When drug prices are a Trojan Horse for other costs, we all lose
By Peter Kolchinsky
Peter Kolchinsky is a founder and Managing Partner at RA Capital Management and author of The Great American Drug Deal.
Giovanni Domenico Tiepolo, Public Domain, via Wikimedia Commons
July 14, 2021
America’s byzantine drug pricing systems are chock-full of middlemen. These intermediaries benefit from the spread between inflated list prices (which hurt patients on the hook for high out-of-pocket costs) and the much lower net prices received by manufacturers.
That hidden fee stack not only drives the profits of PBMs but also funds all kinds of services provided by hospitals and clinics.
The way that hospitals benefit from inflated list prices is sometimes harder to understand. But it’s a common theme across different kinds of drugs dispensed at hospitals and clinics across the country that’s not just a problem for the drug industry but is turning out to be freakonomically* bad for the middlemen themselves.
An NBC News piece last week about the federal drug pricing law called 340B shows how hospitals and clinics can buy drugs on the cheap (sometimes even receiving them for free), jack up their prices for patients/insurers, and use the difference to pay for all kinds of other stuff. This practice is akin to money laundering in that hospitals are obscuring their expenses, making drugs seem more expensive so as to make the services appear less expensive, or even free. Unlike actual money laundering, hospitals aren’t breaking the law here – the 340B law was designed to have drug prices subsidize services and hospitals are arguably just going with the flow – but they are now discovering how the dishonesty of 340B can backfire.
What drew NBC’s attention is that sometimes the free-flowing 340B spigot runs dry when a drug goes generic.
For expensive brand-name drugs, the 340B spread can be quite a substantial sum. By contrast, when these clinics prescribe a cheaper generic medication, the difference between the price they pay and the price at which they are reimbursed is often relatively minimal; so the prescription generates little revenue.
And all of a sudden, those services begin to look much more expensive. So expensive, that clinics serving low-income and otherwise marginalized populations might have to close down. Such is the case with HIV clinics that have become reliant on the spread generated from drugs like Gilead’s combination antiretroviral Truvada, which can be used to treat and prevent HIV. Truvada has long been an expensive branded drug, which meant that clinics that got this drug at a low price or even free from Gilead and charged branded prices for it were making a windfall. Basically, the money that you would have thought Gilead was making by selling the drug at its branded price was actually being made by health clinics that prescribed its drug. But Truvada went generic in April 2021, collapsing the spread, and clinics found themselves exposed. What had the Truvada 340B spread been paying for? The answer seems to be everything.
Clinics have been able to use this windfall to subsidize for their uninsured PrEP patients the quarterly clinic visits and laboratory tests that are required to maintain the prescription and that are not covered by Gilead’s patient assistance program.
Such funds have also been channeled into paying 340B clinics’ facility and technology costs and to pay for patient navigators, safe sex counselors, outreach workers, condoms, advertising, patient transportation, sexually transmitted infection screening and treatment, and opioid use disorder treatment. And in some cases, this money covers other medications for uninsured people ...
These are all important services. Insurers could have reimbursed 340B clinics for what all those HIV-related services actually cost. Clinics could have charged insurers and patients lower prices for Truvada that reflected the fact that they got it at a deeply discounted rate. In that scenario, Truvada’s patent expiry – a thing society ought to celebrate, as it will benefit from inexpensive generic Truvada for as long as it needs to use it – wouldn’t have jolted the system at all. Instead, we get this mess.
Why would the ability to fund them be tied to the price of a drug? The answer is because it’s politically easy. 340B was a way for Congress to get pharma to appear to pay for things that otherwise would have hit federal and state budgets. Congress made it so that Gilead has to give away free or low-cost drugs to clinics but knew that Gilead would have to make up the difference by charging higher prices to the non-340B segment of the American market. In other words, people with private insurance tend to pay more in premiums and out-of-pocket costs so that the federal and state governments can pretend their expenses are lower, and therefore taxes can stay lower.
And yet, while we can pretend all we want, the costs of paying for those important services that HIV clinics and similar caregivers provide are real – they employ people and use all kinds of products to care for patients. While it may look like Gilead is somehow helping to pay for all that, the reality is that those costs have simply been passed through Gilead’s product to private insurance. Which means that all Americans who pay insurance premiums are paying for those clinics but are conned into thinking that we’re paying higher prices for drugs.
Beyond 340B
340B isn’t the only way hospitals distort drug prices. New CMS regulations came into effect in January, forcing hospitals to disclose list and negotiated net prices for drugs, and the price for cash-paying patients. Analysts at Bernstein Research took a peek (though most hospitals at the time had failed to comply with the new rules) and found out what you might now expect. That regulatory sunlight showed hospitals jacking up drug prices substantially – sometimes charging 500% of what manufacturers charged.
Over at STAT, Pharmalot summarized it like this:
As Americans grapple with the rising cost of prescription drugs, a new analysis found that some hospitals mark up prices on more than two dozen medicines by an average of 250%, underscoring the incentives to use more expensive brand-name treatments than lower-cost biosimilars.
