In late February, Time Magazine published a 26,000-word article written by Steven Brill titled "Bitter Pill: Why Medical Bills Are Killing Us." The article describes in detail the mind-numbing prices hospitals charge many patients for medical care in the United States. Several examples of high, seemingly irrational charges for drugs are cited. In particular, one hospital's charge of more than $13,000 for a dose of the chemotherapy drug Rituxan was highlighted. The author found that the hospital paid less than $3,000 for the drug and went on to ask how a 400 percent markup was justified.

Increased public awareness is heating up the conversation about hospital charge practices in general. And since drug pricing is a big part of that conversation, for many Panacea clients we thought it might be a good time to bring some perspective to this issue so providers can make thoughtful decisions regarding their pricing strategies.

Sources of Drug Pricing Distortions

Historically, hospitals have focused on gross charge levels, because patients with indemnity insurance generated reimbursement based on those charges. For years, annual increases were applied to charge masters, which had not necessarily been developed in a systematic or standardized way, but instead formed over decades with varying degrees of attention and resource commitment. With inflationary increases being applied to thousands of charge codes over time, and with varied methods being applied to charge setting, it has become difficult for many hospitals to explain or rationalize the basis of their charges.

Drug Charges Often Viewed as "Subsidies"

Hospitals often use their pharmacies to help generate revenue in order to "subsidize" other operating costs of the facility. This can be done because hospitals still get reimbursed by assorted commercial payors based on a negotiated percentage of charges, reflecting the hospital's self-defined list price for a drug. Because of this payment method, a hospital is incentivized to mark up a drug to create a very high charge and then accept a discount off the charge for payment. This often is cited as the rationale for price levels set in other revenue centers, such as laboratory and imaging. Also, patients and payors often are told that price scales are based on numerous factors, including personnel, insurance, and facility costs. The most common reason put forth by hospital representatives for high drug prices is that "there's a huge difference between the costs of operating a retail pharmacy compared to a hospital pharmacy." Oddly, these statements are seldom, if ever, substantiated with hard data or true comparisons.

Price Transparency is Key for Hospital Drugs

Hospital pharmacy charges generally are managed by the director of pharmacy, with some direction from finance regarding overall revenue objectives. Price development methods can range from cost plus a standard markup to more sophisticated pharmacy markup tables or algorithms. These tables generally are developed by drug category, and are often complex enough to vary costs by drug type, means of administration, involvement of pharmacy staff, etc. Overhead costs generally are incorporated into the formula as well, but are often gross generalizations and not well understood or uniformly applied.

In recent experience with dozens of hospitals across the country, price development methods based on actual acquisition costs or GPO (group purchasing organization) contract data is emerging as a best practice. This is because this method is based on actual data and is far more accurate and defensible, as it reflects real-time product purchase activity.

Ideally, price-setting methods in a hospital pharmacy should have the following attributes. They should:

  • Account for complexity of drug distribution practices;
  • Align with the number and types of medication categories available in the hospital setting;
  • Be based on accurate cost benchmark data;
  • Comply with internal pricing policies;
  • Be simple enough to execute and manage;
  • Relate reasonably to hospital costs;
  • Create a reasonable profit margin; and
  • Be transparent, rational and defensible.

In the wake of all the recent publicity, hospital administrators, providers and leadership should be prepared for increased demands by patients and payors to defend their drug prices. Taking a proactive approach and developing transparent, rational and defensible pricing methods for drugs now will be of tremendous benefit to patients, payors and providers alike in the long run. For more information on Panacea Healthcare Solutions' pharmacy pricing services, contact Gary Fong, Pharm. D., at 863-450-3233, Ext.708, or email him at This email address is being protected from spambots. You need JavaScript enabled to view it..

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