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Evans is a senior research analyst of global pharmaceuticals at Sanford C. Bernstein & Co. He argues that if a prescription drug benefit does not pass in Congress, the battleground will shift back to the states with several consequences for the pharmaceutical industry. He tells FRONTLINE that although re-importation of drugs from Canada is only a "mild headache" for the industry, it is troublesome that Americans are becoming increasingly savvy about lower overseas drugs prices. "If I were a drug company executive, on average, I'd be very worried," Evans says. "My ability to set prices in an open market is very much under siege. And that ultimately is probably the most important economic variable that my success depends on." This interview was conducted on Nov. 7, 2003. [Also, read an earlier interview with Evans from February 2003.]


Did you feel in your most optimistic moment that maybe [the prescription drug benefit would pass] this time?

I guess in my most optimistic thinking, I did think that it was possible that we would get a drug benefit passed this time around. I have to admit I was surprised, but I did think it was possible.

What were the good signs?

The good signs that would favor passage are first of all, that you had a significant budget allocation, one. Two, you had industry on the side of passage. And three is, you've got a three-way majority of one particular party who intend to pass the bill. For those reasons, just historically, you would say that the odds were in favor of the bill.

It doesn't get much better than that.

If the Medicare drug benefit does not pass, then re-importation provisions will -- simply because they're passable; they're not terribly controversial; they don't do any harm, because they ultimately don't have any effect.

Well, it does. And in fact, when you've got your most vocal voting bloc favoring the legislation as well, that would argue that the legislation would pass also -- i.e. seniors.

Break out the constituencies. Seniors, drug companies, White House, Republicans, Democrats. What are they after?

Seniors want cheap drugs. Seniors want this drug bill, but they want it in the abstract. This drug bill and cheap drugs are not the same thing. In my point of view, 2003 is 1988 all over again, when we passed the Medicare Catastrophic Coverage Act, which included a drug benefit, which was very much advocated by seniors. However, once they saw what they had gotten, they had it repealed. I think we're going down the same pathway. In particular, the senior who has coverage today from former employment is most likely to lose that coverage and get less generous coverage from the government. That's a fairly vocal, active voter. I think the abstract idea of getting cheap pills has a lot of political traction with seniors. The reality of this drug bill in the market in 2006 does more political harm than good.

Is the drug industry worried about all this state action and so forth?

The drug industry views a Medicare drug benefit as ultimately inevitable. If that is your conviction, then you want to have that drug benefit passed on the best possible terms. And I think the industry feels that with a Republican in the White House and Republican majorities in both chambers of Congress, that now's the time.

I think also what motivates the industry to support a federal solution is the fact that the states are increasingly activist. Some states are taking what are economically extreme approaches. And history shows you that the states collectively ultimately go to the best solution. So if some of these more aggressive solutions at the state level play out, I think the industry is rightly concerned that the balance of the states go in these more extreme directions.

Like following Maine, for example?

Yes, exactly. And paradoxically, I would argue that you want the states purchasing more of the drug bill, not less, for a complex reason. To simplify it, the states buy 16 percent of drug demand. And by law, they get the best price. My biggest private client may buy a percent. The private client tells me they want a 30 percent discount. I say no, because if I give them a 30 percent discount, by law, I have to [give the same discount to] the states, who are 16 percent of my business. So, because the states are so big, and because I have to give them the best price by law, I don't discount aggressively in the private market.

If you shrink the states' consumption, then that disincentive shrinks as well, and the companies become more willing to cut their own throats in the private market and price aggressively to managed care. Economically, it's actually a good solution. But in terms of industry strategy, trying to get away from the states probably brings more negative consequences than benefits.

The Senate Democrats -- what was in it for them?

I think what is in the bill for the Senate Democrats depends very much on who you ask. If you have presidential ambitions, what's in the bill is loss of a major agenda item to your presidential campaign. So for you, I think passage of the bill would be negative. If you are a sort of Great Society advocate and you very much believe in maintaining Medicare as private, then what's in this for you is a chance to disarm the Republicans, who I believe clearly would prefer to privatize Medicare. The only way to get a senior out of Medicare and into the private market is to give them something to make that transition. That "something" is a drug benefit. If you can get this drug benefit passed without Medicare reform, then you, for example, as a Senate Democrat, have disarmed the Republicans' ability to reform Medicare.

For the Republicans, particularly in the House, it's the opposite?

I think what the Republicans see here is an economically illogical expansion of a very large entitlement, an entitlement that already crowds out a great deal of discretionary spending, and will only increasingly do so as time goes on. If this drug bill passes in its current form, depending on which side passes, the House version or the Senate version, I think Republicans see a loss of ability to rein in Medicare as a rapidly growing entitlement over time.

Their strategy is what?

To a Republican legislator, the utility of the drug benefit is two-fold. One is, it's votes. Right? Your most loyal constituency is a senior. Seniors are 20 percent of the electorate. They're the most loyal Republican demographic. And through history, they're also one of the most fluid demographics, moving back and forth between parties on single issues. So you want to maintain your grip on seniors. Accordingly, you want to answer their need for a drug benefit. That's part one.

