The Best American Magazine Writing 2014

by The American Society of Magazine Editors

  The country’s largest lab tester is Quest Diagnostics, which reported revenues in 2012 of $7.4 billion. Quest’s operating income in 2012 was $1.2 billion, about 16.2 percent of sales.

  But that’s hardly the spectacular profit margin we have seen in other sectors of the medical marketplace. The reason is that the outside companies like Quest, which mostly pick up specimens from doctors and clinics and deliver test results back to them, are not where the big profits are. The real money is in health-care settings that cut out the middleman—the in-house venues, like the hospital testing lab run by Southwestern Medical that billed Scott and Rebecca $132,000. In-house labs account for about 60 percent of all testing revenue. Which means that for hospitals, they are vital profit centers. Labs are also increasingly being maintained by doctors who, as they form group practices with other doctors in their field, finance their own testing and diagnostic clinics. These labs account for a rapidly growing share of the testing revenue, and their share is growing rapidly. These in-house labs have no selling costs, and as pricing surveys repeatedly find, they can charge more because they have a captive consumer base in the hospitals or group practices. They also have an incentive to order more tests because they’re the ones profiting from the tests. The Wall Street Journal reported last April that a study in the medical journal Health Affairs had found that doctors’ urology groups with their own labs “bill the federal Medicare program for analyzing 72% more prostate tissue samples per biopsy while detecting fewer cases of cancer than counterparts who send specimens to outside labs.”

  If anything, the move toward in-house testing, and with it the incentive to do more of it, is accelerating the move by doctors to consolidate into practice groups. As one Bronx urologist explains, “The economics of having your own lab are so alluring.” More important, hospitals are aligning with these practice groups, in many cases even getting them to sign noncompete clauses requiring that they steer all patients to the partner hospital. Some hospitals are buying physicians’ practices outright; 54 percent of physician practices were owned by hospitals in 2012, according to a McKinsey survey, up from 22 percent ten years before. This is primarily a move to increase the hospitals’ leverage in negotiating with insurers. An expensive by-product is that it brings testing into the hospitals’ high-profit labs.

  4. When Taxpayers Pick Up the Tab

  Whether it was Emilia Gilbert trying to get out from under $9,418 in bills after her slip and fall or Alice D. vowing never to marry again because of the $142,000 debt from her husband’s losing battle with cancer, we’ve seen how the medical market-place misfires when private parties get the bills.

  When the taxpayers pick up the tab, most of the dynamics of the marketplace shift dramatically.

  In July 2011, an eighty-eight-year-old man whom I’ll call Alan A. collapsed from a massive heart attack at his home outside Philadelphia. He survived, after two weeks in the intensive-care unit of the Virtua Marlton hospital. Virtua Marlton is part of a four-hospital chain that, in its 2010 federal filing, reported paying its CEO $3,073,000 and two other executives $1.4 million and $1.7 million from gross revenue of $633.7 million and an operating profit of $91 million. Alan A. then spent three weeks at a nearby convalescent-care center.

  Medicare made quick work of the $268,227 in bills from the two hospitals, paying just $43,320. Except for $100 in incidental expenses, Alan A. paid nothing because 100 percent of inpatient hospital care is covered by Medicare.

  The ManorCare convalescent center, which Alan A. says gave him “good care” in an “OK but not luxurious room,” got paid $11,982 by Medicare for his three-week stay. That is about $571 a day for all the physical therapy, tests, and other services. As with all hospitals in nonemergency situations, ManorCare does not have to accept Medicare patients and their discounted rates. But it does accept them. In fact, it welcomes them and encourages doctors to refer them.

  Health-care providers may grouse about Medicare’s fee schedules, but Medicare’s payments must be producing profits for ManorCare. It is part of a for-profit chain owned by Carlyle Group, a blue-chip private-equity firm.

