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It’s a good bet that most Americans have not the slightest idea what pharmacy benefit managers (PBMs) do, yet these companies have an enormous impact on what we pay for drugs. Now, the Trump Administration is moving to reform an opaque system in which PBMs drive higher list prices and keep rebates out of the hands of patients who deserve them.
As the Washington Post put it, “That rebate is not always passed on to consumers -- instead, it's mainly being pocketed by the insurers and the PBMs, a dynamic that prompts drugmakers to push prices even higher.” Since rebates are proportions of list prices, the higher the list price, the more the PBM makes. This perverse incentive can, for example, discourage the use of biosimilar drugs, which are almost identical copies of more expensive biological products. Biosimilarsapproved by the Food & Drug Administration (FDA) must have “no meaningful differences in efficacy, safety, and purity” from a patented FDA-approved reference biologic. Their uptake has been hampered in the United States, in large part by the preferences of PBMs, which score greater rebates from biologics. (More on the biologic “rebate trap” below.) ‘A Pretty Good Place to Start’ In a hilarious segment of his Netlfix program, “Patriot Act,” on Feb. 17, Hasan Minhaj made a valiant attempt to explain how drug pricing works (beginning at 16:00 of the video on YouTube). “It’s hard to know what the most broken part of this system is,” he said, “but PBMs are a pretty good place to start.” Minhaj showed a video from a large PBM, Express Scripts, describing what the company does (here it is on YouTube). “Some people think we make pills,” says the narrator. “We don’t. Some people think we’re an insurance company. We aren’t. Some people think we’re a middleman, but we’re not.” Then the video shows company employees doing just that – acting as middlemen on behalf of businesses, “negotiating with drug manufacturers.” There’s nothing wrong with negotiations, but the system that PBMs have concocted goes beyond tough discussions with drugmakers. “A unique feature of the retail pharmaceutical supply chain,” says a 2017 study by the Berkeley Research Group, “is that retrospective rebates are negotiated by health plans or PBMs and serve to reduce the initial price of brand drugs after the point-of-sale. After a prescription is filled, the manufacturer frequently pays a negotiated rebate back to the health plan or PBM, which results in a lower net price.” As a result, says the Berkeley study, brand and generic manufacturers collect only 58% of total U.S. drug revenues. Much of the rest goes to PBMs in the form of rebates. An article by Ellie Kincaid, assistant editor of Forbes for health care, cited Faisal Mushtaq, CEO of the company Truveris, which helps employers choose a PBM, as saying that “$100 billion of the $500 billion spent on pharmaceuticals in the U.S. is ‘wasted’ on the middleman.” As President Trump said in May, announcing the Administration’s “American Patients First” blueprint in May, “We’re very much eliminating the middle men. The middle men became very, very rich.” Now that the specific proposal on pharmacy benefit managers is out, it’s clear that “eliminating” PBMs is not the Administration’s aim. After all, through negotiations, PBMs do provide an important service, especially if the alternative is government price controls. What HHS Secretary Alex Azar wants, as he announced on Jan. 31, is a more rational, transparent system, with the right incentives: Every day, Americans—particularly our seniors—pay more than they need to for their prescription drugs because of a hidden system of kickbacks to middlemen. President Trump is proposing to end this era of backdoor deals in the drug industry, bring real transparency to drug markets, and deliver savings directly to patients when they walk into the pharmacy. Azar said the proposal “has the potential to be the most significant change in how Americans’ drugs are priced at the pharmacy counter, ever, and finally ease the burden of the sticker shock.” A System With Incentives for Higher List (But Not Net) Prices Currently, PBMs negotiate with drug companies to determine which of their pharmaceuticals will be offered to members of insurance plans through forumularies, and at what price. Those deals typically include a rebate, which, unlike a typical discount, is paid by the manufacturer after the medicine is sold. Azar writes that the rebate amounts, on average, to between 26% and 30% of a drug’s list price. The system, as Azar says, provides “the most significant incentive drug manufacturers cite in raising their list prices every year, the pressure to provide larger and larger rebates.” Media and politicians are continually citing list-price increases on drugs, but, contrary to appearances, drug manufacturers are not the beneficiaries. Consider this report from the news service FiercePharma on Feb. 21 about the giant pharmaceutical company Sanofi: As drug pricing continues to command attention daily in Washington, D.C., and elsewhere, Sanofi unveiled Thursday morning that it hiked list prices on nearly half its prescription products last year—but that net prices sunk. The company raised list prices on 35 of 76 prescription medicines by an average of 4.6%, Sanofi reported. But despite those list