America's Bitter Pill

by Steven Brill

  Whatever the rationale for the compensation rates, the prospectus that Sloan Kettering’s bankers and lawyers used to sell the bonds that helped finance its incessant expansion (including opening satellite clinics in New York’s suburbs) struck a tone that seemed at odds with the daily sight of men and women rushing through the halls of this great cancer center doing God’s work. The halls were sprinkled with cheerful posters aimed at patients, but the prospectus was sprinkled with phrases such as “market share,” “improved pricing,” and “rate and volume increases.” Then again, the same prospectus described the core of the business this way: “higher five-year survival rates for cancer patients as compared to other institutions.”

  Indeed, if I had needed cancer treatment instead of heart surgery, I would have fought to get into Sloan Kettering (which was across the street from New York–Presbyterian, where I had my operation). I wouldn’t have cared how much they paid their fund-raisers or anyone else.

  A 460 TO 800 PERCENT MARKUP

  The business at the beginning of the Flebogamma supply chain did even better than Sloan Kettering when it came to Alan’s care.

  Made from human plasma, Flebogamma is a sterilized solution intended to boost the immune system. Sloan Kettering likely bought Alan’s Flebogamma from a Barcelona-based company called Grifols.

  In the company’s 2011 annual report, worldwide sales of all Grifols products were reported to be up 7.7 percent, to 2.3 billion euros. Despite the continuing worldwide recession, net profit was up 10.1 percent. In its half-year 2012 shareholder report, “Growth in the sales … of the main plasma derivatives” would be highlighted, as would the fact that “the cost per liter of plasma has fallen.”

  A Grifols spokesman would not discuss what it cost Grifols to produce and ship Alan’s dose. But he did say that the average production for 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 told me that plasma products typically have some of the industry’s higher profit margins. He estimated that the Flebogamma dose for Alan—which Sloan Kettering seemed to have bought from Grifols for $1,400 to $1,600 and sold to Medicare for $2,123—can’t cost more than $200 or $300 to collect, process, test, and ship. That would be a 460 to 800 percent markup.

  In Spain, as in the rest of the developed world, Grifols’s profit margins on sales are much lower than they are in the United States, where, thanks to PhRMA’s vigilant efforts, the company 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 had, by the time Obamacare was passed, regulated what drugmakers could charge, limiting their profit margins. In fact, the drugmakers’ securities filings routinely warned 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 & Company researchers found that overall prescription drug prices in the United States were “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.

  By 2012, more than $280 billion would be spent each year on prescription drugs in the United States. If Americans paid what other countries did for the same products, they would save about $94 billion a year.

  As you would know from talking for five minutes to Billy Tauzin, 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 issue of whether a country with a healthcare-spending crisis should subsidize the rest of the developed world—not to mention the question of who signed Americans up for that mission—the companies’ math doesn’t add up.

  According to the securities filings of major drug companies, in the last few years their R & D expenses have generally been 15 to 20 percent of gross revenue. In fact, Grifols spent less than 5 percent on R & D in 2011. Neither 5 percent nor 20 percent is enough to have cut deeply into the pharmaceutical companies’ 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.

  In 2011, Grifols made a 27.4 percent net operating profit—after all its R & D expense, 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 stellar profits.

  All the numbers seemed to tell one consistent story: Regulating drug prices the way other countries do would save tens of billions of dollars while still offering profits that would encourage the pharmaceutical companies’ quest for the next great drug. But the deal-making dynamics of Washington hadn’t allowed for the healthcare reformers to do that. Instead, Obamacare sent more customers into this highprofit market, most of whom had government subsidies to pay insurance premiums that were inflated by these high drug prices.

  A $0.33 BILL = BILLIONS IN WASTE

  The mound of bills and Medicare statements Alan showed me for 2011—when he had his heart attack and continued his treatments at Sloan Kettering—seemed to add up to about $350,000. His total out-of-pocket expense was $1,139, or less than 0.4 percent of his overall medical bills. Those bills included what seemed to be thirty-three visits in one year to eleven doctors who had nothing to do with his recovery from the heart attack or his cancer.

  In all cases, Alan was routinely asked to pay almost nothing because Medicare and his supplemental insurance covered so much of it. He had paid $2.20 for a check of a sinus problem, $1.70 for an eye exam, and $0.33 to deal with a bunion. When he showed me those bills he chuckled.

  A comfortable member of the middle class, Alan could easily have afforded the burden of higher co-pays that would have encouraged him to use doctors less casually or would at least stick taxpayers with less of the bill if he wanted to get that bunion treated. However, the AARP (formerly the American Association of Retired Persons), and other liberal entitlement lobbies opposed these types of changes early on in the debate over healthcare reform. Their support was crucial, and no reforms requiring those who could afford it to pay a higher share of the Medicare bills ever made it into any Baucus drafts or any other. As with doing something to control drug prices, that was more reform than the process would allow.

