You don’t have to be an economist to understand the law of demand: The higher the price, the less likely a customer is to buy a product. This, of course, limits how much companies can charge.
The law of demand applies to pharmaceuticals, but with one big difference. It’s not always the customer who decides that the price is too high. Often, it’s the insurer.
Insurers who regard a drug price as too high have only two ways to respond. First, they can force patients who want the medicine to pay high out-of-pocket costs in the form of high copayments. Because that reduces demand, drug companies are willing to lower prices in response. Second, insurers can limit access to new drugs. They can exclude the drugs from their formularies and refuse to cover them at all, or they can limit access via prior authorization, step therapy, and similar policies. Those two approaches — high out-of-pocket costs or limited access — are what constrain drug companies from setting prices even higher and higher.
But that leaves patients stuck in the middle of what we call an “impossible trinity.” Patients want three things from insurers: access to new drugs, low out-of-pocket costs, and low drug prices. But because insurers need to bargain prices down by either raising copayments or imposing prior-authorization restrictions or exclusions, patients can never get all three.
The impossible trinity is not uniquely American — it applies wherever health care is provided. Take the United Kingdom’s National Health Service. The NHS achieves low drug prices without imposing high out-of-pocket costs on its British beneficiaries. Instead, the NHS limits access to new drugs.
Many Americans envy the British for their low drug prices and the low out-of-pocket costs. But the British reliance on exclusions still imposes tremendous costs on patients. Consider how the NHS handled breakthrough treatments for cystic fibrosis developed by Vertex Pharmaceuticals. Starting in 2016, the NHS refused to cover the drugs because it decided that Vertex’s price was too high. British parents of children with cystic fibrosis protested in the streets, holding up pictures of their children lying in hospital beds. It took three years for the NHS and Vertex to agree on a discounted price. For those three years, British kids with cystic fibrosis knew that new treatments for their disease existed, but they had no access to them.
In the U.S., the impossible trinity works somewhat differently. Typically, as soon as a new, effective treatment is developed, it becomes available for insured Americans. Without exclusions, American insurers have to rely on making patients pay more out-of-pocket to deter use or else simply pay higher and higher prices.
Take the case of Zolgensma. Zolgensma is a one-time treatment, produced by Novartis, that can cure spinal muscular atrophy (SMA) in young children. SMA is a debilitating disorder that affects 1 in 10,000 births. If left untreated, those born with the disease will die early in life. Given how devastating SMA can be, and how effective Zolgensma is in treating it, the arrival of the therapy seemed like nothing but good news. Except for one thing: Novartis priced Zolgensma at $2.1 million per treatment.
What do American insurers do when faced with that $2.1 million price tag? They can’t bargain the price down by threatening to impose high copayments on Zolgensma. After all, the treatment is so effective that a few copayments won’t matter much. Insurers also can’t rely on prior authorization or step therapy: Any decent physician will go to the ends of the earth to get a patient Zolgensma if they need it.
All that’s left is exclusion. And, indeed, in 2019, UnitedHealthcare announced that it would not cover Zolgensma — the price was just too high. For weeks, managers at UnitedHealthcare stuck to that decision, hoping that the exclusion would lead Novartis to negotiate on the price. But before Novartis could give in, an outcry among patients forced UnitedHealthcare to reverse course and cover Zolgensma despite the $2.1 million price tag.
In the story of Zolgensma and UnitedHealthcare, who is the villain? It’s tempting to blame Novartis for setting a price of $2.1 million. But the Institute for Clinical and Economic Review estimated that a fair price for Zolgensma, given its enormous benefits, would be somewhere between $1.2 million and the $2.1 million price that Novartis originally chose. It’s then natural to point to UnitedHealthcare as the villain for, at first, refusing to cover Zolgensma. But if all American insurers were to cover all new treatments like Zolgensma without even contemplating exclusions, then there would be no downward pressure on prices.
Zolgensma is likely a sign of what’s to come. Over the coming years, about a dozen new gene therapies will be released each year, many with seven-figure prices.
It is tempting to imagine that regulators might find a way out of the impossible trinity. The Inflation Reduction Act of 2022, for instance, allows the secretary for Health and Human Services to negotiate drug prices for some of the most expensive drugs purchased by the Medicare program. That policy might seem like an unambiguous win. And yet the process involves an implicit threat to pull coverage of high-priced drugs.
Moreover, the law will lead to more-subtle limitations on access. The Congressional Budget Office predicts drug companies will respond to the lower prices by developing fewer drugs. Some of those drugs that go undeveloped may be unimportant, but others might have been breakthrough treatments.
In the end, there is no escape from the impossible trinity. High drug prices, restrictions on access, or copayments — pick two.
Keith Ericson is professor and department chair of markets, public policy, and law at the Questrom School of Business at Boston University and a research associate at the National Bureau of Economic Research. Tal Gross is an associate professor of markets, public policy, and law at the Questrom School of Business at Boston University and a faculty research fellow at the National Bureau of Economic Research.