price increases, net prices fell an average of 8% last year. In all, the company paid out 55% of gross sales in the form of rebates. Nor was 2018 an aberration. In the past three years, the list price for Sanofi’s medicinesrose an average of 3.4% annually, but the net price, after rebates, fell an average of 6.2%. Earlier, Reuters reported that Johnson & Johnson would be raising list prices in 2019 by an average of 4.2%. “However,” says the Jan. 11 article, J&J “expects the net price it actually receives for its medicines to drop. That is because drugmakers negotiate rebates and discounts off the list price with payers in order to ensure patient access to their products.” Pfizer estimated the effect of prices on total revenue growth in 2018 at “negative 1 percent in the U.S. compared with 2017.” In our last newsletter, we showed that several sources, including the Consumer Price Index of the U.S. Bureau of Labor Statistics, reported that drug prices in the United States actually fell last year – despite anecdotes about increases for individual drugs. The implication that drug manufacturers are reaping the benefits of price hikes is nonsense. The winners are PBMs. It is no wonder that in December, Cigna, a large insurance company, paid $68.5 billion to purchase Express Scripts, one of the three top PBMs, in the biggest corporate acquisition of the year in the United States. In an era when technology is taking the friction out of transactions, in what other sector would a middleman be worth so much? As for the other two PBM giants: United Healthcare, the largest health insurer in the world and the number-five company (by revenues) on the Fortune 500, owns OptumRX, and CVS Health, which also comprises a pharmacy chain and the insurer Aetna, owns CVS Caremark. The Biologic ‘Rebate Trap’ A particularly pernicious problem involves biological products, which are among the most powerful, popular, and expensive treatments. Biologics are clearly the future of health care – and, to a large degree, the present. For example, the biologic Humira, an anti-inflammatory, is the top-selling medicine in world. But many makers of biologics are able to fend off competition from biosimilars (roughly the biologic equivalent of generics) in large part because of the rebate system. Aaron Hakim and Joseph Ross, both of the Yale University School of Medicine, explained the “rebate trap” in a 2017 article in JAMA: Rebate agreements between pharmaceutical companies, pharmacy benefit managers, and other payers create an incentive for payers to prefer more expensive branded biologics over biosimilars. Most pharmaceutical companies currently provide rebates to pharmacy benefit managers to support preferred position of their branded biologic drugs on payer formularies. In many biologic drug categories, such as the branded anti–tumor necrosis factor antibodies, rebates can reach up to 50% of the drug’s list price. If a biosimilar manufacturer intends to upend the preferred position of the brand by offering a substantial price discount to the payer, the branded manufacturer can respond by withdrawing the rebate on the reference biologic, creating a “rebate trap.” For any patient continuing the reference biologic, a payer’s costs for that patient will double once the rebate is withdrawn…. The rebate trap ensures that payer total costs actually increase relative to costs prior to biosimilar availability. The rebate trap, write Hakim and Ross, is the “most important” obstacle to the adoption of biosimilars for chronic diseases. A white paper from the Biosimilars Council last year noted that “Europe has approved more than 40 biosimilar medicines in the last decade and accumulated more than 700 million patient days of experience with biosimilars. FDA has approved 10 biosimilar medicines and only three of these have been launched on the U.S. market.” In an interview with CNBC, FDA Commissioner Scott Gottlieb also placed blame on rebating agreements, citing them as a key contributor to “a lopsided playing field that disincentives biosimilar developers from making the sizable investment in bringing such products to market. I am concerned this will lead to reduced competition in the long-run and unsustainable costs.” Changing the Kickback Laws The Trump Administration’s remedy for the problems caused by PBMs is fairly simple. First, HHS would “expressly exclude from safe harbor protection under the Anti-Kickback Statute rebates on prescription drugs paid by manufacturers to pharmacy benefit managers.” Such rebates, now common practice, would become illegal. Second, HHS, according to its Jan. 31 press release, “would create a new safe harbor for prescription drug discounts offered directly to patients.” In addition, HHS would mandate “historic new level of transparency to a system that has been shrouded in secrecy for decades.” While the Administration can make these changes to Medicare Part D insurance without legislation, Congress would have to make changes in the Anti-Kickback Statute. “The reception on Capitol Hill,” where PBMs are well connected, “was mixed,” according to aBloomberg article. One reason for an initial lack of enthusiasm may be that PBM reform would make it harder to rail against drug manufacturers, a favorite political villain. The Boomerang Effect From EpiPen The recent focus on PBMs may, ironically, have stemmed from the