Attorney General Mike Hatch is doing good work in his actions against drug makers that allegedly inflate listed “average wholesale prices.” Such alleged artificial price setting — the basis for patient co-pays and Medicare and Medicaid reimbursements — constitutes simple fraud against taxpayers and patients.
It would be a mistake, however, to view the Minnesota AG’s lawsuits as a permanent fix. Policy changes are needed to prevent recurrences of this particular scheme. Hatch’s litigation may result in headline-winning settlements, but it won’t change underlying incentives.
This case and others illustrate how hard it is to avoid inadvertent creation of perverse incentives when designing mechanisms to pool or socialize risk. In plainer English, it is hard to write insurance policies that don’t motivate at least some people to do bad things.
A quick review of the case:
According to the attorney general, New Jersey-based drug company Pharmacia sells Vincasar, a chemotherapy drug, to doctors for about $8 per unit. The doctors who administer the drug to Medicare, Medicaid and other patients charge these patients more than $700, which is what the manufacturer posts as its “average wholesale price.” The government then pays the doctor about $560, or 80 percent of the average wholesales price, and the patient ponies up the remaining $140.
Hatch acknowledges that it is the doctor and not the drug company pocketing the difference between the real price and the artificially inflated average wholesale price. He is suing the drug producers rather than the doctors because, he says, the manufacturer attests to what the actual average is. Some cynics, aware of the AG’s populist tendencies, note that drug companies also rate far lower in public opinion than the heroic doctors who save our lives.
You may wonder why a firm would engage in this activity if the doctors pocket the “spread,” as the difference between actual and posted wholesale prices is termed in the industry. The answer is simple: The drug business is competitive.
Doctors are human. All mumbo jumbo about the unsullied motivations of M.D.s aside, doctors tend to prescribe more of those drugs that offer them a wider, more profitable “spread.” Companies that offer attractive “spreads” sell more products than those that do not.
The “spread” between the actual and posted “average” drug prices is an incentive for doctors to use a particular drug. Both essentially defraud an insurer who passes the cost on to those who pay for the insurance. In the case of Medicare and Medicaid, this means taxpaying citizens.
Structuring policies to prevent such abuse is difficult, particularly when the government itself is the largest customer for the insured good or service in question. Approaches to this thorny issue will be the subject of Sunday’s column.
(This column is part one in a two-part series. Part two, “Insurance firms struggle to avoid moral hazard,” continues the discussion of how the “spread” affects insurance companies.)
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.