How Do Medicaid and Medicare Set Drug Prices?

This is a short supplemental piece on how Medicaid/Medicare set drug prices.(Click here to view the main article on the role of payers.)

As much as healthcare is a fundamental right, capitalism still reigns as one of the core tenets of the U.S. And thus by design, neither Medicare nor Medicaid directly negotiate with pharmaceutical companies.

So how do Medicaid and Medicare set drug prices?

• Medicaid takes the lowest negotiated price by private payers. After which, states have the right to further negotiate price. Aetna, Express Scripts, and Oscar Insurance all negotiate with pharma companies for the best price. Perhaps Aetna and Oscar only receive 20% discounts while Express Scripts receives a 30% discount. This 30% discounted price is now the Medicaid price. Additional requirements ensure this price level adjusts to inflation. Although the federal government helps fund Medicaid, it’s managed at the state level. At the state level, Medicaid can indeed negotiate further discounts with pharmaceutical companies. However, the federal government is still prohibited.
• Medicare lets private payers negotiate on their behalf. Medicare outsources the negotiation process to private payers. For drugs bought in pharmacies, these drugs are paid under what’s known as “Part D” insurance plans. Seniors purchase Part D plans from private payers who contract with Medicare to provide this insurance. For drugs administered by a doctor, Medicare will average the drug prices negotiated across all private payers. This is called the “Average Selling Price.”

“Average Selling Price” or ASP is an important price point in healthcare as it largely dictates how doctor’s get paid for drug-related services. Medicare reimburses doctors ASP + 4.3% for doctor-administered drugs. This means when a doctor administers you a drug in their office, Medicare will reimburse the doctor the “ASP” rate to cover the price of the drug + an additional 4.3%. This 4.3% is designed to pay for the service of the doctor administering that drug.

Congress likes to play with this ASP reimbursement rate of 4.3% as it is a simple lever to move when balancing Medicare’s budget. Lowering it directly decreases Medicare payments to doctors. Prior to 2013, the ASP reimbursement rate was 6%.

This reimbursement system has led to some controversy. For example, it raises the question of whether doctors are incentivized to administer more drugs and higher priced drugs. 4.3% of a $100 drug is only $4.30, but 4.3% of a $10,000 drug is $430.00. Will a doctor prescribe the more expensive drug to earn that additional profit?

There are some checks to this and additional billing complexities I will not explore in this short piece. I hope this introduces part of why drug pricing methodologies can have such an enormous impact on healthcare.