public reproach suffered by the drugmaker Mylan for dramatically hiking prices on EpiPen. Mylan’s CEOHeather Bresch put much of the blame on PBMs, elevating the companies from obscurity. In a 2016 article, Gottlieb, then a scholar at the American Enterprise Institute, referred to the EpiPen blow-up in encouraging a reform of the PBM system: Mylan pointed to a long sequence of drug supply middlemen who get a series of rebates, mostly as economic inducements for helping drug makers sell their medicines. To fund these rebates, drug makers push up the list price of their pills, only to furtively pay much of the money back to pharmacy benefit managers later. This byzantine model for selling drugs aids both parties–the drug makers who use the rebates to buy access on restrictive drug formularies, and the pharmacy benefit managers that take a cut from these rebates to improve their profit margins. In the piece, Gottlieb noted that it was a 1996 court ruling on an antitrust case that helped put the current opaque “intricate system.” He advised legislation as “a simple way to improve the transparency, competitiveness and affordability of how drugs are priced and sold.” Two and a half year after Gottlieb’s article, the Trump Administration is taking steps to fix the problem. It’s worth quoting two more paragraphs from Gottlieb’s piece: The way this system is designed, it’s inevitable that there would be a growing disconnect between the publicized “list” price of a drug, and the real price that’s paid by large purchasers. The political class is using these anecdotes of excessive list pricing to further a legislative push for enactment of drug price controls. But the list prices that are being objectified are disconnected from the real costs, despite the best attempts of drug industry critics to blur these economic distinctions. This doesn’t mean some patients don’t get stuck with the high list prices. It’s usually the underinsured or uninsured that can end up paying the full amount. It’s precisely the folks who can least afford these costs. But instead of seeking to leverage the confusion between perceived and actual costs, and pretend that the list price reflects the average price, Congress can act instead to end the nonsensical pricing. Gottlieb focuses here on a critical defect of the current system – one that has been exploited by media and politicians. Anecdotes of high list prices serve what Gottlieb calls “the political class” well. Politicians gin up votes by pointing to list prices of drugs. But, as Gottlieb says, list prices can also have real-life effects, especially on the uninsured and people with insurance policies that force them to pay a proportion of the list price, even as PBMs are collecting rebates. Gag Clauses, Spread Pricing, Unhappy Business Leaders The system produces other outrages as well. Minaj pointed to one of them on Netflix. He showed a clip from PBS NewsHour of a Long Island, NY, pharmacist explaining how he would charge a customer $4 for a prescription for Metformin (an anti-diabetic medicine) if the customer paid for it. But if the customer presented an insurance card, then the PBM required the pharmacist to $10.84, of which the PBM itself pocketed $8.91. PBMs often prevent pharmacists from pointing out the chance for a lower price, but states are now proposing an end to such “gag clauses.” As Axios has reported, the federal government isn’t the only battleground for PBMs. "You will be hard-pressed to find a state that now isn't looking into this," an Illinois pharmacist told the Columbus Dispatch, which has done in-depth reporting on PBMs in Ohio. That state’s government audited CVS and OptumRX and, wrote Bob Herman of Axios, “found that PBMs ‘kept $224 million through spread pricing’ — a practice where PBMs retain the difference between what they bill insurers and employers and what they pay to pharmacies.” West Virginia fired its PBMs, and Pennsylvania, Arkansas, Connecticut, and other states are investigating PBM practices. In Kentucky, a state government report released last week charged that PBMs took $123.5 million in hidden fees from Medicaid programs through a technique called “spread pricing.” According to Robert Langreth of Bloomberg, “In Ohio, a summary report last year found that CVS and other PBMs took an 8.8 percent spread on name-brand and generic drugs from March 2017 to March 2018. That amounted to an average of $5.70 per prescription. Ohio officials told Medicaid plans to terminate spread-pricing agreements this year. In Kentucky, the spreads averaged $6.07 per prescription in 2017, and $8.70 per prescription in 2018.” The Washington Post reported last year that state lawmakers have introduced at least 83 bills targeting PBMs across 33 states either being considered or that have been enacted, according to the National Academy for State Health Policy. PBMs are supposed to serve businesses, which shoulder most of the costs of health insurance, yet a survey of 170 large employers last year by the National Business on Health found widespread disenchantment. Said a press release about the poll: “Three in four employers do not believe drug manufacturer rebates are an effective tool for helping to drive down pharmaceutical costs, and over 90% would welcome an alternative to the rebate-driven approach to managing drug costs.” That alternative may soon be at hand.
