• Drug shortages and Medicare’s price controls

    In the US, there is currently a shortage of many injectable, generic drugs, and it is affecting patient care. There are many reasons why this might be happening, and I will focus on just one in this post.

    Atop a post on this subject yesterday, Julian Pecquet’s headline read, “Hatch blames government price controls for shortages of medical drugs.”

    “Experts contend that federal government pricing and rebate programs are a significant contributing factor to the current drug shortage crisis,” Sen. Orrin Hatch (R-Utah) said during a committee hearing on the issue. “Current pricing structures have been very effective at driving generic utilization. However, they may not fully capture or reward the costs associated with the complex development and manufacturing of injectables, as opposed to the more straightforward manufacturing process in the pill market.”

    In what sense is this “price control” and not just garden variety low government payment rates? After all, if the government sets a low payment rate for a medical service or product, that does not mean that the provider or manufacturer can’t charge others a different and higher price. Where’s the “control”? Bruce Chabner, in NEJM, explains.

    Currently, Medicare legislation resets reimbursement for injectable generics at no more than 6% above the average sales price (ASP) paid during the preceding quarter for any given agent.3 These limits affect price and reimbursement for all purchasers and providers, result in little profit for the manufacturer and the provider in the U.S. market, and greatly limit the ability of generic-drug manufacturers to increase their prices. Meanwhile, generic drugs manufactured in the United States can be sold abroad for a greater profit. (Emphasis mine.)

    I followed the referenced link, but that didn’t provide much help in understanding why Medicare’s reimbursements “affect price and reimbursement for all purchasers and providers.” Here I plead ignorance and ask readers for help. It’s clear that Medicare’s low reimbursement rate could limit availability of drugs for Medicare beneficiaries. But that’s not how the problem is characterized. It’s characterized as a widespread shortage. If that’s due, in part, to Medicare “price controls” how does the low Medicare price “control” that of other insurers? Why can’t insurers pay whatever (higher) price is necessary to incentivize manufacture of the drugs? Medicare pays low prices for a lot of things, but that doesn’t cause a shortage of them for those of us not on Medicare. What am I missing?


    • Here’s the reason:
      Once Medicare sets a price for something, the commercial insurers follow suit and essentially force the manufactuer, or even doctor provider, to accept nearly the same prices in return for getting their contracts.

    • Don’t look at Medicare. It doesn’t reimburse the drug companies for cancer drugs.

      You have to look at the demand and supply sides separately.

      Demand side: Community oncologists and hospitals, who provide most chemotherapy, are reimbursed 6% above the price they pay for drugs (the average sales price or ASP). Those prices from Medicare are adjusted looking back a quarter. So if prices rise rapidly, and the doc is reimbursed at an old price plus 6%, he won’t buy at the price he is offered because it is below the cost of his reimbursement. So he/she has a shortage.

      The generic manufacturer, recognizing that he can get higher prices when there is a shortage in supply, switches to providing the drug to those who aren’t hemmed in by the ASP+6% system: hospitals and foreign health care system. Hospitals, who have other ways of making up revenue, report widespread gouging when drugs go into short supply.

      Supply side: So the question remains: Why the short supply? It’s complicated. Chemo drugs have limited markets. Injectables are harder to manufacture than pills. Many chemo drugs are injectables. The most widely used injectable drugs have very few companies that make them, in some cases just one. Some companies switch using their manufacturing facilities from one injectable to another since it only takes short runs to make a year’s supply (or your market share of a year’s supply). Some have had problems with safety and quality (glass in the vials, etc.). The FDA has cracked down on some of these manufacturers, even temporarily closing facilities.

      Finally, there are middlemen between the generic manufacturers and the hospital pharmacists and community oncologists who buy their own drugs. Few buy directly from manufacturers.

      A lot of middle men are charging huge mark-ups on their stocks when manufacturers run into problems. And in a few cases, single source manufacturers have had to shut down briefly. Either one can result in huge price hikes and shortages.

      At least, that’s my understanding. The FDA has a whole report on it on their website.

    • I think this is a specious argument intended to scapegoat government. If Medicare paid more, wouldn’t it be blamed for not controlling drug costs?

      Another consideration: more than half the drugs purchased in the world are bought outside the US. Why single out Medicare? Yet another consideration: pharma as a whole has a very high profit margin. It has long had unusually high margins, far more than any other part of healthcare or other R&D intensive industries. What is the net income of these companies that say they can’t take profitable risks because of Medicare.

      • Profit margins for the Generic companies that are the subject of this discussion are razor thin in the US. This is not because of government policies, but because of competition. They have little room for manufacturing problems, which are particularly likely for injectable products.

        • If you look across all sectors you’ll find that thin margins and intense competition are more the rule than the exception, yet persistent supply shortages are exceptionally rare outside of sectors with price controls. I can’t think of any off of the top of my head, but perhaps others can.

          Within this particular sector, it seems like this is a question that could be addressed rather easily by looking into the data on persistent shortages of injectable generic chemotherapeutics in the 20 year period before price controls and contrasting that to the situation that’s emerged since the implementation of the Medicare part D price controls. Are they more or less of a problem?

          • In case it isn’t clear, injectables are covered under Part B, not Part D. If it were the latter, there would be no “price controls” since Part D plans (or PBMs on their behalf) negotiate privately with manufacturers.

            • That’s a useful clarification, so thanks for that. Change the letter from D to B and you’re still left with a system-wide change in the price regimen followed by system wide shortages that followed in its wake.