  About a decade ago, Alan A. was diagnosed with non-Hodgkin’s lymphoma. He was seventy-eight, and his doctors in southern New Jersey told him there was little they could do. Through a family friend, he got an appointment with one of the lymphoma specialists at Sloan-Kettering. That doctor told Alan A. he was willing to try a new chemotherapy regimen on him. The doctor warned, however, that he hadn’t ever tried the treatment on a man of Alan A.’s age.

  The treatment worked. A decade later, Alan A. is still in remission. He now travels to Sloan-Kettering every six weeks to be examined by the doctor who saved his life and to get a transfusion of Flebogamma, a drug that bucks up his immune system.

  With some minor variations each time, Sloan-Kettering’s typical bill for each visit is the same as or similar to the $7,346 bill he received during the summer of 2011, which included $340 for a session with the doctor.

  Assuming eight visits (but only four with the doctor), that makes the annual bill $57,408 a year to keep Alan A. alive. His actual out-of-pocket cost for each session is a fraction of that. For that $7,346 visit, it was about $50.

  In some ways, the set of transactions around Alan A.’s Sloan-Kettering care represent the best the American medical market-place has to offer. First, obviously, there’s the fact that he is alive after other doctors gave him up for dead. And then there’s the fact that Alan A., a retired chemist of average means, was able to get care that might otherwise be reserved for the rich but was available to him because he had the right insurance.

  Medicare is the core of that insurance, although Alan A.—as do 90 percent of those on Medicare—has a supplemental-insurance policy that kicks in and generally pays 90 percent of the 20 percent of costs for doctors and outpatient care that Medicare does not cover.

  Here’s how it all computes for him using that summer 2011 bill as an example.

  Not counting the doctor’s separate $340 bill, Sloan-Kettering’s bill for the transfusion is about $7,006.

  In addition to a few hundred dollars in miscellaneous items, the two basic Sloan-Kettering charges are $414 per hour for five hours of nurse time for administering the Flebogamma and a $4,615 charge for the Flebogamma.

  According to Alan A., the nurse generally handles three or four patients at a time. That would mean Sloan-Kettering is billing more than $1,200 an hour for that nurse. When I asked Paul Nelson, Sloan-Kettering’s director of financial planning, about the $414-per-hour charge, he explained that 15 percent of these charges is meant to cover overhead and indirect expenses, 20 percent is meant to be profit that will cover discounts for Medicare or Medicaid patients, and 65 percent covers direct expenses. That would still leave the nurse’s time being valued at about $800 an hour (65 percent of $1,200), again assuming that just three patients were billed for the same hour at $414 each. Pressed on that, Nelson conceded that the profit is higher and is meant to cover other hospital costs like research and capital equipment.

  Whatever Sloan-Kettering’s calculations may be, Medicare—whose patients, including Alan A., are about a third of all Sloan-Kettering patients—buys into none of that math. Its cost-based pricing formulas yield a price of $302 for everything other than the drug, including those hourly charges for the nurse and the miscellaneous charges. Medicare pays 80% of that, or $241, leaving Alan A. and his private insurance company together to pay about $60 more to Sloan-Kettering. Alan A. pays $6, and his supplemental insurer, Aetna, pays $54.

  Bottom line: Sloan-Kettering gets paid $302 by Medicare for about $2,400 worth of its chargemaster charges, and Alan A. ends up paying $6.

  The Cancer Drug Profit Chain

  It’s with the bill for the transfusion that the peculiar economics of American medicine take a different turn, even when Medicare is involved. We have seen that even with big discounts for insurance companies and bigger discounts for Medicare, the chargemaster prices on every
thing from room and board to Tylenol to CT scans are high enough to make hospital costs a leading cause of the $750 billion Americans overspend each year on health care. We’re now going to see how drug pricing is a major contributor to the way Americans overpay for medical care.