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In his State of the Union message on Feb. 5, President Trump pointed out that “in 2018 drug prices experienced their single largest decline in 46 years.” According to the Bureau of Labor Statistics, the Consumer Price Index (CPI) for the prescription drug category (all urban consumers) dropped 0.6% between the end of 2017 and the end of 2018. The increase in the CPI for all items was 1.9% over this period; medical care services as a whole were up 2.5%.
The notion that drug prices actually fell last year was shocking because it contradicted the narrative that the media, activists and many elected officials, including President Trump himself, have been promoting for so long. In its fact-checking of President Trump, CNN called his statement about medicine prices “true but misleading.” Tami Luhby wrote that “some experts are concerned that the [CPI] index isn’t as adequate a measure as it was” in the past. She then wrote that the prices of “more than 2,300 drugs have gone up so far this year taking into account different dosages of the same drug.” This theme was repeated by the Associated Press, which noted that there were 2,712 price increases in the first half of January and that “Trump is selectively citing statistics to exaggerate what seems to be a slowdown in prices.” An article by Casey Ross in STAT News went even further, with the headline, “Trump falsely claims ‘drug prices declined in 2018.’” The article was referring to this Tweet by the President that previewed his State of the Union: “Drug prices declined in 2018, the first time in nearly half a century.” Ross added: The statement is…demonstrably false. A recent analysis of brand-name drugs by the Associated Press found 96 price increases for every price cut in the first seven months of 2018. At the start of last year, drug makers hiked prices on 1,800 medicines by a median of 9.1 percent, and many continued to increase prices throughout the year. Actually, the President’s statement was demonstrably true. Saying that some prices went up tells you nothing about what all prices did. As the meme goes, the plural of “anecdote” is not “data.” Also meaningless – as reporters at such outlets as STAT and AP must know – are list prices themselves. The bizarre drug pricing system is riddled with opaque rebates and fees. As Wayne Weingarten of the Pacific Research Institute wrote inForbes a few months ago: Based on the historical price trends, in fact, a 5% list price increase will likely lead to no net price increase at all and may even indicate that net prices will decline. According to the pricing data for medicines collected by IQVIA, the list prices for brand medicines increased 6.9% in 2017. Net prices, or the actual transaction prices of the medicines, increased only 1.9%…. The large gap between the list price and the transaction price has persisted for many years. For example, list prices grew 13.5% in 2014 but net prices only grew 4.3%. The persistent gap between list prices and net prices demonstrates that it is not beneficial to focus on list price increases or announcements. Instead, it is more productive to focus on reforming the ineffective pricing structure. The Administration is wisely addressing that structure – an issue we will address in our next newsletter. Meanwhile, just to be clear: The President’s statement on drug prices was not false or even misleading. It was dead accurate, and the Washington Post, which, in its fact-checking on the speech, played it straight, pointed to a major reason for the decline: The Trump administration has made it less costly for companies to apply for generic approvals. The FDA says it set a record for generic approvals in fiscal 2018 (September through October), 781, breaking the record of 763 set in the previous fiscal year. Express Scripts Confirms the President’s Data The issue of accounting for drug spending and pricing is a complicated one – which is why we launched this newsletter more than two years ago. It is also issue fraught with emotion and ideology, and our job is to present the facts and refute the fictions. CPI for pharmaceuticals may not the best measure of drug prices. The Bureau of Labor Statistics (BLS) deploys sampling techniques while other sources actually count the costs and the prescriptions. One of those sources is Express Scripts, the giant pharmacy benefit manger, which oversees plans for 34.2 million Americans. The company’s annual Drug Trend Report, issued Feb. 8, stated that during 2018 the average unit cost (the price per prescription) for members of its commercial plans fell by 0.4%. For Medicare plans, the price decline was even greater: 1.4%. These figures confirm the BLS data and support what President Trump said in the State of the Union. They also make an objective observer wonder about the political hysteria over drug prices. As Eric Sagonowsky put it in Fierce Pharma: Politicians have been hitting hard at pharma for months and years, using terms such as “skyrocketing,” “astronomical” or “soaring” to describe drug costs. But leading pharmacy benefits manager Express Scripts just reported the smallest jump in retail drug spending in a