In January, California’s new governor, Gavin Newsom, signed an executive order requesting a plan to grant Medi-Cal, the state’s version of Medicare, the ability to negotiate with drug manufacturers. California has already passed a law forcing drug companies to announce impending price increases.
To understand why price variability is currently on the legislative radar, it’s important to look at an industry that should be our partner, but which loves to toss us under the bus — healthcare insurers.
According to a story by Joseph Walker and Christopher Weaver in The Wall Street Journal, insurers are boosting national healthcare costs by exploiting Medicare to generate a $9 billion windfall in excess profits.
The process is simple. Medicare offers two subsidies — a direct subsidy that covers routine medical costs and a reinsurance subsidy that helps cover the costs of very expensive drugs insurers are obligated to provide.
Under Medicare Part D, if insurers overestimate their basic expenses by 5%, they must return some of the extra money to the government.
This is like a contractor taking a deposit of $100,000, spending $50,000, and refunding $45,000.
In 2015, insurers overestimated costs by $2.2 billion and paid back roughly half of that, for a 50% profit. And that’s above the profit they built into their original estimate.
How widespread is this practice? Walker and Weaver wrote nearly 70% of Medicare patients with Part D coverage were in plans that overestimated costs by 5% or more.
Note Part D has allowances for underestimates and will reimburse insurers if they have a revenue shortfall. Strangely enough, this never seems to happen. Why settle for being reimbursed for a loss when you can make extra on top of a profit?
But it gets trickier. There’s also the reinsurance subsidy, which was added to the Affordable Care Act in 2009 to address concerns that private companies wouldn’t participate in the program.
Congress agreed to help cover the costs of very expensive drug treatments if these turned out to be greater than the insurers’ estimates and to reimburse companies if they had any losses.
Here’s the bottom line. If insurers overestimate their basic costs, they can keep up to 5% of the overage. And if they underestimate the projected costs of expensive drugs and charge lower premiums, they’ll be reimbursed for all or most of the loss. The insurers can’t lose and Medicare can’t win.
You won’t be surprised to learn that, according to historical data covering the past decade or so, direct subsidy estimates were more than $17 billion high and reinsurance subsidy estimates were almost $28 billion low. In both cases, Medicare made up the slack.
I’m not criticizing anyone. Who wouldn’t want to try to maximize their returns? My objection is that the insurers blunt any criticism of their tactics by blaming pharma. According to insurers, they are forced to add wiggle room to their estimates because drug prices are simply too variable.
Of course, they don’t mention that variations in our pricing are largely due to the rebates demanded by most payers and the incessant calls for increased competition and legislated price controls.
It’s like seeing robbers running out of a bank carrying bags of money as they point at the depositors and cry, “It’s their fault. They made us take the money.”
Sander Flaum is principal at Flaum Navigators.