  Medicare spent more than $6.5 billion in 2011 to pay doctors (even at the discounted Medicare rates) for the service codes that denote the most basic categories of office visits. From looking at Alan’s bills and the near-free ride he got for any type of treatment, it seemed clear that a provision in Obamacare asking people like Alan to pay more than a negligible share, could have recouped $1 billion to $2 billion of those costs yearly, and probably saved billions more on needless tests generated by all of those office visits.

  THE DOCTORS PARADE IN

  Another bill, for which Alan’s share was $0.19, illustrated why Peter Orszag was so fixated on fee-for-service.

  It was one of fifty bills from twenty-six doctors who saw Alan at Virtua Marlton hospital or at the ManorCare convalescent center after his heart attack, or read one of his diagnostic tests at the two facilities. “They paraded in once a day or once every other day, looked at me and poked around a bit and left,” Alan recalled. Other than the doctor in charge of his heart attack recovery, “I had no idea who they were until I got these bills. But for a dollar or two, so what?”

  The “so what” was that although Medicare deeply discounted the bills, it—meaning taxpayers—still paid from $7.48 (for a chest x-ray reading) to $164 for each encounter.

  “One of the benefits attending physicians get from many hosp
itals is the opportunity to cruise the halls and go into a Medicare patient’s room and rack up a few dollars,” explained a doctor who has worked at several hospitals across the country when I asked about all the traffic trooping in and out to have a look at Alan. “In some places it’s a Monday morning tradition. You go see the people who came in over the weekend. There’s always an ostensible reason, but there’s also a lot of abuse.”

  With the kind of “bundled” pricing Orszag favored, Alan would likely not have been as popular with all of those doctors. The hospital and its doctors would have been paid a set price for treating him successfully, not for how many times how many doctors looked in on him. But the bundles Orszag, Kocher, and Zeke Emanuel managed to wedge into the final bill involved limited pilot projects. They might ultimately lead to reforms, but they were far from revolutionary.

  AN INSURANCE COMPANY IN SILICON ALLEY?

  “I was just told that a company that I would like to start would be impossible,” tweeted twenty-six-year-old Joshua Kushner on December 11, 2011. “The harder an idea is to execute the bigger the opportunity,” he added. “We want you to call us. We want you to take your medicine. Free calls, free generics.”

  Kushner was tweeting about starting a health insurance company. His inspiration: Obamacare and the coming insurance exchanges.

  Kushner was not an insurance company type. Two weeks after this tweet, Forbes would choose him—along with HBO’s Girls creator and star Lena Dunham—as one of its “30 under 30” future superstars. As a junior at Harvard four years earlier, Kushner had founded what had become the largest online gaming service in Latin America. He had since raised $200 million for a private equity firm called Thrive Capital, which became an early investor in Instagram.

  Kushner was rich before those successes. His father had been a wealthy New Jersey–based real estate developer and investor. His brother, Jared, now ran the firm, which had expanded into Manhattan. Both brothers, while unfailingly polite (as if their parents would take away the car keys if they didn’t behave like gentlemen), cut high profiles in New York’s fast lane. Jared had bought the New York Observer, a Manhattan weekly that lost money yet was a favorite in New York media and real estate circles. And he was married to Donald Trump’s glamorous daughter, Ivanka. Josh, too, was regularly found in the gossip columns that kept tabs on the models he was dating.

  Although Joshua Kushner was not your usual health insurance executive, he was an insurance customer, which is how he got the idea that he had started talking to friends about.

  Kushner, who had just graduated from Harvard Business School, had been reading a lot about Obamacare when he happened to get an Explanation of Benefits from his insurance company, purporting to explain why the insurer had paid only a portion of a recent bill. Kushner couldn’t understand it, no matter how many times he read it. Yet as a Harvard College and Harvard Business School graduate, he considered himself a pretty smart guy. Maybe the fault was theirs, not his.

  It was a thought a lot of us have probably had. Only Kushner, who was vaguely aware that Obamacare was going to allow for the sale of health insurance in a competitive online exchange, saw the baffling insurance bill as an opportunity rather than a frustration. And, as his tweet about his friends’ reaction revealed, he was too naïve to realize how impossible it would be. That his friends dismissed the idea just spurred him on. He was an entrepreneur, not a realist.

  Following the tweet, Kushner would find himself incessantly “jamming the idea with my friends,” he later recalled. “That’s how you do something like this; you find your smartest friends.”