quarter century. Sagonowsky is talking about spending increase, or “trend,” as Express Scripts likes to say. Spending is a function of price increase and utilization increase combined. Utilization went up (which is a good thing because more Americans are using medicines to fight disease rather than occupying hospital beds), and prices went down. According to Express Scripts: Politicians have been hitting hard at pharma for months and years, using terms such as “skyrocketing,” “astronomical” or “soaring” to describe drug costs. But leading pharmacy benefits manager Express Scripts just reported the smallest jump in retail drug spending in a quarter century. Sagonowsky is talking about spending increase, or “trend,” as Express Scripts likes to say. Spending is a function of price increase and utilization increase combined. Utilization went up (which is a good thing because more Americans are using medicines to fight disease rather than occupying hospital beds), and prices went down. According to Express Scripts: We achieved the lowest commercial drug trend in 25 years, just 0.4% across our clients’ commercial plans. In delivering these results, we drove a 0.4% decline in unit costs by guiding plan members to effective, lower-cost therapies and by securing deeper discounts from manufacturers and pharmacies. And, 50% of our commercial plans had a negative trend, a decline in per member drug spending. Express Scripts reports that generic prices fell 6.5% for “traditional,” or commonly used, brand drugs and rose just 2.1% for more expensive brand “specialty” drugs. The company said prices of generics fell 12.1%. The downward trend is clear. Before declining this year, drug prices for members of Express Scripts commercial plans rose 3.2% in 2015, then 2.5% in 2016, and 0.8% in 2017. The CEA’s Report on Prices The President’s Council of Economic Advisers, which boasts an impressive team of health economists, recognized what was happening back in October. In a report titled, “The Administration’s FDA Reforms and Reduced Biopharmaceutical Drug Prices,” the CEA stated: After 20 months of zero or slightly negative relative inflation, as of August 2018 the relative price of prescription drugs was lower than it was in December 2016. In addition, due to the way price inflation for drugs is measured, the actual reduction in inflation after January 2017 may be larger. As of August 2018, the slower price inflation for prescription drugs under President Trump implies annual savings of $20.1 billion. By “relative price,” the CEA means the price of drugs compared with the price of everything (that is, the Consumer Price Index for all goods and services). In a footnote, the CEA explains that the actual reduction in price versus inflation may be larger because the BLS “has a six-month lag for incorporating generics, so any generic entry after March 2018 is not included.” Why have relative prices come down? Like the Washington Post, the CEA points to reforms that have lowered barriers for the approval of generics. As a result, 17% more generics are being approved each month since January 2017 “than were approved during the previous 20-month period.” The CEA report also states, “Although many factors affect prices in the large and complex market for drugs, it is also plausible that the Administration’s vocal advocacy concerning the challenges of high drug prices could have played a role in the observed slowdown of drug price growth.” Other Reports on Declining Drug Prices Meanwhile, a report issued in January by the IQVIA Institute for Human Data Science found real prices of branded drugs declining: Net prices increased at an estimated 1.5% in 2018 and are expected to rise at 0–3% over the next five years. Included in this overall average are the potential for some companies and products to have net price declines in the face of competitive markets. Additionally, net price growth was below inflation in the wider economy in 2018; an occurrence expected to continue for the next five years. Also arriving recently are aggregate data for 2017. As we reported inNewsletter No. 38, a December study by the Centers for Medicare and Medicaid Services (CMS), found that drug spending in 2017 rose 0.4% and prices fell 1.4%. A trend report from Blue Cross Blue Shield, issued in November, found that spending in 2017 for its members rose 2.2%. BCBS did not reveal utilization increases overall, so we can’t calculate what happened to prices with any precision. But the report did say that for the top 10 medications, utilization gains were 2.6%, so it’s likely that price rises were close to zero and certainly below inflation. CVS Caremark, another large PBM, reported that in 2017, prices for its members rose an average of 0.2%. The company also said that its members spend an average of just $12 per month for drugs out of pocket. That’s the same figure that CMS reported. More remarkably, CVS said that nine out of ten members spent less than $25 a month, on average, for drugs. The Whys These stunning statistics beg an important question: If average drug prices are declining, or at worst rising less than inflation, then why are politicians, the media, and average Americans