At the last major DC showdown with big pharma, we learned a crucial fact about US drug prices. It's sure to come up again this week.

At the last major DC showdown with big pharma, we learned a crucial fact about US drug prices. It's sure to come up again this week.

Heather Bresch Mylan


Mylan CEO Heather Bresch holds up an EpiPen while testifying in Washington in 2016 on EpiPen price increases.

  • Key executives of seven top drugmakers will testify about drug prices at a US Senate committee hearing on Tuesday. Last time a top pharma CEO faced tough questions about drug prices, we learned about a crucial feature of US drug prices called rebates.
  • Drug rebates are a common business practice in the US. Drugmakers pay them and other discounts to get health insurers and pharmacy-benefit managers to cover their medications.
  • But rebates have also been blamed for driving too-high US drug prices.
  • The practice became more widespread because of a forgotten 1990s class action lawsuit brought by mom and pop pharmacies, according to one expert, Scott Gottlieb, who now leads the US Food and Drug Administration.

CEOs from top drug companies like Pfizer and Merck will be in the hot seat on Tuesday, when they're set to testify before US Senators at a hearing about high drug prices.

The last time a top pharma executive faced tough questions from members of Congress about prices, we learned something crucial about how US drug prices work - and it's likely to inform Tuesday's hearing.

Back in 2016, Mylan had raised the price of its lifesaving EpiPen allergic reaction treatment more than 500% over several years, sparking public outcry.

Hauled before lawmakers that fall, Mylan CEO Heather Bresch said that Mylan wasn't reaping much of the financial benefits of those price increases. Instead, she said Mylan had to give industry middlemen large discounts and after-the-fact rebates. Of the more than $600 that an EpiPen two-pack cost that year, Mylan made just about $100, after things like rebates, she said.


Drug rebates are a common feature of the US health system, used by drugmakers in negotiations with middleman to get their medicines covered by health insurers. Rebates have also been blamed for driving up the cost of drugs in the US. And the Trump administration even recently proposed getting rid of rebates in an effort to bring down drug prices.

At the time, Bresch's defense got pushback from at least one lawmaker, in part because Mylan later clarified that its profit was $166 per EpiPen two-pack.

But one expert named Scott Gottlieb, writing in a Forbes piece that year, agreed with Mylan. He said that a flawed system was at play, one that benefited everyone but patients.

Describing the model as "byzantine" and "inept," he called on Congress to do something. Gottlieb, by the way, now heads the US Food and Drug Administration, which makes sure medications are safe and effective, but doesn't regulate their prices.

"The convoluted arrangement by which drugs are priced and sold arose accidentally as a result of litigation. But now that this inept system is firmly entrenched, bringing rationality to the selling model is going to disrupt inter-reliant business practices," he wrote. "As much as the drug makers complain about the rebating scheme, they've grown as dependent on its subterfuge, opacity and inequity as everyone else in the system."


Read more: A new proposal from the Trump administration to tackle high drug prices could actually be a huge victory for Big Pharma

Driving drug prices up?

You may already know about rebates from consumer products like clothing and TVs.

In the healthcare world, businesses, rather than consumers, are often the ones that receive rebates and other discounts on prescription drugs. Middlemen like pharmacy-benefit managers bargain for these discounts, from which they typically get a cut. Critics say that these practices drive up a drug's public, "list" price.

Patients at the pharmacy counter, meanwhile, may end up paying some or all of a drug's higher list price.

That may sound convoluted - which is exactly the word that Gottlieb used.


Related: A biotech is proposing a plan to pay for its pricey rare-disease treatment the same way you'd buy a TV or dishwasher. Here's the inside story.

In explaining how this rebate system arose, Gottlieb pointed back to a 1990s class action lawsuit, which he says permanently shaped the drug pricing landscape.

Discounts have long been a part of how drugs are sold in the US. In the 1990s, drugmakers offered them to companies that bought a lot of their medications, including a type of health insurer called a health maintenance organization, or HMO.

Pitched as a way to cut down on rising health costs, HMOs grew rapidly in the early 1990s. Those who pay for HMOs get both health insurance and health care through them, and so the organizations had significant influence over what their doctors prescribed.


Hollis Johnson/Business Insider

See: Trump may have shamed Pfizer for increasing drug prices, but that isn't stopping drugmakers from doing more of the same


A forgotten 1990s lawsuit

Pharmacies, meanwhile, felt that they were getting a bad deal. So they fought back by suing drug companies. Drugstore and supermarket pharmacy chains came together with thousands of independent pharmacies in a class action lawsuit against 23 big drug companies, alleging that they had illegally conspired to fix prices, according to a 1996 New York Times report.

The pharmacies won a settlement of more than $408 million. As part of the settlement, the drug manufacturers did not agree to change their practices, according to the New York Times report.

Related: A new proposal from the Trump administration to tackle high drug prices could actually be a huge victory for Big Pharma

But it did change the way they structured the discounts, Gottlieb would later testify in front of a Senate subcommittee in October of 2016.

Instead of offering discounted prices on the front end, drugmakers started hiding them by offering discounts after customers bought their medicines, Gottlieb said. Gottlieb was then a resident fellow at the American Enterprise Institute, an influential conservative think tank.


Not everyone agrees with Gottlieb. As lawyers from the firm Foley Hoag LLP noted in a report last year, rebates existed before that 1990s lawsuit. They found, though, the lawsuit did influence how rebates are used today.

That's because rebates started getting linked to how much of a drug that a partner business, like a pharmacy-benefit manager, was able to sell to customers. This was intended to help drug companies avoid antitrust concerns and other lawsuits.

Gottlieb argued that a system of up-front discounts would give consumers lower drug prices at the pharmacy counter.

A proposal to ban rebates today

The Trump administration has signaled it wants to ban those rebates in the government-funded Medicare health program, which covers the elderly and some disabled individuals, and in some parts of the Medicaid program for low-income people.

Those changes were brought up in a new proposal, and the Trump administration hopes it will have an even further reach, affecting those who have commercial health insurance as well. The proposal is explicitly geared at helping lower drug prices.


But drugmakers are likely to focus again on rebates and discounts on Tuesday, and point a finger again at the role of middlemen like PBMs.

Like Mylan's Bresch, pharmaceutical companies have insisted that there's a large discrepancy between their products' list prices and what they actually get to keep. And rebates are one part of that.

Importantly, though, the new Trump administration proposal doesn't require drug companies to lower the prices of the drugs themselves. Drug companies could even benefit from a shift on rebates - and in fact, they applauded the rebate proposal when it came out in February.

"We applaud the Administration for taking steps to reform the rebate system to lower patients' out-of-pocket costs," Stephen Ubl, president and CEO of the main pharma-industry lobbying group, said in a statement at the time.