Why do prescription drugs cost so much in the United States? Even for patients with health insurance, the cost of medications can be steep. A new research paper co-authored by Richard Zeckhauser, Frank Plumpton Ramsey Professor of Political Economy at Harvard Kennedy School, and Richard Frank, Margaret T. Morris Professor of Health Care Policy at Harvard Medical School, offers a diagnosis of the problem, and a prescription for what to do about it.

The Diagnosis

Medicare, through its Part D optional coverage program, pays a substantial portion of the national drug bill. In 2015, U.S. government spending on Part D of Medicare reached $80.1 billion, a 74 percent increase from 2007. Consumers often aren’t aware of the true cost of drugs since insurance companies don’t always disclose them, and the federal government is precluded from negotiating with pharmaceutical companies.

Just a handful of high-cost drugs account for much of the Medicare Part D spending, the authors explain in the paper, and while some of them are highly effective, others are less so, considering their cost. Because these drugs often have little competition in the market, there are few incentives for companies to lower the prices. Zeckhauser and Frank argue that a remedy could emerge by focusing on a very costly component of Medicare Part D, the so-called “reinsurance region,” the range of coverage that kicks in once a consumer has spent $4,950 on drugs in a calendar year.

The Prescription

The authors offer a framework for the government to negotiate some drug prices with pharmaceutical manufacturers given three conditions: the drug is a unique product with few competitors; most of its costs will be paid for in the reinsurance region; and expenditures on the drug will make up a meaningful portion of the Part D bill. Zeckhauser and Frank conclude that an ideal payment framework will take into account a drug’s effectiveness, and provide higher payments for higher-value drugs.

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Richard Zeckhauser

Frank Plumpton Ramsey Professor of Political Economy
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