Press Release: Does Medicare Reimbursement Drive Up Drug Launch Prices?

DURHAM, NC -- A new study shows that launch prices of drugs have more than doubled since a 2005 Medicare policy change. Researchers from Duke University and the National Taiwan University show in a paper published in the Review of Economics and Statistics that the Medicare Modernization Act’s policy change to reimburse provider-administered drugs based on the average sales price has caused a large increase in drug launch prices.

“Politicians and patients are grappling with what to do about high prices for prescription drugs, so we looked at one of the major causes of the problem,” said David Ridley, an economist at Duke University’s Fuqua School of Business and a core faculty member of the Duke-Margolis Center for Health Policy. “Our research shows that an important driver of high drug prices is the way Medicare reimburses doctors for drugs.”

The researchers used a model to better understand the effects of Medicare’s Part B current drug reimbursement policy to providers. The model shows that when public and private insurers reimburse providers based on past, average prices for a drug, manufacturers choose a higher launch price because: 1) providers are less sensitive to the price of the drug when reimbursement covers a portion of its price; and 2) while providers prefer low current prices for drugs, they favor high past prices because the insurers’ reimbursement to them will be greater.

The researchers suggest that Medicare should end “cost-plus” reimbursement because it drives up costs. “If a health care provider knows she’ll be paid $1.04 for every $1 in price then she won’t worry as much about the price,” said Ridley. “Knowing that the customer is not sensitive to the price, the drug maker will charge a high price.” The study’s main findings are summarized in a brief video produced by Fuqua School of Business.

“Rather than reimbursing based on a drug’s cost, we should reimburse based on a drug’s value,” said Ridley. “Value-based payment would drive down the prices of low-value provider-administered drugs. For patients, this would mean lower copayments, lower premiums and lower taxes.”

For more comments on this research, see the Q & A with David Ridley.