High Prescription Drug Prices Hit Pension Plans, Hurt State and Local Taxpayers

While high prescription drugs costs are most often seen as a problem for individual consumers or the federal Medicare program, they also significantly impact state and local governments. Reining in these costs could benefit local and state agencies struggling to pay for employee and retiree medical benefits.

The federal government estimates that retail prescription drugs cost $333 billion in 2017, with pharmaceuticals administered in hospitals and medical offices adding about $150 billion more. A large share of third-party payments for prescription drugs are shouldered by state and local governments, which usually provide employee health insurance and other post-employment benefits.

The Legislative Analyst’s Office finds California’s Medi-Cal program spends around $8 billion a year on prescription drugs. The Los Angeles County Department of Health Services spends $242 million a year on prescription drug purchases, according to County Supervisor Janice Hahn.

Across the state, California’s public agencies have almost $200 billion of unfunded other post-employment benefit obligations (OPEBs). About one-seventh of those unfunded liabilities can be attributed to prescription drugs. OPEB burdens fall most heavily on certain local governments, with the Los Angeles Unified School District’s $15 billion worth of unfunded OPEB liabilities being the most visible case in Southern California.  Aside from providing retiree health coverage, the school district, like most public sector employers, shoulders the high cost of covering active employees and their dependents.

Given taxpayers’ exposure to prescription drug prices, advocates of small, efficient government should welcome parts of Gov. Gavin Newsom’s efforts to come to grips with this problem. Upon taking office, Newsom issued an executive order centralizing state drug purchasing into a single agency which will use its enhanced bargaining power to negotiate with pharmaceutical companies.  The order also invited local governments and private sector entities to join the state’s bulk purchasing initiative. Los Angeles County recently announced it would join Newsom’s initiative, further increasing its buying power and spreading the potential savings. Other counties could follow suit.

At first blush, this plan may seem like an attack on pharmaceutical companies who bear steep costs for securing the Food and Drug Administration’s (FDA’s) approval for new drugs. But it’s important to note that bulk purchasing is not the same as price controls: Newsom’s order does not compel drug companies to sell their products at a legislated price. It simply gives a state agency the ability to drive a hard bargain with suppliers on behalf of taxpayers.

Drug companies might not like that aspect of it, but there are other ways in which they clearly benefit from government interventions in the pharmaceutical market. In a pure free market, competition would restrain drug prices to a relatively small margin over the cost of production. But federal laws and regulations create monopolies for many prescription medications.

Patents, which often provide 10-to-20 years of protection against competitors, are usually justified as a return for companies bearing the costs of research and obtaining FDA approval. But, in many cases, companies receive lucrative patent protection without making large investments. For example, drug companies have learned to work the system by creating “me-too” drugs, which are very similar to existing medications but still qualify for extra patent protection.

AstraZeneca used this tactic when the patent on Prilosec, its gastro-esophageal reflux disease medicine, was expiring.  The company patented an almost identical medication named Nexium and urged doctors to prescribe it in lieu of Prilosec, which was switched from prescription to over-the-counter dispensing. Many patients opted for Nexium over Prilosec despite a massive price difference, because their insurance would cover the prescription drug —Nexium— while Prilosec OTC was not covered by most plans.

Overhauling the patent process along with shortening and streamlining the FDA’s long and expensive drug-approval process would increase competition and lower drug prices. Until that happens, the state, county and local government purchasers are wise to use their negotiating power to lower prescription drug prices borne by taxpayers.

This article first appeared in the Orange County Register.