The second reason you as a Republican legislator want a drug benefit is, you want to use it as a lure to get that senior out of Medicare and its current fee-for-service, rapidly-growing-cost form, and into the private market, where you believe you can provide health care to that person for less money.

Is the conflict really an ideological one? Or do Republicans really believe they can offer health care cheaper?

I think this debate, at its core, is ideological. However, the wrapper is electoral. ... Congress, I think, is in a very short-term focus right now. I think it's the electoral [image] that matters. ...

So there's a fundamental split between continued public Medicare and a future Medicare which would have the private sector.

There's an ideological split between Medicare delivered by government and Medicare delivered by the private market.

And it's very difficult to bridge this.

It's very difficult to bridge that gap.

The drug companies' biggest fear is working with one big purchaser?

I think the pharmaceutical industry's biggest fear is price control. And ironically, the prevailing motive here in the short term, I believe, has been to get a deal done while we have a Republican majority, and so avoid price controls.

I think what the industry has lost sight of is that even though you won't have black and white legislative statutory language authorizing price controls, government buys 52 percent of the market. What do they need legislation for? They set the price. I think the industry has lost sight of that. So from a purely economic, strategic perspective, from industry's point of view, later is better. Democrat, Republican, independent -- who cares? Later is better.

One way or another, we're entering an era—

My feeling is, regardless of the author, regardless of the prevailing political winds, a Medicare drug benefit equals a government with price control, period. Whether it's legislative price control, or de facto price control because you purchase so much of the market, it's price control.

The idea of re-importation from Canada.

Both the House and the Senate versions of the Medicare drug benefit have re-importations, which would allow pharmacies to re-import goods from Canada and stock them and sell them at the corner drugstore. The political appeal of that is obvious. Drugs are expensive. Drugs in Canada are cheaper. The drugs from Canada cost you less.

There are a couple of problems with the re-importation language in these bills. First of all, it's not going to save the consumer money. Canada buys about 7 percent of the total pills sold in North America. So let's say that I, as a corner drugstore, can now buy my fair share of Canadian pills. Behind the counter, they've got 93 pills. Ninety-three are American; seven are Canadian. And I'm going to fill, let's say, three prescriptions with that. Let's call it Lipitor. So 93 pills are American; seven are Canadian. You come in for a prescription of Lipitor. How much do I charge you? [They're] charging the American price, the Canadian price, or a blended price. Well, the reality is, I charge you the American price and I get a better profit on the seven Canadian pills. So you as a consumer simply are not going to see a discount if I, as a corner drugstore, I as a wholesaler, re-import goods from Canada. I'm going to pocket that profit.

What if I'm a state and I buy it for my workers?

Right. If you're a state and you buy the drug for your workers from Canada, you're going to save money. Absolutely.

What can the companies do about that?

The companies can do several things to get around the re-importation provisions. Two things they will certainly do. One is limit supply to Canada. Canada buys 7 percent of North American units. If you fix that number at 7 percent and you expose that market to the full force of American drug demand, prices go up in Canada. Very simple. ...

The second step that the Senate or House version of re-importation would lead to is, I would no longer sell goods outside of the United States that are FDA-approved. I would make sure that any goods I sold outside the United States were actually manufactured outside of FDA-approved facilities. So then technically those goods are no longer FDA-approved, and per both of these legislative proposals, it would be illegal to re-import those goods.

So these mechanisms would effectively stop this?

The re-importation provisions in both the House and Senate version of the Medicare drug bill are toothless.

And as for towns and states?

Towns and states are ultimately facing two things. One is Canadians' willingness to ship ultimately their own products back here for a profit, as opposed to consuming them themselves. So there is only so much supply that's going to come back across the border, first of all. Second of all, the states and municipalities are, at the end of the day, breaking the law. So ultimately I think there will be a solution to that in the courts.

So this isn't really going anywhere?

I don't think so.

The clock is ticking. Congress adjourns Nov. 21. Are you more or less optimistic than you were in June?

I'm less optimistic. We've had the entire summer and fall to bridge what is probably an irreconcilable ideological gap, and we've failed. Do I believe that we'll suddenly bridge that in the next two weeks? No. That's part one.

Part two is, we've got a $400 billion budget gap over a 10-year period. That calculation presumes that employers are going to continue to provide drug coverage to retirees. That's incorrect. I think the conferees now realize that, and in these final days are trying to find a way to incentivize employers not to dump their retirees into the government plan. I'd argue that's economically impossible.

What will happen if it doesn't pass, if Congress fails again after promising?

If the Medicare drug benefit does not pass, then re-importation provisions will -- simply because they're passable; they're not terribly controversial; they don't do any harm, because they ultimately don't have any effect. So as a legislator, you don't go home completely empty-handed. But in a practical sense, you've really accomplished nothing. So if Medicare drug benefit does not pass, re-importation independently does pass.

And you're saying that's just a mild headache for the drug companies?

Absolutely. If re-importation passes, it's only a mild headache for the drug industry. If the Medicare drug benefit fails, then the states are going to be more active, because the states will have lost the chance to have substantial budget relief, and accordingly, examples such as Maine, such as Oregon, become the standard way of doing business at the state level. So clearly the states become more aggressive.