For instance, hospitals charged more than five times the purchase price for Epogen, which is used to treat anemia caused by chronic kidney disease for patients on dialysis. And the price for Remicade, a rheumatoid arthritis medication, was raised 4.6 times above the purchase price.
So it’s not just overpriced Band-aids and aspirin. (Though to be sure, it’s that as well – as hospitals are sometimes caught charging crazy prices for common over-the-counter and generic drugs too. See this recent report from GoodRx on that phenomenon.)
Just as Truvada going generic revealed the unintended consequences of 340B for HIV clinics, healthcare looks absurd when viewed through the fun-house mirror of hospital economics. We can see why cheaper biosimilars can’t make inroads against more expensive brands that hospitals prefer because they are more expensive. And if not for the fact that patients are constantly being hit with surprise bills and other out-of-pocket costs, some tied to the list prices of the drugs they need, it might not seem so important how a hospital balances its budget. Those could be details worked out between the hospital and insurance plans.
But patients do pay. And so pretending that drugs are more expensive than they are shifts public ire toward pharma companies. It’s a terrible way to keep the lights on in the ICU.
Taken to the extreme, higher drug prices could serve as a Trojan Horse for all health care costs. Remember, many drug companies already report average rebates of around 50% on their drugs, while patients pay out-of-pocket costs based on the list price. Insurers are already using this system to pay for services and offset costs elsewhere – e.g., to reduce premiums for healthy people. All of which contributes to the false narrative that drugs are too expensive and need to be price-controlled.
So if Congress wanted, it could just make the drug industry appear to pay for all of healthcare by letting hospitals and clinics mark up all the drugs they prescribe as much as they needed to pay for 100% of their costs.
Imagine if heart surgery was listed on a bill as free but the generic blood thinner you were sent home with was marked up 1 million percent to cost $60,000. Arguably no problem if insurance is going to cover the whole bill. But it’s a huge problem if you have co-insurance. Who are you going to blame? The drug company of course, except in that case the generic company selling that drug would be making pennies. And what do you think would happen to that hospital if governors started telling patients they could bring in their own $10 prescription of blood thinners into the hospital? Would they say “ok, since you brought your own meds, we’ll just do the surgery, which is free.” No. Much like a bar that forbids patrons from bringing in their own beer and enjoying the ambience for free, hospitals would forbid patients from using anything other than the drugs the hospital prescribed since that would be its only means of generating revenues.
Drug industry critics would have their statistic: “Drug prices have soared to now consume 100% of America’s healthcare budget! Congress must pass price controls!”
A dangerous practice
All these hospital mark-up data – from common, small-molecule generics to HIV meds, to specialty biologics – show that a drug maker could give away products for free, as Gilead sometimes does in 340B, and still be accused of price gouging.
Considering lots of different service providers mark-up products and sell them on, you might say, what’s the big deal? A mechanic takes a cut when he installs new brakes on a car. We get why a plumber makes money on both parts and labor for replacing a water heater.
But here’s the thing: these and other markups aren’t leading to calls for price controls that would hobble future innovation in brake pads or boilers. Arbitrary markups and outrageous out-of-pockets are combining to do just that to the drug industry**. Patients are being led to believe drugs are too expensive, all in an effort to keep the reported prices of surgeries and other services down and hospital margins in the black.
The end result is we’re dangerously close to innovation-killing price control legislation. Perversely, the price controls envisioned by Congress will hardly make a dent in whether drugs are affordable or not to patients paying high out-of-pockets.
These price distortions are also impacting innovation more broadly. If healthcare services, whether physician consultations or surgery, appear to be low-value because they are actually being subsidized by marked-up drugs, then innovators might miss the value to society of improving on those.
We need to recognize the true cost of health care services and see through the false-efficiencies created by 340B and other hospital mark-ups. That way, we can send real and reliable signals to innovators and the market about what kinds of new products we should reward. For example, if we truly appreciated the real cost of surgery, then inventors and investors could strive to make medical devices and other products to reduce the cost of providing that surgery (or drugs to avoid it altogether).
But when it appears that the service is inexpensive and the drugs are costly, Congress mistakenly focuses on lowering what companies charge for drugs… only later to discover, as in the case of Truvada, that those are already low.
Industry leaders engaged in negotiating healthcare reform policy need to resist agreeing to “pay-fors” that allow Congress to jam more of America’s healthcare expenses into higher drug prices. This is going to be hard because Congress hates letting the true cost of anything show up. And yet, when we give in, we merely squeeze the problem balloon creating a larger bulge for ourselves down the road. We need to deflate the balloon entirely.
*If you haven’t read Freakonomics, I urge you to. Because America has indeed freakonomicized healthcare, riddling it with unintended consequences of seemingly logical policies, and we have to understand how it all works to suggest sounds reforms.
**We need insurance reform. See how No Patient Left Behind is advocating for that, here.
