№ 043 — The Formulary — American Dividend Fund

The problem

Americans spend around $450 billion a year on prescription drugs, net of rebates. Comparative work by RAND has put US prices at roughly 2.5 times the average of other wealthy countries across all drugs, and closer to 3.4 times for brand-name products specifically.

Before going further, one thing has to be said plainly, because most writing on this subject omits it and is dishonest for the omission: the American generic drug market is excellent. Generics are about 90 percent of prescriptions filled and only around 13 percent of spending, and Americans often pay less for them than Europeans do. The problem is not "drug prices." It is brand-name prices, and it is the machinery in between.

That machinery is the strange part.

A drug has a list price, which is fictional. Off that list price flow rebates, negotiated confidentially between manufacturers and pharmacy benefit managers, that never appear in public data. The gap between list and net has grown into what the industry calls the gross-to-net bubble, and it is measured in the hundreds of billions of dollars a year.

Three PBMs control roughly 80 percent of that market. They are, in each case, owned by or integrated with a major insurer, and in some cases with a pharmacy chain. Their compensation has historically been tied to the rebate, which means to the list price. That single fact explains a great deal of otherwise inexplicable behaviour, including insulin list prices that rose by many hundreds of percent over two decades while net prices moved far less. A high list price with a large rebate can be more profitable to the intermediary than a low price with none.

The result is a market in which the manufacturer, the PBM, the insurer, the pharmacy and the patient all face different prices for the same molecule, and the patient, particularly an uninsured or high-deductible patient, is the only one paying the fake number.

At the other end of the market, there is a shortage problem that runs the opposite way. Sterile injectables, basic chemotherapy agents, and a rotating list of off-patent essentials go into shortage regularly, because the margins are so thin that only one or two manufacturers remain and a single plant inspection can empty hospital shelves. Here the price is too low to sustain supply, and no amount of negotiation helps.

The proposal

Publish the real price. Pay pharmacy benefit managers a flat fee for a service instead of a share of a markup. Extend Medicare's negotiated prices to every payer. And build a public manufacturer for the essential drugs nobody will make.

How it would work

Net price transparency. Manufacturers report actual net transaction prices, by product and channel, to a public database with a short lag. Not list prices. Not average wholesale price, an invented number that has been litigated over for decades. What was actually paid.

PBMs become fiduciaries paid in dollars. Compensation delinked from list price and from rebate size, replaced by a flat per-claim administrative fee, with a statutory fiduciary duty to the plan sponsor and full pass-through of manufacturer rebates. This is the single highest-leverage item here and the one the incumbents will fight hardest, which is usually the same sentence.

Negotiation, extended. The Medicare negotiation authority enacted in 2022 covers a small annual tranche of high-spend drugs. Expand the number, shorten the delay before a drug becomes eligible, and make the negotiated price available to all payers, including commercial plans and cash-paying patients, rather than to Medicare alone. A negotiated price that only one buyer may use is a subsidy from everyone else to that buyer.

A public manufacturer of last resort. A federally chartered non-profit manufacturer, with authority to produce off-patent essential drugs that are in shortage or supplied by fewer than three makers, selling at cost plus a fixed margin. The model exists: Civica Rx has been doing this for hospitals since 2018, and California's CalRx has pursued it for insulin. This addresses the shortage half of the problem, which negotiation cannot touch.

Patient-facing prices tied to net. Coinsurance calculated on the net price rather than the list price, ending the arrangement in which an uninsured or deductible-phase patient pays a number that no institution in the chain actually pays.

Innovation held harmless where it is real. Genuinely novel first-in-class medicines get a defined exclusivity runway before negotiation eligibility. What does not get protection is the pattern in № 042: incremental reformulation, patent thickets, and exclusivity extended by filing rather than by discovery.

The numbers

PBM reform. Rebates run to something like $200 billion a year gross. Independent analyses of delinking and full pass-through suggest system savings in the tens of billions annually, with the largest gains to cash and high-deductible patients whose out-of-pocket cost currently tracks a fictional number.

Extended negotiation. The Congressional Budget Office scored the 2022 Medicare negotiation provisions at roughly $100 billion of federal savings over a decade from a narrow tranche. Widening the tranche and extending negotiated prices to commercial payers plausibly triples the effect economy-wide, on the order of $30 billion a year across all payers.