  By law, Medicare has to pay hospitals 6 percent above what Congress calls the drug company’s “average sales price,” which is supposedly the average price at which the drug maker sells the drug to hospitals and clinics. But Congress does not control what drug makers charge. The drug companies are free to set their own prices. This seems fair in a free-market economy, but when the drug is a one-of-a-kind lifesaving serum, the result is anything but fair.

  Applying that formula of average sales price plus the 6 percent premium, Medicare cuts Sloan-Kettering’s $4,615 charge for Alan A.’s Flebogamma to $2,123. That’s what the drug maker tells Medicare the average sales price is plus 6 percent. Medicare again pays 80 percent of that, and Alan A. and his insurer split the other 20 percent, 10 percent for him and 90 percent for the insurer, which makes Alan A.’s cost $42.50.

  In practice, the average sales price does not appear to be a real average. Two other hospitals I asked reported that after taking into account rebates given by the drug company, they paid an average of $1,650 for the same dose of Flebogamma, and neither hospital had nearly the leverage in the cancer-care marketplace that Sloan-Kettering does. One doctor at Sloan-Kettering guessed that it pays $1,400. “The drug companies give the rebates so that the hospitals will make more on the drug and therefore be encouraged to dispense it,” the doctor explained. (A spokesperson for Medicare would say only that the average sales price is based “on manufacturers’ data submitted to Medicare and is meant to include rebates.”)

  Nelson, the Sloan-Kettering head of financial planning, said the price his hospital pays for Alan A.’s dose of Flebogamma is “somewhat higher” than $1,400, but he wasn’t specific, adding that “the difference between the cost and the charge represents the cost of running our pharmacy—which includes overhead cost—plus a markup.” Even assuming Sloan-Kettering’s real price for Flebogamma is “somewhat higher” than $1,400, the hospital would be making about 50 percent profit from Medicare’s $2,123 payment. So even Medicare contributes mightily to hospital profit—and drug-company profit—when it buys drugs.

  Flebogamma’s Profit Margin

  The Spanish business at the beginning of the Flebogamma supply chain does even better than Sloan-Kettering.

  Made from human plasma, Flebogamma is a sterilized solution that is intended to boost the immune system. Sloan-Kettering buys it from either Baxter International in the United States or, as is more likely in Alan A.’s case, a Barcelona-based company called Grifols.

  In its half-year 2012 shareholders report, Grifols featured a picture of the Flebogamma plasma serum and its packaging—“produced at the Clayton facility, North Carolina,” according to the caption. Worldwide sales of all Grifols products were reported as up 15.2 percent, to $1.62 billion, in the first half of 2012. In the United States and Canada, sales were up 20.5 percent. “Growth in the sales … of the main plasma derivatives” was highlighted in the report, as was the fact that “the cost per liter of plasma has fallen.” (Grifols operates 150 donation centers across the United States where it pays plasma donors twenty-five dollars apiece.)

  Grifols spokesman Christopher Healey would not discuss what it cost Grifols to produce and ship Alan A.’s dose, but he did say that the company’s average cost to produce its bioscience products, Flebogamma included, was approximately 55 percent of what it sells them for. However, a doctor familiar with the economics of cancer-care drugs said that plasma products typically have some of the industry’s higher profit margins. He estimated that the Flebogamma dose for Alan A.—which Sloan-Kettering bought from Grifols for $1,400 or $1,500 and sold to Medicare for $2,135—“can’t cost them more than $200 or $300 to collect, process, test, and ship.”

  In Spain, as in the rest of the developed world, Grifols’ profit margins on sales are much lower than they are in the United States, where it can charge much higher prices. Aware of the leverage that drug companies—especially those with unique lifesaving products—have on the market, most developed countries regulate what drug makers can charge, limiting them to certain profit margins. In fact, the drug makers’ securities filings repeatedly warn investors of tighter price controls that could threaten their high margins—though not in the United States.

