Editorial: Why are doctors and health clinics in the business of selling prescription drugs?

Americans spent almost half a trillion dollars on prescription drugs last year, or nearly $1 out of every $6 spent on healthcare. And the total is rising fast, driven by an increased reliance on medications and a shift toward higher-priced drugs.

Federal taxpayers help pay for some of those drugs, and last week the Obama administration proposed a new approach aimed at encouraging the use of the most effective medicines, not the most expensive ones. The proposal was quickly denounced by doctor groups and drugmakers, who argued that it could harm patients. But what it really targets is a bad business model that makes heatlhcare needlessly expensive.

The focus of the experiment is Medicare Part B, the optional but popular insurance program for older Americans that covers physician and outpatient services. Part B pays for a number of specialty medicines, typically ones like chemotherapy drugs administered in a doctor’s office or hospital. These drugs cost Americans more than $22 billion last year, which was twice the amount spent in 2005. The biggest part of that increase was a tripling in the amount spent on biologic drugs — complex medications generated from living cells — which federal researchers said was mainly due to price hikes.

The Part B drug program exemplifies a problem in the healthcare system. The way Medicare pays for prescription drugs gives doctors an incentive to choose the most expensive alternatives, and gives drugmakers an incentive to raise prices relentlessly. In other words, the system works for doctors and pharmaceutical companies at the expense of everyone else. Eliminating such perverse incentives without reducing the quality of care is crucial to slowing the unsustainable growth of healthcare costs.

Here’s how Part B works for many of the drugs it covers. Doctors, clinics and pharmacies buy medications for the patients they treat, then get reimbursed by the government based on the average price paid for those drugs plus a 6% markup. The obvious problem is that the more expensive the drug, the more the doctor, clinic or pharmacy makes on the transaction. That encourages them to use the most expensive of the effective treatments, which in turn encourages drugmakers to raise prices.

The system has one important safeguard: Brand-name drugs and their cheaper generic equivalents are reimbursed at the same, comparatively low price, which encourages prescribers to use the generics. But prescribers still have the option to choose a different, more expensive brand-name drug that may not have a generic. If it’s more effective, great. If not, the system gets nothing for the extra money spent.

On Friday, the administration published plans for a five-year experiment designed to test ways to shift to a system that encourages prescribers and drug suppliers to get better results at lower cost. In one part of the test, prescribers would receive a much smaller markup — average cost plus 2.5% — and a fixed fee of about $17 per prescription. The amount is intended to be large enough to cover prescribers’ financing and insurance costs, but small enough to eliminate the profit motive for prescribing costly meds. Other methods to be explored include paying the same amount for different drugs that yield similar effects, and eliminating the 20% copay for drugs that deliver the biggest bang for the buck.

One might wonder why doctors and clinics are in the business of buying and selling drugs in the first place. They shouldn’t be. The government tried once before to take doctors out of these transactions by paying drug suppliers directly for Part B medications, but participation was voluntary and the effort was suspended in 2009. As part of the new experiment, the administration is exploring whether and how to try again.

The drug industry’s trade association defended the current Part B system, calling it “an effective, market-based pricing mechanism that works to control costs.” But as with so much of the healthcare system, Part B’s prescription program doesn’t function that way, with prices influenced only by supply and demand. The interests of the people who need care and pay the bills for it have to be aligned better with those of the doctors, hospitals and drugmakers that provide it. The administration’s proposal is an overdue step in that direction.

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