Thursday, March 26, 2015

How Hospitals Inflate Specialty Drug Prices: The Latest Medical Benefit Reimbursement Data

Hospitals eagerly blame pharmaceutical manufacturers for high specialty drug prices. Yet the new Magellan Rx Management 2014 Medical Pharmacy Trend Report demonstrates how hospitals contribute to drug prices, unashamedly capturing much larger mark ups than do other sites of care. (The full report is free with registration.)

Below, I summarize the report’s findings on drug reimbursement methods and costs for provider-administered drugs paid under a patient’s medical benefit. As you will see, commercial payers often reimburse hospitals based upon the hospitals’ fabricated sky-high “charges.” Meanwhile, physician offices receive drug reimbursement based upon the government’s Average Sales Price (ASP) metric.

Such top-selling specialty drugs as Avastin, Neulasta, and Remicade cost two to three times as much in a hospital outpatient facility than they do in a physician office. (See table below.) This inflates drug costs by thousands of dollars per claim, fuels hospitals’ acquisition of physician practices, and accelerates the growth of the 340B Drug Pricing Program. Read on and be perturbed.


The 2014 Medical Pharmacy Trend Report draws upon self-reported survey responses from medical, pharmacy, and clinical directors at 48 health plans, representing 125.1 million covered lives. The survey was conducted in mid-2014. Fifty-eight percent of the respondents participated in last year’s survey. The report also includes a useful analysis of medical claims data, which I highlight below.

Be careful, however, when reviewing the results. Some survey responses are weighted by covered lives, while others are presented as unweighted responses, i.e., percentage of plans.

The report has a lot of data—perhaps even too much. Just my $0.02, but the report would have benefited from better organization and a tighter editorial focus.


The two crucial channels for provider-administered specialty drugs are (1) physician offices and (2) hospital outpatient. In 2014, 48% of medical benefit claims were administered in a physician office, while 39% were administered in a hospital outpatient clinic. Home infusion accounted for only 13% of claims. (See page 40 in the Magellan report.)

From the provider reimbursement data on pages 17-28, I developed the summary chart below.

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As you can see, payers used highly different reimbursement methodologies for each channel.
  • Physician Offices: For these sites, 85% of payers follow Medicare and use the Average Sales Price (ASP) benchmark for provider-administered specialty drug reimbursement. Payers with more than 1 million covered lives are more likely to use ASP than are smaller payers. For background on ASP and buy-and-bill, see chapter 3 of our 2014–15 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.
These reimbursements apply to drug purchased under a buy-and-bill model. According to the Magellan report, 24% of physician offices drug volume was sourced from specialty pharmacies, a.k.a., white bagging. (See section 3.7.4 in the 2014–15 Economic Report on Retail, Mail, and Specialty Pharmacies.) Buy-and-bill accounted for only 64% of physician office medical benefit drug volume.
  • Hospital Outpatient Facilities: Hospitals, however, are often reimbursed by commercial payers based upon a negotiated percentage of charges—the hospital’ self-defined list price for a drug. Basically, a hospital marks up a drug to create a stratospheric "charge," then discounts the bogus charge to make it merely outrageous. Hospitals are also more likely to receive reimbursement based on a discount from Average Wholesale price (AWP).
The Magellan report correctly refers to charges as “an arbitrary way of establishing fees for services versus more transparent methods based on drug rate benchmarks such as ASP, WAC or AWP.” On average, the report notes, payers reimbursed hospitals at 66% of billed charges. A percent-of-charges approach allows a hospital to get paid much more than a physician office. For particularly shameful examples, look below. You’ll see Magellan’s comparison of reimbursements for comparable drugs in different care settings.
  • Home Infusion: Payers use ASP and AWP for a combined 68% of claims paid to home health providers. Payers also use the Variable Fee Schedule (VFS) approach. This approach uses different tiers with markups and discounts to incentivize the use of lowest-cost alternative agents within a therapy class.

The Magellan report provides the ASP and AWP payment computations for two of the three sites of care. The table below summarizes the results. As you can see, commercial payers pay larger mark-ups than Medicare Part B's ASP+6% (or +4%, under sequestration).

[Click to Enlarge]

Note that these figures do not apply to newly-released, unclassified medical benefit drugs. Payer reimbursement for these products—documented separately in the report—is based generally on AWP.


For commercial payers, hospitals’ percent-of-charges approach allows them to be paid two to three times as much as physician offices. Here’s a key table that’s buried on page 86.

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Consider Remicade, which appears in the third row. Hospital outpatient facilities received more than $8,000 per claim, while the other sites of care received +/-$4,000. Nice work if you can get away with it.

