Since 2004, Medicare has reimbursed outpatient prescriptions through the “Part D” program. Medicare Part D’s costs have been significantly lower than initially budgeted, because the government does not fix the prices it pays for prescription drugs.[45] Instead, it contracts with a large number of private insurers, which offer Part D drug plans to Medicare beneficiaries. Private insurers win these contracts by bidding against each other in annual auctions. This is unique: Medicare Part A (for hospitals) and Part B (for physicians) use government-dictated prices to reimburse providers.

Injectable drugs fall under the Part B program, because doctors buy them. In 2005, Medicare stopped reimbursing doctors using a benchmark called “average wholesale price” and switched to a figure called “average sales price.” This is because the AWP (which market insiders referred to as “Ain’t What’s Paid”) was a fictional price quoted by drugmakers, unrelated to actual wholesale transaction prices. The AWP was also the benchmark for very large payments from drugmakers to doctors. Medicare Part B reimbursements were set at 95 percent of AWP in 1998 and reduced to 85 percent of AWP in 2004.

These reimbursements, however, bore no relation to the “spread” that a physician (especially a cancer specialist) earned from the drugmaker. For example, a physician might receive an invoice from a drugmaker for $100 — the AWP — which he would forward to Medicare for a reimbursement of $85. He might also receive a “spread,” though, of 50 percent (or $50) back from the drugmaker. Thus, he would make a lot more than a casual observer (or taxpayer) would expect — a process called “selling the spread.”

The average sales price used in Medicare now is an average of actual net sales. The reimbursement to the doctor from Medicare is 106 percent of the ASP.

This change had a dramatic impact on medical oncologists (cancer specialists), whose practice largely consists of injecting drugs (chemotherapy). A 2005 survey of more than 2,000 drug codes found that the ASP is 49 percent less than the AWP. For a sample of over 1,000 generic drugs, the ASP was 68 percent less than the AWP.[46]

Clearly, injecting drugs became less profitable for physicians, especially cancer specialists.[*] But would the same be true for drugmakers? One scholar has developed a highly theoretical model that shows that the AWP to ASP change could have contributed to drug shortages, because it increased the difference between what private insurers pay and what Medicare pays. According to this model, each 10 percent of market share accounted for by Medicare is associated with an increase of shortage frequency of 7.5 percentage points.[47]

But actual history does not support this theoretical model: The volume of generic injectable cancer drugs in Medicare Part B increased by nearly 30 percent in 2006 through 2010, while the volume of injectable cancer drugs overall, as noted, increased by just 14 percent. Only 10 percent of the volume of Part B injectable drugs in 2006 and 2007 consisted of drugs that experienced shortages during the next three years.[48] The evidence continues to suggest that shortages are a result of supply being unable to meet increased demand, not too much demand caused by artificially low prices dictated by government.

Nevertheless, the change in the benchmark does really change the incentive for medical oncologists to view their drugs as a profit center, so it might not be surprising that the reform would have motivated them to use more drugs — that is, to make up in volume what they lost in the spread. Two physicians have proposed dramatic reform that would pay physicians an administrative fee to inject drugs, thereby reducing any perverse incentive.[49]


[*] If anything, the change in reimbursement should have led to a reduction in the number of medical oncologists practicing. Ali Yurokoglu, “Medicare Reimbursements and Shortages of Sterile Injectable Pharmaceuticals,” (Graduate School of Business, Stanford University and NBER, 2012), 9, http://goo.gl/fVkH2 (accessed June 12, 2012). Evidence of this is weak. Advocates for the specialty assert that a shortage is developing. The Community Oncology Alliance states that there have been 199 clinic closures and 369 practices struggling financially since early 2008. Three hundred and fifteen clinics have been acquired by hospitals and 111 have merged or been acquired by a corporate entity. But the report did not conclude that oncologists themselves have quit practicing. Zosia Chustecka, “Community Oncologists Not to Blame for Drug Shortages,” (www.medscape.com, 2011), http://goo.gl/iptdS (accessed June 12, 2012). (Available with free registration.)