Pay-for-Performance Is No Miracle Cure
Cross-posted with US News
A recent trend favored by some large insurers who cover prescription drugs, according to the Wall Street Journal, is to negotiate prices paid for a drug that vary depending on how well it works for some set of insured patients. The issue, known as pay-for-performance, primarily arises with very expensive cancer drugs that may help with a variety of different cancers but often work better for one in particular.
Specifically, the large pharmaceutical benefits manager Express Scripts wants to pay less for a cancer drug called Tarceva for pancreatic cancer patients than for lung cancer patients because clinical trials show that, while it extends survival in both cases, the increase is months for lung cancer versus weeks for pancreatic cancer. Roche, one of the co-marketers of Tarceva, currently charges $6,850 per month for the treatment, and, although no one is willing to spell out specific details, the idea would be to pay less for the drug for pancreatic cancer patients than for lung cancer patients. This concept was proposed last year by a physician practicing economics named Peter Bach, and (perhaps surprisingly or suspiciously) drugmakers (like Roche's Genentech unit) have made favorable comments about the idea.
The underlying concept does, however, have a long and checkered history in economics, where it goes by the unlovely name of price discrimination and already occurs in a variety of settings where the seller has the power to control its price and to tell who is using its product. For example, airlines charge more for the same seat when purchased by a late-booking business traveler than by a foresighted retiree, or theaters charge more for the same movie on a Saturday night compared to a Sunday matinee.
Express Scripts and other insurers, it seems obvious, are tempted by the prospect of getting the same product for less – and presumably imagined a sequence in which Tarceva is sold for a lower price to pancreatic cancer patients while the price remains the same for the lung cancer patients. What insurers can offer to drug sellers that the seller cannot itself accomplish is access to the information on characteristics of patients (e.g., the type of tumor) and assurance that a treatment sold at a low price for a pancreatic cancer patient will not be used for a lung cancer patient: The insurer can keep the markets separate in a way the seller cannot.
So is going from a uniform price regime to one of price discrimination a good idea or not? Unsurprisingly, given that this is an economic question, the answer is ambiguous and depends on who will benefit and the particular circumstances. To begin with Express Scripts' bottom line, price discrimination might not lower the company's total claims costs. First, it seems likely that if the price falls for pancreatic cancer patients, the rate of use for such patients will increase from what it is now. For those patients who would have used it even under the old high price the insurer saves money, but for the new users it spends money – and if there is enough of an increase in demand, Express Script may end up spending more.
But there is another consideration – the drug works very well for lung cancer patients and has few close substitutes, so Genentech might reexamine the price it charges for those patients and increase it. (Genentech and other drugmakers often explain their pricing based on the value of the benefits from their product.) The drugmaker presumably set its initial price to attract at least some pancreatic cancer patients, but if those lower-value buyers are separated out, the company can charge for the remaining high-benefit patients what it is really worth to them – which could mean a higher price.
The bottom line is that the new weighted average of high and low prices could end up being higher than the $6,850 starting point. It might be more praiseworthy if, instead of discriminating based on the type of disease, drug companies set lower prices for lower-income buyers to help them afford treatments which are of low monetary value, as suggested by my colleague Patricia Danzon. But that is not what Express Scripts or Bach have in mind.
Now we get to the most counterintuitive part of the impact of implementation of price discrimination – even as it may lead to higher seller revenues (paid ultimately by consumers), the fact that the product is now used by more patients who benefit from it means that, from the perspective of society, there may be an overall improvement in both health outcomes and welfare. While making more of the drug will entail some resource costs, that additional cost is likely to be low. So the health benefits (primarily to pancreatic cancer patients whose prognosis is otherwise hopeless) may more than offset the additional costs of making the product – and society as whole then is better off.
But here's the rub: The additional revenue for drug companies will be larger than the cost of making more doses of the drug and may well be larger than the value of the additional health benefits. Drug company stockholders, many of whom are American, will have captured a disproportionate share of the benefits to society. Indeed, if the drugmaker with a patent could set the price for every buyer just a little lower than to the benefit to that buyer, almost all of the gains from having a new product put on the market will go to the seller, and buyers will be no better off than if the product did not exist.
This theoretical nightmare is unlikely to be experienced precisely in practice – sellers are not that smart – but it raises the practical prospect that paying based on value can be, at best, a mixed blessing – and the distribution of benefits from moving to a price-discriminatory world are unpredictable. Of course, a regulation that prohibited a drug seller from raising its price for the high value treatments might be an answer. But so far in the U.S., we have not been willing to run the risk of government regulation of drug pricing, just because there are so many conflicting interests and no bright line to lead government officials to choose a better price.