Congress asked Martin Shkreli to defend prescription drug price gouging — he pleaded the 5th

Pharmaceutical company enfant terrible Martin Shkreli is being dragged before a congressional hearing today to talk about the skyrocketing price of drugs.

Shkreli, the former CEO of Turing Pharmaceuticals, became a symbol of the problem when he famously raised the price of an old drug used to treat AIDS patients by 5,000 percent, from $13.50 per tablet to $750.

His reasoning: pure profit. "Although Mr. Shkreli spent no funds on developing Daraprim, which has been on the market for decades," a congressional memo released ahead of the hearing explains, "he purchased it for the purpose of increasing the price dramatically and making hundreds of millions of dollars by exploiting its existing monopoly..."

Shkreli — who is expected to keep uncharacteristically quiet today after pleading the Fifth — isn't alone. According to Congress, the prices for 30 of America's most popular drugs have increased by 76 percent between 2010 and 2014 — that's eight times the rate of inflation.

Another company, Valeant Pharmaceuticals, will also be a focus in Washington today: It bought the rights to two old heart drugs (Isuprel and Nitropress) that it didn't invent, and then increased their prices overnight (by 525 percent and 212 percent, respectively), sparking protest from doctors and hospitals that rely on these drugs.

Many have wondered how pharmaceutical companies can get away with this. Today's hearing will dig into the "reasoning behind recent drug price increases." Besides Shkreli, the interim chief executive of Valeant Pharmaceuticals, Howard Schiller, as well as Turing's current chief commercial officer, will testify, among others.

But in order to understand the recent trend, and why Shkreli is only a very small part of it, you first have to understand how the US system of drug pricing actually works.

1) In the United States, drug prices are set by the market — unlike elsewhere

In other countries with single-payer systems, governments exert much more influence over the entire health care process. That allows them to negotiate directly with drugmakers. The government sets a maximum price that it will pay for a drug, and if the company doesn't agree, it simply loses out on the entire market. This puts drugmakers at a disadvantage, driving down the price of drugs.

The United States, by contrast, has long taken more of a free market approach to drugs. Pharmaceutical companies can haggle over prices with a variety of private insurers and can also sell to the government. What's more, Medicare, the government program that is the nation's largest buyer of drugs, is actually barred from negotiating drug prices. That gives Pharma much more leverage.

So drug companies here do what any other profit-maximizing company does — they try to get the highest prices possible without going so high that no one will buy them. And they do this because they can. Martin Shkreli could set the price of drugs as high as he thought the market would bear. There was no government regulator pushing back.

There are some upsides to this system — but also clear downsides, as we'll see below.

2) Drug companies consider a number of key factors in setting prices

There's no magic formula for how drug companies decide on prices, and since pricing information is considered proprietary, it's largely hashed out in private, usually in negotiations between drug companies and insurers. But experts say companies usually account for several things:

• How many people will buy the drug
• How many of those will be privately insured or on Medicare or Medicaid
• The drug's benefit, according to clinical trials and real-world experience
• How many other similar drugs are already on the market
• How competitors have priced their products
• How often people will use the drug (a lifetime, a week, etc.)
• How much it costs to develop and manufacture the product
• How long the patent on the drug will last (ensuring the company market exclusivity)

But at the end of the day, drug companies are considering profitability — they are not trying to figure out what price will benefit the most people.

Back in 2012, the drugmaker Gilead sold Sovaldi, which was then the only cure for hepatitis C, at $1,000 per tablet, or $84,000 for a course of treatment. That meant that only one-tenth of the people who needed it could afford it. But Gilead was not a charity, trying to help the greatest number of people. It was trying to recoup its costs and maximize profit.

3) Americans pay more for drugs than people in other countries

OECD

Perhaps not surprisingly, drug prices are higher in the United States than they are elsewhere, where there are stricter price controls.

Because drug companies typically hold exclusive patents for their drugs for a period of time, they tend not to have much competition. That gives them room to bargain up prices. And without a single-payer system on the other end bargaining down, costs tend to rise in the United States. "There’s a supplier and then a bunch of purchasers [insurance companies]," said Aaron Kesselheim, a professor of medicine at Harvard Medical School. "The supplier has full control."

You can see that with individual drugs. The cost of the cancer medicine Gleevec is higher here:

International Federation of Health Plans

So is the cost of the multiple sclerosis treatment Copaxone:

International Federation of Health Plans

The examples are endless.

4) The US system arguably has some upsides, too

The high prices in the United States are a huge, obvious drawback. But experts say there are some advantages to the US system. For one, drug companies are more likely to introduce drugs in the United States first, to get those higher prices. "New drugs come to the market here a little bit faster than in other countries," said Johns Hopkins professor Gerard Anderson. Other countries then tend to pivot off US prices, using them as the baseline.

The US system also arguably encourages innovation, says Amitabh Chandra, a health policy professor at the Harvard Kennedy School. "The innovation is coming from the patent system, and it's coming from the higher market size." Because there's no government regulator setting a ceiling for prices and squeezing out some drugs, the market is bigger. If that market shrank, we might not see as many new drugs coming out.

Margot Sanger-Katz of the New York Times reached a similar conclusion: Higher US prices can encourage innovation, which benefits people in many other countries. "Note that connection is true even if you think most innovations come from universities or the NIH rather than being hatched by Big Pharma," she added. "There is still a pot at the end of the rainbow for the significant innovators in this process."

So there are trade-offs to this US system — and there are, potentially, real trade-offs to changing it.

5) Drug spending is rising — and becoming a bigger political issue

The higher-cost aspect, however, is becoming more and more salient in recent years. In the United States, spending on drugs has more than doubled in the past 15 years, from $121.2 billion in 2000 up to nearly $374 billion in 2014. The average person spent $100 more on drugs in 2014 than in 2013.

There are a few reasons often cited for this increase. Part of this is due to the recent availability of new (and pricey) treatments, such as Sovaldi for hepatitis C, a number of immunotherapies for cancer, and treatments for multiple sclerosis, according to the IMS Institute for Healthcare Informatics. Meanwhile, there are fewer brand-name drugs going generic. Last year, Americans spent $7.9 billion on Sovaldi, another $1.6 billion on cancer treatments, and nearly $2 billion to multiple sclerosis treatments. Spending on diabetes drugs totaled $32 billion.

But this isn't just a recent trend, either. Drug prices have been rising in America for decades, as my colleague Sarah Kliff writes. In response, insurers have been forced to either increase premiums or limit the drug coverage they offer. The Kaiser Family Foundation's annual survey of benefits last year found that the number of workers with a deductible over $2,000 has more than doubled since 2011.

Kaiser Family Foundation

The latter means that more Americans have to pay out of pocket for key drugs. And the Affordable Care Act is not expected to halt those trends.

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