coverage, Spending, Utilization, and Prices, 108 (Apr. 2000).
4. Testimony of Jack Stafford, President, American Home Products, before the Senate
Subcommittee on Courts, Civil Liberties, and the Administration of Justice (June 27, 1984).
5. Id.
6. Pharmaceutical Research and Manufacturers of America (PhRMA), Leading the Way in
the Search for Cures (1998) (www.phrma.org/publications/brochure/leading/index.html).
7. Testimony of Gerald J. Mossinghoff, President, Pharmaceutical Manufacturers
Association, before the House Subcommittee on Health and Environment (September 14, 1990)
(attachment to testimony dated May 22, 1990).
8. Leading the Way in the Search for Cures, supra note 4; Drugs on Trial, Fort Lauderdale
Sun Sentinel (June 13, 1999).
9. Drug Lobby Fights Bill for Senior Citizens, Portland Press Herald (Feb. 18, 1999).
10. Drug Dependency: U.S. Has Developed an Expensive Habit, Wall Street Journal (Nov.
16, 1998).
11. Id.
12. 1999 Fortune 500 Industry Snapshot: Pharmaceuticals (1999) (on line at
www.pathfinder.com/fortune/fortune500/ind21.html).
13. Houlihan Lokey Howard & Zukin, Expert Analysis of Profitability (Feb. 1998).
14. Annual Report of Ford Motor Co. for the Fiscal Year Ended Dec. 31, 1997; Annual
Report of Merck & Co, Inc. for the Fiscal Year Ended Dec. 31, 1997.
15. Merrill Lynch, Pharmaceuticals: A Medicare Drug Benefit: May not be so Bad (June
23, 1999).
16. Schondelmeyer, Stephen W., PRIME Institute, University of Minnesota, Competition
and Pricing Issues in the Pharmaceutical Market, University of Minnesota, 12 (August 1994).
17. Medicare Reformers Seek, Once Again, to Implement Drug Benefits for Elderly, Wall
Street Journal (Nov. 17, 1998).
18. Clinton's Plan to Have Medicare Cover Drugs Means a Big Debate Ahead in Congress,
New York Times (Jan. 23, 1999).
19. Washington Post, Drugmakers Launch Campaign on Medicare (July 28, 1999).
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