How the government makes healthcare more expensive by cutting costs

Increasing healthcare costs are one of the most important issues facing the United States today.  Although the rate of increase has slowed down over the past few years, the amount of money spent on healthcare in the US has risen at an alarming rate over the past decade.   It’s not only an issue for private insurers as the impact of Medicare and Medicaid spending also threatens to balloon the federal budget.  Incredibly, cost savings measures instituted by the government have, and will, lead to further increases in healthcare costs.  How will this happen?  Lets focus on the treatment of cancer for a moment; the cause and effect should be clear.

When a cancer patient requires treatment such as chemotherapy, they are typically treated in one of two settings: (1) a community-based oncology clinic or (2) a hospital-affiliated clinic.  Community-based clinics are private clinics owned by the doctors who practice there and can vary in size from only a few physicians to 50 or more.  These clinics are run like small businesses with physicians paying themselves a salary and the clinic taking either a profit or loss at the end of the year. Hospital-affiliated clinics look very similar to community clinics from the outside, but differ in that the hospital system handles all of the accounting and the physicians who work there are typically paid a salary.

Another, very important difference between the two settings is that treating a cancer patient in a hospital-affiliated clinic is typically much more expensive than treating a patient in a community clinic.  Data gathered by Avalere shows that, on average, the cost of treating a cancer patient is 20% to 55% more in a hospital-based setting (table 3 in this report).


Now, if you wanted to reduce the cost of healthcare, it would seem prudent to encourage cancer patients to receive their care at community-based clinics.  If you’re saving roughly a third per patient on average, it adds up to a significant amount of money.  The reality is that the government has instituted two different programs that are pushing patients away from community-based clinics towards hospital-affiliated clinics.  And incredibly, both of these programs were instituted to reduce healthcare costs.

The first government program was an attempt to reduce the amount spent on the drugs used to treat cancer.  Typically, oncologists are reimbursed through “buy-and-bill.”  Physicians purchase a cancer drug using their own money and once they have used it to treat a patient, they bill the patient’s insurance company.  Insurers, both public and private, typically pay physicians more than what the drug actually costs  in order to cover some of the overhead associated with treating a patient.  This extra money is typically referred to as the “spread.”  In the past, the spread was quite generous; if a doctor bought a drug for $10,000, they might get an additional 10 or 20% ($11,000 or $12,000 back from the insurer).  As healthcare costs continued to rise, Medicare and Medicaid decided to reduce their reimbursement levels so as to provide as little as an additional 4.2% in spread and there is talk of lowering it further.  These changes have drastically reduced the revenue that community clinics take in and in many cases has forced doctors to sell or close their community-based practices.  A recent report has shown that in 2012 there was a 20% increase in both oncology clinics closing or merging with existing hospital systems.  Between 2005 and 2011, the percentage of cancer patients treated in the hospital setting increased by 150% (from 13.5% to 33%).  As the number of community-based clinics decreases, more patients get treated in the more expensive hospital-affiliated clinics.

The other factor driving patients to hospital-affiliated clinics is the 340b program.  Initially designed to assist hospitals who treat patients with little or no health insurance, the program allows certified hospitals to purchase out-patient drugs (such as cancer therapies) at a 23.1% discount (same discount Medicaid gets).  This certainly helps those hospitals who treat underinsured and uninsured patients, but the program has a catch: 340b hospitals can purchase all of their out-patient drugs through this program, whether they are used for uninsured or insured patients.  In addition, hospitals don’t have to pass along the savings to the insurer, they are allowed to pocket the difference.  It isn’t unusual for oncology therapies to cost more than $100K/yr per patient, so that 23.1% discount becomes a lot of money, all of which goes to the bottom line of the hospitals.  To give you an example, the Duke University Hospital system effectively doubled their profit margin on drugs to 53% for a gross profit of $70M.  This has created a huge incentive for hospitals to both become 340b certified and for them to attract oncology patients to their clinics.

The situation we now have is that cancer patients are being pushed out of the less expensive community-based setting as oncologists struggle to stay profitable and pulled into the more expensive hospital-affiliated clinics as hospitals seek to capture as much 340b business as possible.  Not exactly a great way to save money now is it?

Controlling healthcare spending will be a priority for the US in the coming decade.  In order for that to happen, we need a coordinated effort by the government and private insurers to find a way to incentivize not only quality care but also cost-efficient care.  Without an understanding of the economic pressures and incentives offered by the current system, this may prove a very difficult task.