  The difference between the regulatory environment in the United States and the environment abroad is so dramatic that McKinsey & Co. researchers reported that overall prescription-drug prices in the United States are “50% higher for comparable products” than in other developed countries. Yet those regulated profit margins outside the United States remain high enough that Grifols, Baxter, and other drug companies still aggressively sell their products there. For example, 37 percent of Grifols’s sales come from outside North America.

  More than $280 billion will be spent this year on prescription drugs in the United States. If we paid what other countries did for the same products, we would save about $94 billion a year. The pharmaceutical industry’s common explanation for the price difference is that U.S. profits subsidize the research and development of trailblazing drugs that are developed in the United States and then marketed around the world. Apart from the question of whether a country with a health-care-spending crisis should subsidize the rest of the developed world—not to mention the question of who signed Americans up for that mission—there’s the fact that the companies’ math doesn’t add up.

  According to securities filings of major drug companies, their R&D expenses are generally 15 percent to 20 percent of gross revenue. In fact, Grifols spent only 5 percent on R&D for the first nine months of 2012. Neither 5 percent nor 20 percent is enough to have cut deeply into the pharmaceutical companies’ stellar bottom-line net profits. This is not gross profit, which counts only the cost of producing the drug, but the profit after those R&D expenses are taken into account. Grifols made a 32.3 percent net operating profit after all its R&D expenses—as well as sales, management, and other expenses—were tallied. In other words, even counting all the R&D across the entire company, including research for drugs that did not pan out, Grifols made healthy profits. All the numbers tell one consistent story: Regulating drug prices the way other countries do would save tens of billions of dollars while still offering profit margins that would keep encouraging the pharmaceutical companies’ quest for the next great drug.

  Handcuffs on Medicare

  Our laws do more than prevent the government from restraining prices for drugs the way other countries do. Federal law also restricts the biggest single buyer—Medicare—from even trying to negotiate drug prices. As a perpetual gift to the pharmaceutical companies (and an acceptance of their argument that completely unrestrained prices and profit are necessary to fund the risk taking of research and development), Congress has continually prohibited the Centers for Medicare and Medicaid Services (CMS) of the Department of Health and Human Services from negotiating prices with drug makers. Instead, Medicare simply has to determine that average sales price and add 6 percent to it.

  Similarly, when Congress passed Part D of Medicare in 2003, giving seniors coverage for prescription drugs, Congress prohibited Medicare from negotiating.

  Nor can Medicare get involved in deciding that a drug may be a waste of money. In medical circles, this is known as the comparative-effectiveness debate, which nearly derailed the entire Obamacare effort in 2009.

  Doctors and other health-care reformers behind the comparative-effectiveness movement make a simple argument: Suppose that after exhaustive research, cancer drug A, which costs $300 a dose, is found to be just as effective as or more effective than drug B, which costs $3,000. Shouldn’t the person or entity paying the bill, e.g., Medicare, be able to decide that it will pay for drug A but not drug B? Not according to a law passed by Congress in 2003 that requ
ires Medicare to reimburse patients (again, at average sales price plus 6 percent) for any cancer drug approved for use by the Food and Drug Administration. Most states require insurance companies to do the same thing.

  Peter Bach, an epidemiologist at Sloan-Kettering who has also advised several health-policy organizations, reported in a 2009 New England Journal of Medicine article that Medicare’s spending on the category dominated by cancer drugs ballooned from $3 billion in 1997 to $11 billion in 2004. Bach says costs have continued to increase rapidly and must now be more than $20 billion.

  With that escalating bill in mind, Bach was among the policy experts pushing for provisions in Obamacare to establish a Patient-Centered Outcomes Research Institute to expand comparative-effectiveness research efforts. Through painstaking research, doctors would try to determine the comparative effectiveness not only of drugs but also of procedures like CT scans.

  However, after all the provisions spelling out elaborate research and review processes were embedded in the draft law, Congress jumped in and added eight provisions that restrict how the research can be used. The prime restriction: Findings shall “not be construed as mandates for practice guidelines, coverage recommendations, payment, or policy recommendations.”