Most patients are shielded from these price discrepancies, because their cost share usually doesn't vary by site of care. (See the report’s Exhibit 44.)


The Magellan data help explain how hospitals can generate more revenue from specialty drug administration than can independent physician-owned clinics. The 340B Drug Pricing Program lets the hospitals purchase the drugs far below ASP, further increasing profits. See Unsweet Charity: 340B Abuses When Hospitals Buy Oncology Practices.

Average CEO compensation at so-called not-for-profit hospitals was $2.2 million. (source) Some earned much, much more. Perhaps these executives should look in the mirror before complaining about pharmaceutical company pricing.


  1. Adam:

    What you have presented here is reality of mutually subsidized healthcare system and greed. Everyone in the healthcare system is capitalizing on human weakness and desire to live for ever. When person "A" wants to live for ever, they will pay the highest price for it. Everyone in the supply chain including pharma companies, distributors, hospitals and PBM have figured out how to do that. They even have bought our legislatures every step of the way to make sure they will remove any and every obstacles that come along.

    Yes we can have our blood boil but the real fact is we created a monster/genie but do not know how to contain it.

  2. Greta explanation of how one channel inflates drug prices for the payers. I'm just curious, have you ever presented an equally thorough explanation of generic price inflation by the PBMs on the self insured plan sponsors?

  3. So now we know why that .0002 cent aspirin cost $15 on my hospital bill.

  4. Hi Dave - I'm not sure about your question's relevance to today's article. But FWIW, see Winners and Losers from Generic Drug Inflation.

  5. You did a great job of explaining how hospitals inflate specialty drug costs in this article. I was wondering if you have ever addressed how PBMs artificially inflate (not the manufacturer that you refer to in your article) generics?

  6. Care to suggest a valid, independent data source? I'm not aware of one. TBH, I'd prefer not to have the comments here hijacked onto the unrelated topic of pharmacy owners' rampant and unproven paranoia about PBMs.

    In the meantime, you may want to revisit 2010's Why do pharmacy owners care about PBM transparency?.

  7. So I guess the answer is no you have never addressed that topic?

  8. Sigh. Yes, Dave, I have written about spread vs. pass-through pricing by PBMs. See Exhibit 84 (page 126) in my 2014–15 Economic Report on Retail, Mail, and Specialty Pharmacies and the accompanying discussion. On average, PBM gross margins on retail network generic prescriptions are about 5%.

  9. Sigh, Sigh...Really? This is an overall Economic Report on the various pharmacies (that must be purchased no less) with a mention of MAC pricing buried in chapter 5. It's not a specific article where you address generic price inflation by PBMs on this blog. I'm curious why that has never been addressed here?

  10. I have written extensively about generic inflation. As I discuss in In the Third Quarter, Retail Generic Drug Inflation Kept on Truckin’, the FDA approval backlog is a key factor behind generic inflation right now.

    If you unhappy with the blog, I am happy to refund your subscription fees. Please email me your credit card information and I'll take care of it right away.

  11. Great comments. I wonder if the company's strategy is to slowly focus on the higher margin infusion business. If this is the case, will it be willing to sacrifice market share on the low margin specialty pharmacy segment? I guess what the future brings will be very interesting. I personally prefer a small profitable company rather than the opposite.

  12. Perhaps you should should show this to Express Scripts.

  13. The data are not comparable. The Express Scripts report looks at the pharmacy benefit, while the Magellan reports looks at the medical benefit. See Express Scripts New Trend O’ Drugs Report: Price Without Value.

  14. It would be interesting to understand the % of the hospital outpatient administered drugs that could be moved to physician office / home for each drug - i.e. are there any clinical barriers?

    Regardless, this seems to be a failure of commercial plans to serve their sponsors by creating protections or better yet, patient incentives to shop around (I'm assuming most all patients blow through out-of-pocket max after the first or second treatment).

    Lastly, I would think that ACOs can help this... if/when they include drug spend (and extend further into commercial).

  15. Adam, I think the article sensationalizes hospital clinic non-Part B drug reimbursement. Here’s the thing, is there anyone out there in the Industry who doesn’t know that reimbursing hospitals based on a percent of charges is an anachronism?? The hospital charge master captures all hospital overhead and amortizes across service billing lines of which pharmacy is one. This has served as the cost basis for in-patient DRG charge building forever. The question is: why are private payers still reimbursing using this in-patient cost accounting method for out-patient services is a mystery, especially since they have parallel OP comparators with physician offices and Medicare Part B. If ASP works for those OP services, why isn’t it good enough for hospital OPD private-pay reimbursement?