so concerned and even angry about drug prices? Two reasons: First, the upside-down structure of insurance reimbursement for drugs. Consumers pay almost nothing – and often, literally nothing – for inexpensive medicines. Insurers foot the bill for a $10 prescription for cholesterol-lowering statins, for example. But consumers are faced with hefty co-pays, running into the thousands of dollars, for more expensive, live-saving drugs for such conditions as autoimmune disease and cancer. Second, high public list prices, which are the numbers which the media trumpet but which, as we noted above, have little relationship to how manufacturers are compensated or what insurers and consumers actually pay.Adam Fein of Drug Channels explained in the Wall Street Journal on Feb. 3: Rebates and discounts mean drugs almost always sell far below their list prices. The payments are massive. Last year manufacturers paid $166 billion in rebates and discounts, amounting to a 40% reduction in prices for off-brand drugs. Certain essential drugs like insulin sell at even deeper discounts. PBMs are able to demand these big rebates from drugmakers because a small number of them handle most of the drug purchases for America’s insurers. Old narratives are hard to kill. But the story that drug prices are skyrocketing or out of control deserves to die. It is impossible to make good policy if you ignore facts. Politicians, academics, and journalists have an obligation to recognize the truth about how much Americans are really spending on the most innovative and powerful medicines the world has ever seen. One of the great mysteries in recent years is why pharmaceutical companies are portrayed as the villains in the story of rising U.S. health care costs while hospitals are virtually ignored. A devastating article in the new issue ofNational Affairs, a respected journal that explores domestic policy, helps to set the record straight and to explain the conundrum. Before we get the article itself, here are some recent facts about hospital costs.
 Hospital Costs Soar, But Utilization Metrics Decline
What makes soaring hospital spending hard to understand is that key metrics on the utilization of hospitals have been declining. For example:
It is no surprise, then, that the cost of stays and procedures is rising. For example, between 2005 and 2014, the average cost per hospital stay, adjusted for inflation rose a total of 12.7%, according to a 2017 H-CUP report. “The cost of a maternal (childbirth) hospital stay rose 12.8% (again, adjusted for inflation); neonatal stay, 19.2%; surgical, 16.4%; injury, 17.1%.” These increases have occurred even though stays are generally shorter than in the past. One study found that the average hospital stay for pneumonia fell from 5.6 days to 3.6 days over just a six-year period in the early 2000s. More and more appendectomy patients are going home the day of the operation; in the 1960s, the surgery required a stay of nearly a week. Government Subsidies and Protectionism Make Hospitals Inefficient So, less use of hospitals, more spending on hospitals. What gives? In the National Affairs article, Chris Pope, a fellow at the Manhattan Institute, has an answer. He blames the problem on excessive government intervention creating what he calls “hospital protectionism.” He writes, “America's hospital industry is already one of the most politicized sectors of the nation's economy, and its shape and structure are the product of decades of deliberate legislative and regulatory actions.” Pope begins with basic hospital economics. Hospitals have high fixed costs. One study found that “84% of expenses relate to buildings, medical equipment, and (often-unionized) labor — costs which, unlike medications or supplies, cannot easily be expanded or reduced in line with patient volumes.” The normal response would be for “expenditures [to] be spread over more patients, [so] prices can be greatly reduced.” That is what has happened in Europe, and Pope offers some eye-opening examples: The United States performs only slightly more MRI scans (118 per 1,000 residents) than France (105 per 1,000) but employs three times as many MRI machines (39 versus 13 per million residents). This helps explain the disparity in the average cost of an MRI: $1,121 in the United States but only $363 in France. America's hospital sector has become plagued with such overcapacity. Whereas the European Union had an average hospital-bed occupancy rate of 77% in 2015, the rate in America's community hospitals was only 63%. Occupancy rates were less than 30% for American hospitals with between six and 24 beds, and 42% for those with 25 to 49 beds. The United States simply has too many hospitals. While we have 4,840 community general hospitals, Pope writes, the initial 13 Eurozone members, which have a population greater than the U.S., have only 2,901. “This is not just a matter of population density,” he writes. Massachusetts, for example, has a population density nearly twice that of Denmark (not including Greenland), yet Massachusetts has 75 hospitals compared with 21 for Denmark. On average, hospitals in Europe have 235 beds; in the U.S., 150. U.S. hospitals are characterized