New Data: How Outrageous Hospital Markups Hike Drug Spending

On Drug Channels, I highlight the two primary reasons pharmaceutical manufacturers’ list prices don’t represent what third-party payers actually spend for drugs: (1) channel intermediaries add markups that account for the costs, profits, and value of the channel's services, and (2) manufacturers provide rebates and discounts to third-party payers.

The new 2015 Medical Pharmacy Trend Report (free download), from Magellan Rx Management, documents just how outrageous a channel’s markups can be.

As I show below, the reimbursement approaches that commercial payers use permit hospitals to get paid two to three times as much as physician offices—and to inflate drug costs by thousands of dollars per claim. Naturally, the 340B program plays a part in this sordid tale.

A few prominent hospital-based physicians have become very public critics of pharmaceutical list prices. It may come as no surprise that these physicians neglect the pricing behavior of their own employers, ignore the hospital-related factors affecting payers’ spending, and fail to examine drugs’ true net costs. I guess that when the media spotlight is shining, it’s better to take the money and run than be intellectually honest.

HERE’S A STORY

The 2015 Medical Pharmacy Trend Report draws on survey responses from medical, pharmacy, and clinical directors at 59 health plans, representing 129.7 million covered lives. Five payer respondents accounted for nearly two-thirds of covered lives in the survey. The report also includes a useful analysis of medical claims data, which I highlight below.

The report’s structure and organization have improved somewhat from those of previous years, but the document remains a hard-to-follow grab bag of content and topics. Still, the report provides an impressive amount of data on medical benefit management.

Physician offices and hospital outpatient facilities are the two most crucial administration sites for such provider-administered drugs as biologicals, injectables, IVIG, immunoglobulins, and other products. In 2014, these two sites accounted for 85% of commercial medical pharmacy benefit spending and 90% of Medicare medical pharmacy benefit spending. (See page 37 of the report.) The remaining spend was primarily via home infusion/specialty pharmacy.

REIMBURSEMENT: THEY GOT THE MONEY, HEY

Medicare is the largest payer of provider-administered drugs. Its Part B program covers provider-administered injectables and certain other drugs. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) mandates that Medicare use a drug’s Average Sales Price (ASP) for reimbursing provider-administered injectable drugs. ASP is based on the manufacturer’s actual selling price, i.e., a drug’s list price minus price concessions. I briefly review this buy-and-bill system in Why CMS’s Crazy Plan to Remake Medicare Part B Won’t Work.

Commercial payers, however, have different reimbursement methodologies for different types of administration sites:

Physician Offices: For these sites, 72% of payers follow Medicare and use the ASP benchmark for provider-administered specialty drug reimbursement. (See the chart below.) These reimbursements apply to drugs purchased under a buy-and-bill model. For physician offices reimbursed using ASP, the average mark-up was ASP+9%.

Note that the Magellan report found that buy-and-bill accounted for only 70% of physician office medical benefit drug volume. A further 24% of physician offices sourced drugs from specialty pharmacies—a process known as “white bagging.” For an explanation of white bagging, see our 2015–16 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors, section 6.2.4.

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Hospital Outpatient Facilities: Hospitals, however, are most commonly reimbursed by commercial payers based upon a negotiated percentage of charges—a hospital’s self-defined list price for a drug. Basically, a hospital marks up a drug to create a highly inflated "charge." It then discounts the charge to the level of the merely outrageous. Unlike public drug benchmarks (ASP, AWP, and WAC), charges are arbitrary and do not follow any particular methodology. Magellan found that on average, payers reimbursed hospitals at 50% of billed charges. For hospitals reimbursed using ASP, the average markup was ASP+10%.

DRUG COSTS: EXACTLY WHAT THE FACTS IS

Commercial payers’ different reimbursement approaches allow a hospital to get paid much more than a physician office.

The chart below compares a payer’s unit cost at a hospital outpatient facility with the unit cost at a physician office. These data include 10 of the top medical benefit drugs. The numbers show each drug’s cost per unit at a hospital outpatient facility as a percentage of cost per unit at a physician office. Figures that exceed 100% indicate that the hospital outpatient facility is more expensive, while figures below 100% indicate that the physician office is more expensive.

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For commercial payers, hospitals’ percent-of-charges approach allows them to be paid two to three times as much as physician offices. Note that the blue bars are all above 100%. Unit costs are much closer for Medicare, which does not generally permit large variations between different sites of care.

Consider Remicade, which accounted for the greatest share of commercial medical benefit spending. For Remicade, hospital outpatient facilities received $214.21 per unit, while physician offices received $80.67, i.e., a ratio of 266%. These differences translated into almost $5,000 more per claim at a hospital outpatient facility than at a physician office.

Put another way, hospital mark-ups translate directly into higher drug spending—regardless of how manufacturers set list prices.

340B: ADDING INSULT TO PRICE GOUGING

But wait—there’s more!

Thanks to the 340B Drug Pricing Program, hospitals receive big discounts on almost half of their drug purchases, regardless of payer. See 340B Purchases Hit $12 Billion in 2015—and Almost Half of the Hospital Market.

Consequently, there are two more inconvenient facts related to our analysis of the Magellan data:

(1) A manufacturer may earn a small fraction from a drug that hospitals mark up by thousands of dollars. A manufacturer’s net price from a 340B-eligible hospital is far below a drug’s list price. In some cases, 340B-eligible hospitals can acquire brand-name pharmaceuticals for as little as $0.01, a situation referred to as penny-pricing. In other words, there could be drugs with a list price of $5,000 for which the manufacturer receives $0.01 but the hospital receives (and a health plan pays) $15,000. Amazing. (BTW, the Magellan report found that most commercial payers also received rebates for provider-administered injectable or infused drugs billed under the medical benefit.)

(2) 340B-eligible hospitals can generate insane profits vs. other sites of care. Hospitals retain thousands more per Medicare beneficiary than do physician offices and non-covered hospitals for expensive cancer medications. On average, hospitals earn markup margins from Medicare that exceed 50%, while physician offices make do with margins of 3% to 4%. See New OIG Report Shows Hospitals’ Huge 340B Profits from Medicare-Paid Cancer Drugs.

Given these economics, we shouldn’t be surprised that health systems are acquiring practices and shifting care from lower-cost physician practices to high-cost, high-margin hospital outpatient facilities. On Thursday, I'll explore this issue in more depth.

It’s time for hospital-based physicians to be intellectually honest—and admit that their hospitals’ markups are contributing significantly to drug costs. I don’t think it would be a great big hassle.

STILL RUNNING TODAY

Steve Miller—musician and reluctant Rock And Roll Hall Of Fame inductee—summarizes hospitals’ drug pricing strategy in this 1976 ditty. Click here if you can’t see the video.