              Ergo hoc isn’t necessarily propter hoc, but the analytical and empirical connection between price controls and shortages is clear, so if we apply Occam’s Razor here isn’t the burden of proof on the folks are arguing that price controls have nothing to do with systemic shortages for goods with controlled prices?

              Where does the author below get it wrong on this one?

              “Prior to 2003, Medicare paid for cancer chemotherapy injectables based on the average wholesale price. But with no transparency, some distributors or physicians could reap huge profits. To combat this, and with the best of intentions, a new system was developed as part of the Medicare Modernization Act of 2003, based instead on the average selling (retail) price, updated quarterly. Oncologists, who purchase the drugs from distributors and then administer them, are reimbursed the average selling price, plus a 6 percent administrative fee. This would at first glance seem perfectly reasonable. Not quite. In effect, it means that Medicare allows a maximum of only a 6 percent increase per year; any more, and the reimbursement would be less than the cost.

              In the generic drug business, prices can decline tremendously. If the price drops too low, some manufacturers simply cease producing it and use their capacity to make other, more profitable, drugs. The remaining producers cannot raise their prices more than 6 percent, so they have little incentive to make up for lost capacity by investing in new plants or equipment.”

    • Like you, I don’t see how Medicare rates “affect price and reimbursement for all purchasers and providers” – but let’s take that as a given. That Medicare reimbursement determines the price for all. If that’s so, then the price should follow the rule: “6% above the average sales price (ASP) paid during the preceding quarter” since I expect vendors would charge what they can get. If I read this correctly then the manufacturers can raise prices by more than 26% per year! I don’t imagine that many industries would complain about being allowed to increase prices at that rate.

    • -Seems like there are really only two possibilities that make sense – at least as first pass approximations.

      The first is that private insurers rigidly adhere to Medicare pricing, the second is that Medicare provides a high enough percentage of the effictive demand that the profits from the remainder of the volume aren’t sufficient to overcome the losses/lack of profits available through sales to Medicare.

      Neither is entirely satisfactory, but it’s worth contrasting the situation with non-price controlled drugs and asking how frequently one observes a shortage when market prices can coordinate supply and demand.

    • I think the main issue here is high fixed costs for injectable drugs, coupled with very small markets, means that the profit for Generic companies is very small or even negative.

      Any injectable drug is required to have regular scientific studies to demonstrate that it can be manufactured with a high assurance of sterility, that it stays sterile throughout its shelf life, and that the sterilization process does not effect the amount of drug or the amount of impurities. These studies are required not only by FDA, but also by all the other international drug regulators.

      The cost of these studies is pretty much fixed. If you are selling millions of vials in a year, its a relatively manageable cost. If the market is small, it quickly makes it questionable whether a manufacturer wants to participate in that market.

      So you end up with drugs that have maybe only a single plant that is qualified to make it. Any problems in that plant, or even opportunities to make other higher-margin products, can seriously disrupt the supply.

      • The problem with the idea of quality problems or few plants being the explanation alone is that manufacturers could always get a contract manufacturer to supply the drug under the original manufacturer’s approval (ANDA). The contract manufacturer would only need a DMF, which can come rather quickly. My thought is that ASP+6%, with new prices only once a quarter is constraining a big chunk of the market (i.e. Medicare), though no one else really follows part B pricing.

        • I’m just not understanding something. If Medicare isn’t paying enough why isn’t just Medicare patients that experience the shortage? I could speculate, but I’d rather not.

          • If the market share story is true, then it seems like one could ask why Gates, Ellison, and Buffet couldn’t get their hands on Joint Strike Fighters if the Pentagon had imposed price caps below production costs that made ~99% of their production unprofitable, or why a handful Pontiac enthusiasts willing to pay a premium couldn’t induce GM to dedicate a production line to ramping up Fiero production.

            Seems like if the magnitude of the effective demand outside of the price controlled market is small relative to the magnitude of the portion that is price controlled, the total effective demand relative to opportunity costs and profits will be too small to justify the total expenditure required to bring forth production.

    • For many diseases, Medicare is far-and-away the largest payer, because disease prevalence is highly age-related. For many of these generic medications, therefore, Medicare is the major payer.

      The real problem is that we legislated a cap on increase in generic meds — which are generally cheap and where some manufacturers faced with this cap chose not to make new capital investment in continuing to produce these drugs

      If we were going to try to use price regulations, we should have tried them for of BRAND NAME medications – where the increase in prices has been quite high – not for generics.

    • My understanding, is that ASP+6% only applies to the drugs (typically injectables) that are administered directly in the doctor’s office and in hospitals, where the doc (typically an oncologist) bills medicare for the drug itself, or a hospital does the same, and either the doc or the hospital can therefore make a profit from having administered the drug. I think the Medicare folks thought this inappropriately incentivized treatments that may not always have been necessary, or incentivized the use of more expensive drugs, so the ASP+6% rule was implemented.

      As a previous poster said, the ASP+6% rule does not apply to self-administered drugs (e.g. pills) administered at home.

      Another reason why chemotherapy drugs may be unduly influenced by this policy, is that cancer tends to be a disease more often affecting the elderly (those over 65 years of age). These patients probably have a high percentage of participation in medicare, and relatively low participation rate with private insurers, so that the medicare ASP+6% rule may be hitting this market worse than other types of injectable drugs. I haven’t read that anywhere, but that would be my guess.