Dan Snow at the Price Points Substack has a lovely deep dive into the 340B drug pricing program. It is one of thousands of chaotic federal interventions that make our health care system maddeningly costly and inefficient, and a good example of some basic economic mistakes.
340B is a federal program that forces drug companies to sell drugs to certain hospitals at a deep discount. The hospitals can then sell the drugs to patients via private or government insurance at the same price as everyone else charges, and make a big profit doing so. (Dan writes that 340B “lets qualified health care providers…, buy drugs from manufacturers at a deep discount.” But everyone is allowed to buy at a discount, and the government does not reimburse the drug companies. I think “force drug companies” is more accurate.)
Dan:
Below are real prices for the cancer drug Keytruda at Javon Bea Hospital in Rockford, IL. In the standard (non-340B) case, Javon Bea likely practices what’s called buy-and-bill:
1. They buy the drug from a specialty distributor for somewhere close to the Average Sale Price (ASP). In this case, Keytruda is $11,198 for a 200 mg dose.
2. Next they administer the Keytruda to a patient. The patient has commercial insurance, which reimburses the hospital at a negotiated rate of $18,520 for the dose.
3. The hospital makes $7,322 ($18,520 - $11,198). Not all of that is profit. There are costs associated with the handling, administration, and storage of each dose.
Now let’s see what happens in the 340B case:
Javon Bea, a 340B covered entity, buys the same 200 mg Keytruda dose at a discount. Here the discount is estimated at -23.1%, but it’s likely much higher. In this case, they save at least $2,586 (original price - discounted price) via 340B pricing.
They administer the drug and bill the patient’s insurance. The negotiated rate stays the same at $18,520 for the dose.
The hospital now makes $9,908, with the $2,586 in acquisition cost savings getting added directly to their profits.
But 340B covered entities aren’t limited to giving 340B drugs to patients with commercial insurance, they can also give them to publicly-insured patients under Medicare (and Medicaid, but it’s more complex). Let’s see how 340B impacts Medicare Part B patients:
Once again, Javon Bea gets the 340B-discounted Keytruda price of $8,612.
This time however, they administer Keytruda to a Medicare patient. Medicare reimburses at ASP ($11,198) plus 6%, so $11,870.
Since the reimbursement is so much lower than commercial insurance, the hospital makes much less ($3,258) despite the 340B discount. However, without the discount they would’ve made only $672, so 340B almost 5x’d their profit.
The government hopes that the hospitals use those profits to help targeted patient populations, “low income,” “rural” and so forth at lower cost, but there is nothing beyond hope for that result. Dan:
In theory, those profits are supposed to be passed on to patients – used to provide uncompensated care, offer community benefits, expand care access, and/or subsidize otherwise unprofitable lines of business. However, the program doesn’t require hospitals to report their 340B-derived spending, or even how much they make from the sales….The law doesn’t specify, so providers are free to do whatever they want with their 340B savings.
Where does the money come from? Congress isn’t paying. Well, duh, drug companies raise prices on everyone to fund these discounts. Even if they did not — if there were a well of drug-company profit that Congress could pass around — that profit comes from drug prices higher than marginal cost on everyone else.
It’s essentially a direct transfer from drug companies to hospitals. If pharma companies can’t make money on certain 340B drugs, then they’ll find other ways to generate profits.
But there is no transfer “from drug companies.” It’s a transfer from other customers (most likely), or workers, or shareholders, etc. Somebody pays.
Some economic lessons
A few general lessons stood out to me.
The program is essentially a sales tax on drugs, used to fund a subsidy for the selected hospitals. Plus, a whole bunch of disincentives. Why do it that way? Well, taxes and transfers show up on the budget, while mandated cross-subsidies do not. It looks free to the government. But it’s not free. We do a lot of that in the US, starting with “thou shalt provide health insurance for thy employees.”
Mandated cross subsidies are much more inefficient than taxing and spending.
One reason is that our general tax system, for all its ridiculous complexity, is a little bit less distortionary than a tax on one good, drugs. There is no real reason that a sales tax on drugs should subsidize hospitals.
The bigger reason is that mandated cross subsidies cannot stand competition. If a supplier gets to overcharge A in order to subsidize B, we obviously can’t allow anyone else to charge A a competitive price.
Now, patented drugs are a bit special in that they have a temporary monopoly in order to pay for development costs. Then this program as well as the larger “negotiation” over drugs undercuts that monopoly, or at least involves a fight over who pays the fixed costs of drug development. (Perfect price discrimination is in fact efficient. But price discrimination makes people pay according to the elasticity of demand, not the political power of each customer.) Lots of restraint on competition remains. For example, you can’t allow a secondary market.
The “average sale price” is $11,198 (whatever that means). Private insurance pays a “negotiated rate” of $18,520. Medicare pays $11,870. What the heck? Why does private insurance pay $7,000 more than Medicare? Why does anyone pay more than $11,198? (The manufacturer website says the list price is $11,795.44, and quickly promises nobody pays list price.) Well, here you see a huge mandated cross subsidy at work. Congress does not want to own up to what Medicare costs, so it forces a grand cross subsidy from private insurance to Medicare. Congress must in turn restrict competition in private insurance a lot, so that nobody undercuts that $18,520.