  Before long he would recruit Mario Schlosser, then thirty-two, and Kevin Nazemi, then twenty-nine, and set up an office at his venture firm’s headquarters in lower Manhattan. Kushner had met Schlosser at Harvard Business School, and they had started the Latin American gaming service together. Schlosser had also worked at a hedge fund developing trading models and as a McKinsey consultant working on healthcare analytics.

  Kushner also knew Nazemi from Harvard Business School. He had an undergraduate degree from MIT and had run a bunch of consumer businesses for Microsoft. Nazemi would focus on designing and marketing their venture.

  As they began to put together a business plan and lure investors, they developed the shorthand description, or elevator pitch, for their idea: “A health insurance start-up that is using technology, design, and data to help humanize and simplify healthcare.”

  * * *

  *13. In fact, in September 2014, a Kaiser Family Foundation poll reported that of those who actually signed up on the exchanges and received subsidies, nearly half did not know they were getting the subsidies.

  CHAPTER 16

  WAITING FOR OBAMACARE

  January–December 2012

  THE CLOSER IT GOT TO ELECTION DAY 2012, THE MORE THE OBAMA healthcare and political teams seemed to want to avoid doing anything to call attention to the president’s signature domestic policy initiative, including issuing the rules necessary to implement it.

  Through the first quarter of 2012, there were still no regulations telling the insurers exactly what they could or could not sell on the exchanges and how they could sell it.

  Little details were missing, too, such as how an extra charge for smokers, which the final version of the law had allowed, would work.

  There was also the question of how each insurer’s deductibles, co-pays, and network limits could be displayed on the exchange websites. Would people be able to see all of that information before they clicked through to an insurer-specific page? How much leeway would the state-run exchanges have to be different?

  For Karen Ignagni’s insurance companies, these were paralyzing unknowns. They usually took years to bring new products to market once they had a grip on details like these.

  THE STALL

  These were complicated issues, and in Washington even the simplest rulemaking required a five-step approval process culminating in a sign-off by the Office of Management and Budget. OMB often took months to move drafts of regulations off its many desks.

  But there was more to this slowdown than Washington bureaucrats mired in the usual quicksand. It was also deliberate. Two CMS officials would later tell me that beginning in January 2012 they were told by their superiors that the already-slow rule-making process had to be slowed still more. They could take their time sending drafts to the White House for approval, they were told, because the White House was only going to stall before sending whatever the rule was over to OMB, which would stall even more. They did not want to make any waves before the election.

  In a third case, a White House staffer told me that a member of Obama’s political team had said that there was no need to rush anything out the door, though he rationalized it by explaining that for now “the person in charge of Obamacare is John Roberts.” He was referring to the chief justice of the United States and the fact that the constitutionality of Obamacare was on its way to being argued before the Supreme Court in late March 2012.

  “WE DIDN’T KNOW WHAT WE DIDN’T KNOW”

  The technology build didn’t need anyone’s interference to gum up the works. The now-demoted Henry Chao, working under his old deputy director title in his old office, was still waiting for the procurement people in another office to finish signing up the dozens of contractors whose work he would be in charge of cobbling together with what the main contractor, CGI, was supposed to produce.

  Chao had experience managing Medicare and Medicaid data systems. But those systems had long since been built. Chao had never built a new one from scratch. CGI was already telling Chao that without the other contractors signed up and working—and without the rules spelled out for how the insurance would be offered and sold—the October 1, 2013, launch deadline was in danger of being missed.

  Although a poor communicator, who often left non-techies wondering how to translate what he had just said, Chao was a well-respected, hard-driving civil servant. He prided himself on the CMS da
ta machine and the team that ran it. One colleague told me, “Henry exuded confidence as habitually as you and I breathe.”

  Through the end of 2011 and into 2012, Chao assured his boss, CMS head Marilyn Tavenner, that he and his team would be able to get the project done on time.

  “We hadn’t ever built anything like this,” Tavenner would later tell me. “We didn’t know what we didn’t know.”

  $474,000 FOR PNEUMONIA

  As 2012 began, another couple I met while examining medical bills for the Time report, whom I’ll call Rebecca and Scott S., seemed to have carved out a comfortable semi-retirement in a suburb near Dallas. Scott had successfully sold his small industrial business and was working part-time advising other industrial companies. Rebecca was running a small marketing business. Both were in their late fifties.

  On March 4, 2012, Scott started having trouble breathing. By dinnertime he was gasping violently as Rebecca raced with him to the emergency room at the University of Texas Southwestern Medical Center. Both Rebecca and her husband thought he was about to die.

  Scott was in the hospital for thirty-two days before his pneumonia was brought under control.

  Rebecca told me that “on about the fourth or fifth day, I was sitting around the hospital and bored, so I went down to the business office just to check that they had all the insurance information.