by lower volumes of surgery and other procedures. Pope notes that 65% of heart-bypass operations in California occurred at facilities with fewer than 200 procedures a year; compared with 7% at such smaller facilities in Canada. “Low volumes,” he writes, “also inhibit learning (by organizations as well as clinicians) and reduce the quality of care: The 30-day mortality rate following such procedures is 5.2% in low-volume hospitals and 2.1% at high-volume hospitals, with a ‘safe’ threshold achieved by facilities treating at least 415 cases per year. Political Favors Are at the Root of the Problem The mysteries mount. Why does the U.S. have so many smaller, less efficient hospitals? The answer seems to be politics. Pope writes that the current situation is “the product of two decades of deliberate interventions to protect hospitals from falling revenues through a combination of subsidies and restrictions on competition.” What politicians seek to defend through their interventions with hospitals is the status quo. He writes: Whereas hospitals seem strong to economists, they do nothing but plead their weakness to congressional staff: Without assistance, they claim with some plausibility, they will be forced to scale back essential services or close their doors. Members of Congress from both parties, all of whom have hospitals in their districts greatly cherished by their constituents, are highly sensitive to such concerns. In addition to the practical convenience it offers, a well-equipped local hospital gives residents a sense of security and helps anchor a community. Hospitals also bring an enormous number of well-paying jobs (5.7 million in 2015) to places that otherwise may have few. This political power is catalyzed by lobbying spending ($103 million in 2017) that rivals the amount spent by the entire defense industry ($125 million). The result is a host of special political favors. For example, Pope notes that Medicare established fixed-payment rates in 1983, but a GAO study 30 years later found that 91% of hospitals were eligible for upward adjustments or exempt from the rates entirely. Pope enumerates other subsidies that maintain the current bloated system. Fee schedules for Medicare services delivered in a hospital outpatient department, for example, are sometimes “more than three times as much for the same procedures when they are delivered by doctors directly employed by hospitals.” The Stark Law, passed in 1992, “was enacted in 1992 to ban physicians from referring Medicare or Medicaid patients to specialty hospitals in which they have a financial stake, due to conflict-of-interest concerns,” Pope writes, but, in fact, the law’s effect is to keep lucrative operations at community hospitals when they could easily be shifted away. The government “also provides $16 billion per year to hospitals with medical residency programs — a subsidy that is not needed to get hospitals to employ underpriced skilled labor, but which they nonetheless prize.” Then, there are state Certificate of Need laws that allow large hospital systems to “easily get approval for investments they seek to make, while smaller competitors and newcomers can find it hard to establish a foothold or to build the scale needed to challenge incumbents.” One of the Worst Subsidies: the 340B Program One of the worst politically tinged subsidies to hospitals is the 340B program. It was established 27 years ago as a way to help poor hospital patients. In order to participate in Medicaid, drug manufacturers have to provide outpatient medicines at prices discounted by 20% to 50% to hospitals that serve a disproportionate share of low-income Americans. The hospitals are then allowed to claim full reimbursement at undiscounted rates are supposed to use this excess for charitable care. But, as we pointed out in Issue No. 30 of this newsletter, the program is not working as promised. It has become just another subsidy to support inefficient hospitals. The vagueness of the law allows hospitals to ignore the obligation to help poor patients and for hospitals that serve non-poor patients to get benefits as well. In study published in the New England Journal of Medicine last year, Sunita Desai of the New York University School of Medicine and Michael McWilliams of the Harvard Medical School concluded, “Financial gains for hospitals have not been associated with clear evidence of expanded care or lower mortality among low-income patients.” Meanwhile, the program has ballooned in size. Adam Fein of Pembroke Consulting, publisher of the Drug Channels blog, released data last summer showing that the 340B program has grown at an annual rate of 31% since 2013 (by comparison, manufacturers’ net drug sales grew by about 5% a year. In 2007, the program accounted for 1.6% of all U.S. drug sales in 2007; by 2016, the proportion had reached to 5%. Discounted drug purchases under 340B, rose to $19.3 billion, up from $16.2 billion the year before. And, as Fein notes, as those purchases have risen, charity care by hospitals has declined, from 6.1% of total expenses in 2012 to 4.3% in 2016. The 340B program has greatly expanded with little oversight. More than 25%of retail, mail and specialty