For the drug companies, the idea of Maine being copied by other states, does that become a serious concern?

Yes. The idea that Maine's approach to purchasing drugs becomes more widespread is definitely a concern for the industry. The reason is, by giving Medicaid prices to non-Medicaid patients, you're significantly increasing your negotiating leverage ultimately. And what we see the states then doing is moving to formularies to accumulate that negotiating leverage, [and] getting lower prices, which ultimately erodes private market pricing.

If we look back to the last few years, senior bus trips leading to state initiatives, there's a growing awareness of price differences between U.S. and Canada. There's a real political problem. Does that process lead to the beginning of the end of the ability to price drugs the way you want?

Sure. I think that the public's awareness that drugs are less expensive overseas than they are in the United States ultimately will result in prices being much more similar in the United States to what they are overseas. The question's whether overseas pricing comes up, or American prices go down, or some combination of the two. I would argue, some combination of the two.

So there's a way in which you can raise prices abroad?

Absolutely. You restrict supply.

You've got to do something about the difference between the prices. We could copy them and have price controls, or we could force the prices up.

The fact that we have different pricing in the United States versus overseas only becomes an issue when a critical mass of the electorate decides that something has to be done.

The reality is, most people still have their drug coverage. So my out-of-pocket expense, as a working age American, for pharmaceuticals is probably less than the out-of-pocket expense for most Europeans. So personally, as a voter, I don't have a problem.

However, over time, co-pays are going up. Workers are paying more out of pocket. So you gradually increase the number of voters who care about how much they have to pay at retail. I think once you get enough working age voters who are really sore about drug pricing, then I do think you have to address the gap between U.S. prices and international prices.

As a society, what are our options?

Eventually, if the gap between U.S. prices and international prices remains, that's going to have to be dealt with, either by industry or by government. If industry deals with it, which I would imagine industry will move first, then to settle that gap you've got two options: You either lower American pricing, which you're not going to do, or you're going to raise pricing in export markets. And even though these governments are dominant buyers, I can still restrict supply. ...

I don't think we can expect an industry to pull profit out of its last remaining profitable market on its own. I think you have to expect the industry to move to defend its profit, which, if prices have to equilibrate between the United States and export markets, that means raising price in export markets, by whatever means necessary.

[Can you use] Canada as example?

Using Canada as an example, we're already seeing this play out. Manufacturers have restricted shipments to Canada. So, as goods from Canada come back into the United States, it creates scarcity within Canada, and Canadian prices go up.

These other countries have the power to compulsorily license drugs.

Right. The real limit to creating scarcity in your export markets is that these countries just make copies. That's a huge step. We're not talking about sub-Saharan Africa. We're talking about Germany. We're talking about the UK. Right? What's next? Compact discs? Intellectual property respect is a core tenet of most mature capitalist economies. Will these economies selectively apply respect for intellectual property to things non-pharmaceutical, and copy pharmaceuticals? At some price, I think the answer is yes. At American prices, I think the answer's no.

So in your view, the industry has got the wherewithal to defend itself?

The industry has a defense against losing an American price to international levels. Is it a perfect defense? No. You can create scarcity in international markets. You can limit the gap between American and international markets on pharmaceutical pricing. All that falls apart, however, if back home in the American market you have a dominant buyer, i.e. the government. Then, the common theme around the world is that pharmaceuticals are purchased by the government. In every major market, you've got one buyer, and that buyer determines the price. In that scenario, it is more likely that American pricing eventually comes down to more the European or Japanese level.

So the bigger threat is the size of the purchaser?

The biggest issue, the most important issue, is the size of the buyer. The larger the buyer, the lower the price. There're really two things you have to keep in mind here. Export market prices are relatively low, 30-35 percent less than American pricing. That is because those markets are purchased by a dominant buyer who sets the price. In the United States, the market sets the price. If that changes so that you've got one dominant buyer, then yes, you would expect American pricing to fall to European levels.

If you were a drug company executive, how would you be feeling right now?

If I were a drug company executive, on average, I'd be very worried. My ability to set prices in an open market is very much under siege. And that ultimately is probably the most important economic variable that my success depends on.

Are we at the beginning of a fundamental change? Or is it still up in the air?

If we don't change direction politically, then I, as a drug company executive, am going to lose the ability to set drug prices. And as a result, my willingness to invest in research and development will correspondingly decline. And as a further result, my ability to bring new discoveries to market will also decline. ...

Can they cobble some lame bill together and get away with it, which has just got a discount card?

The question being: Can they cobble a lame bill together? I think they already have. The bills that are in conference committee provide drug coverage to people that can already afford drugs -- i.e., people who have good retiree coverage, people who have adequate assets and adequate incomes on their own. And in so doing, I think provides inadequate coverage to people who cannot afford.

My feeling is that the bill in conference committee takes care of the wealthy at the expense of the poor. The poor senior with high drug consumption is not getting as rich a benefit as they deserve. The wealthy senior, who can well afford to finance their own drug consumption, is getting more than they need. That's what I think's broken. ...

 

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posted november 12, 2003

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