Public manufacturing. Small money doing specific work: standing up sterile injectable capacity is a low single-digit billions capital programme, against a shortage problem that periodically forces oncologists to ration chemotherapy in the wealthiest country on earth.

The cost side, stated first rather than buried. CBO's analysis of aggressive international-reference-pricing proposals estimated on the order of ten fewer drugs approved over thirty years, out of roughly 1,300 expected. This proposal is considerably less aggressive than what CBO scored, so the effect should be smaller. But it is not zero, and the honest framing is a trade: tens of billions a year in savings and a functioning supply of essential generics, against some number of medicines that will not exist. We think that trade is worth making. We are not going to pretend there is nothing on the other side of it.

The honest objections

"Every dollar you take out of pharmaceutical revenue is a dollar of research not done. People will die of drugs that were never invented." The central objection and the one that deserves the most respect, because the causal chain is real: revenue funds R&D, and lower expected revenue lowers investment. Three things temper it. A large share of what is being cut here is intermediary margin rather than manufacturer revenue, and no molecule was ever discovered by a PBM. The revenue being protected is disproportionately concentrated in incremental products rather than first-in-class ones, which is what item 6 tries to separate. And the counterfactual is not a world where Americans keep paying and everyone is fine; it is a world where American patients ration insulin. The unseen cost of the drug not invented is real, and so is the visible cost of the drug not taken.

"America is subsidising the world's pharmaceutical innovation, and you are proposing to stop without any guarantee others will pay more." Largely true as a description. The US is roughly half of global pharmaceutical profits on a much smaller share of global population, and other rich countries free-ride on that. The uncomfortable answer is that this proposal does not fix free-riding, because no domestic policy can. Trade policy might, and that is a different proposal. Meanwhile, "we are being taken advantage of, therefore we should continue" is not an argument, and American patients are not obliged to fund the world's drug development indefinitely because the alternative is diplomatically hard.

"Price regulation means delayed access. Europeans wait months or years longer for new medicines." Well documented and a real cost of the European approach. It is also why item 3 negotiates prices rather than setting them by reference to foreign benchmarks, and why item 6 preserves an exclusivity runway. The launch-delay mechanism in Europe is driven largely by country-by-country health technology assessment and reference-price spillovers, neither of which this design imports.

"You are heading toward the government deciding which lives are worth treating." Cost-effectiveness thresholds, quality-adjusted life years, and the machinery of formulary exclusion are genuinely contentious, and this proposal deliberately does not adopt a QALY threshold. What it negotiates is price, not coverage. That said, any negotiation implies a walk-away point, and a walk-away point is a judgment about value. Anyone claiming their drug pricing proposal contains no such judgment has hidden it rather than avoided it.

"A government drug factory will be expensive, slow, and badly run." Possibly. Which is why item 4 is a chartered non-profit rather than a federal agency, is confined to off-patent products in documented shortage, and has a private precedent that already works: Civica Rx was founded by health systems for exactly this reason and has supplied hospitals for years. If it cannot beat the price of a functioning three-supplier generic market, it should not be operating in that molecule at all, and the shortage trigger in item 4 is what keeps it out.

Sources

US prescription drug spending and international price comparisons; RAND Corporation, International Prescription Drug Price Comparisons (US prices approximately 2.5x the OECD comparison average overall, 3.4x for brand-name) (rand.org)
Generic share of prescriptions (~90%) versus share of spending (~13%); Association for Accessible Medicines
PBM market concentration, with three firms administering roughly 80 percent of prescription claims; Federal Trade Commission interim staff reports on pharmacy benefit managers (ftc.gov)
Gross-to-net rebate flows; SSR Health and IQVIA analyses of list versus net price divergence
Inflation Reduction Act of 2022, Medicare Drug Price Negotiation Program; CBO cost estimates (cbo.gov)
CBO, Research and Development in the Pharmaceutical Industry (2021), on estimated effects of lower expected revenues on the number of new drugs
FDA drug shortage database, with persistent shortages concentrated in off-patent sterile injectables (fda.gov)
Civica Rx (founded 2018) and California's CalRx initiative, as public-interest manufacturing precedents
Proposals № 004 (CitizenCare); № 042 (The Patent Bargain)