pharmacies are now eligible for the discount. In 2016, according to findings by Drug Channels, more than 50% of total hospital purchases in the U.S. were through the 340B program. In a paper in 2014, Rena Conti of the University of Chicago and Peter Bach of Memorial Sloan-Kettering pointed out how 340B has set in motion factors that raise overall health costs: The 340B program creates a widening disparity between noneligible and eligible hospitals and affiliated oncology practices in the profits they are able to obtain from the care of well-insured patients with cancer. This disparity is likely underlying trends toward consolidation and affiliations between community-based oncology practices and 340B-eligible hospitals. This disparity may also lead to shifting of care out of community-based oncology practices and into hospital-based infusion suites. These trends will tend to increase total spending. Cancer care delivered in a hospital-based outpatient infusion suite is typically more expensive than that delivered in a physician’s community-based office. In another study, published in the New England Journal of Medicine by Sunita Desai of the New York University School of Medicine and Michael McWilliams of the Harvard Medical School, found that facilities owned by hospitals eligible for 340B had “230% more hematologist-oncologists than expected in the absence of the program” and that “program eligibility was associated with lower proportions of low-income patients in hematology-oncology.” That study concluded, “Financial gains for hospitals have not been associated with clear evidence of expanded care or lower mortality among low-income patients.” High Infusion Costs – And a Response High infusion costs for specialty drugs at hospitals plague the health-care system. An analysis by Fein of data from the Medical Pharmacy Trend Reportfound, for example, that Remicade, an immunosuppressant drug, cost 120% more to administer in a hospital than in a doctor’s office; Neulasta, a bone-marrow stimulant, cost 100% more; and Alimta, a chemotherapy drug for lung cancer, cost 50% more. As a result, health insurers are cracking down. In Michigan, Blue Cross Blue Shield and Priority Health “have created programs to eliminate from coverage most infusion services at hospitals or outpatient centers owned by hospital chains,” wrote Jay Greene last April in Crain’s Detroit Business. And a policy instituted last summer by Blue Cross Blue Shield of North Carolina states bluntly: “Hospital outpatient infusion, in the absence of the clinical indications above [mainly a history of adverse events], is considered not medically necessary.” At the start of 2018, the Trump Administration took a step toward reforming 340B by reducing the Medicare repayment rate by about 30%, cutting the profit hospitals were making from the discounts that were forced on drugmakers. The politically powerful American Hospital Association sued, lost an appeal last July, then refiled the case in September and won a favorable ruling on Dec. 27 in U.S. District Court for the District of Columbia. The case is far from over. Law Requiring Hospital Cost Disclosure Goes Into Effect Meanwhile, a new law went into effect on Jan. 1 of this year requiring hospitals to post their prices online. The law is hardly a panacea. Yes, the average cost of a kidney transplant is $415,000, but the new price postings are confusing, and consumers don’t pay them anyway. In fact, one reason that hospitals do not feel pressure to constrain their prices is that patients pay so little out of pocket. As Pope explains: Hospital services are disproportionately consumed by those with major illnesses who have already passed deductibles and caps on out-of-pocket costs. As a result, a study by Gautam Gowrisankaran, Aviv Nevo, and Robert Town found that patients pay an average of only 2% to 3% of hospital bills as co-insurance, and are more than 40 times less responsive to prices than those paying out of pocket. From the hospitals' perspective, the most lucrative well-insured patients may be sensitive to travel, quality, and amenities, but are usually insensitive to cost. Pope offers the right antidote: competition and the elimination of most, but not all, subsidies. “The objective of public policy,” he concludes, should be “to allow competition wherever possible to eliminate inflated costs while establishing a reasonable floor in access to emergency care. Policymakers should seek to establish a ring-fenced subsidy for emergency and safety-net services, along with an expectation of full competition for elective care.” That makes sense. But just as important as proposed solutions is simply the matter of focus. It’s time policy makers put their own political interests aside and started targeting by far the most important source of higher health-care costs: hospitals. |
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Cost-of-Health-Care News (CHCN) was launched on November 30, 2016, with the aim of providing news and analysis regarding a critical public-policy concern: the costs and pricing of health care. CHCN is published by EAH Strategies, headquartered in Grand Rapids, Mich. CHCN is supported by Pfizer.