Editorial: Here’s how Medicare should negotiate drug prices

The Inflation Reduction Act, passed last year, gave Medicare the authority to negotiate drug prices for the first time. The government will start with 10 medications, which were announced last month. Now it just needs to figure out how much they should cost.

When Congress created Medicare’s prescription-drug benefit in 2003, it prevented the government from haggling with drugmakers — a coup for the industry. Medicare’s new powers are forecast to reduce out-of-pocket costs for seniors and save nearly $100 billion over a decade. For consumers accustomed to paying the highest drug prices in the world, that’s unequivocally good news.

Yet the government needs to strike a careful balance. The goal should be to push prices down while preserving incentives to develop new and better treatments. With this in mind, the law directs Medicare to find the “lowest maximum fair price” while “appropriately rewarding innovation.”

Officials have spent months laying out in painstaking detail how the negotiations will proceed. Nowhere do they explain how Medicare will come up with a “fair price.”

Many other countries have solved this dilemma using what’s called cost-effectiveness analysis, a quantitative method applied regularly within the pharmaceutical industry and by government negotiators to determine how much a drug should cost. Cost-effectiveness seeks to weigh the health benefits of a treatment against its price. It can help health officials with limited resources answer difficult questions such as how much a vaccine should cost during a pandemic, or whether a new Alzheimer’s treatment is worth its $26,500 price tag. For the coming negotiations, it would determine if a drug delivers sufficient health benefits for seniors while offering taxpayers good value for their money.

One might think such an objective would be central to the IRA. In fact, the law explicitly bans the most common cost-effectiveness metric — so-called quality-adjusted life years, or QALYs — from negotiations. Certain interest groups had complained that QALYs discriminate against people with long-term illnesses or disabilities (on the dubious rationale that “sick” years are assigned lower scores than “healthy” ones). The pharmaceutical industry, for its part, doesn’t like the government using QALYs to meddle in the business of pricing drugs. Most other markets don’t need regulators armed with formulas to determine how much products should cost, the argument goes.

Yet the prescription-drug market is different. Patients and providers don’t make decisions about whether a treatment offers good value — middlemen do. These intermediaries, which design prescription-drug coverage and negotiate discounts for health plans, get bigger fees for more expensive medications.

As a result, payers like Medicare can’t be sure they’re getting a good deal. Other countries including Australia and the U.K. don’t have such middlemen because a single negotiator — the government — can press manufacturers for discounts. They regularly use cost-effectiveness assessments and, unsurprisingly, their prescription-drug spending is a fraction the U.S.’s.

Unfortunately, the process for Medicare won’t be so straightforward. With QALYs banned, it will need to use other (less tested) methodologies. Even so, effective alternatives exist, including some that have been developed to minimize the disparities that disability advocates cite. Medicare should embrace these metrics and be transparent with the public about its pricing methods. A quantitative framework is the clearest, most predictable way to achieve the IRA’s goals, not least because it rewards innovation by giving high marks to expensive yet very effective drugs.

It could also minimize rising legal objections to the concept of a “fair price.” The provision to negotiate drug prices could be one of the most valuable parts of the IRA, but it will only work if drugmakers and taxpayers trust the results.

A more data-driven, transparent process is critical to making that happen.