Nobody gives stuff away for free. Our politicians hand free money to hospitals from drug companies, and expect the hospitals out of the goodness of their hearts to provide free stuff to patients. Well, even non-profit hospitals turn out not to do that. Some of the best part of Dan’s post is documentation that 340B hospitals don’t provide more or more expensive charity care, don’t pass on a cent of drug cost saving to consumers, and so forth. They seem to provide exactly the minimum amount of “low income” care necessary to qualify for the program. (How does a hospital know your income, I’d like to know? And why is “low income” a measure of need? Low income people with private, medicaid, spousal, government, or other insurance get the same health care as anyone else.)
Banking regulation suffers the same folly. The government allows banks unique access to low paying government insured deposits, allows them enormous leverage, and bails them out on occasion, all on the presumption that out of the goodness of banker’s hearts, the banks will turn around and lend money at lower rates. In reality, prices are set to maximize profits, not to achieve zero profits!
Expansion
Much of the story of the American Entitlement Fiasco is how a small, perhaps well intentioned program with some aching disincentives and unintended consequences grows massively over time. Here too.
As Dan documents, hospitals got the right to apply their 340B discounts to remote outpatient clinics, and then to expand the number of such clinics.
Broadly speaking, 340B hospitals tend to be located in less wealthy areas. However, their satellite clinics (i.e. child entities) often extend into wealthier areas to capture greater returns from commercially-insured clients.
Each 340B hospital can have an unlimited number of child entities (CE) and contract pharmacies (CP),…
Fifteen years ago, Illinois had around 25 total child entities. Now that number is close to 1,250, a 50x increase. The vast majority of those entities belong to large regional hospitals and DSH providers in the Chicago area.
And there isn’t a program so dysfunctional that Congress doesn’t regularly expand it.
The Affordable Care Act (ACA) expanded the 340B program… Accordingly, the vast majority of Illinois hospitals joined after 2010:
State vs. Federal Incentives
Dysfunction is basically by design
…the design of the 340B program itself encourages growth and invites malfeasance. Congress created an open-ended discount with no reporting requirements, and providers responded rationally by treating it as a general subsidy rather than a charity fund.
Drug companies try to fight back.
Meanwhile, drug manufacturers are trying to hit the brakes. For the past 5 years, they’ve come up with a litany of restrictions to slow the program down. Most recently, they pulled some of the few levers left to them by limiting contract pharmacies to a single location and by switching to rebates instead of upfront discounts.
But hospitals, which have grown to depend on the money, and state legislatures are going to fight tooth and nail to keep the program.
States have responded by legislating to protect 340B providers. In Illinois, SB2385 and HB3350 would prevent drugmakers from limiting contract pharmacies or collecting any data related to 340B. Other states have passed similar bills.
Another general lesson:
In joint state-federal programs, states have a big incentive to fleece other states.
A state legislature may get the idea that this is a singularly ineffective way to provide lower cost health care. But if a state is more generous than the other states, then the overcharged people all live somewhere else. The provider tax that states use to amp up medicaid spending is a related trick. The Feds chip in 90% of medicare spending. The states tax hospitals, driving up the cost to the Federal Government, then give the funds back to the hospitals. In doing so the states get more federal money per amount they put in. The state and local tax deduction works the same way.
Reform?
As Dan notes, there are already scandals in the news and a Senate investigation.
The investigation’s goal was to determine how covered entities spend 340B revenue in the wake of multiple reports of certain 340B covered entities announcing record-setting profits with no transparency surrounding if and how much of their 340B revenue directly benefits patients.
Will there eventually be some sort of reform? Maybe, as with medicaid via small restrictions around the edges. But once everyone has bought in to the system it’s hard to see that the whole crazy thing will be dropped until the big debt crisis comes. And 15 other bright ideas will arise in the meantime. Whack the mole.
If you want to throw your hands up and start over, nationalizing the whole thing is not the only answer. A blueprint here for free market health care.
Very insightful into a purposefully complex system of rules.
How about, when one goes into hospital, one submits not only one's insurance documents, but also a FAFSA? :-)
Thank you for introducing us to Dan Snow and his Price Points blog. Dan provides a good picture of the impact of outpatient drug and 340B pricing on revenue, but he stops short of discussing their impact on hospital margins, probably because data are not readily available. Since CMS implemented their inpatient and outpatient prospective payment systems many years ago and commercial payers, piggy-backing on CMS reimbursement structures, have pushed hard for years to reduce these rates, hospital margins for these services have decreased significantly.
In contrast, outpatient drugs have become major profit centers for hospitals. Dan's example of a $7K gross margin on Keytruda from commercial payers, augmented to $10K with 340B pricing, is a good example. It doesn't cost anywhere near $7K for hospitals to acquire, store, and dispense the drug; it probably costs less than $700, their gross margin on Medicare patients without 340B pricing. As a result, outpatient infusion therapy has become one of the most profitable clinical services hospitals offer. For cancer hospitals, outpatient infusion therapy can account for the bulk of their net income.
Furthermore, as Dan points out, the margin hospitals earn is directly related to the cost of the drug, giving them an incentive to dispense higher cost drugs and go slow in substituting lower cost drugs like biosimilars.