Perverse Incentives in Medicaid

medicaidMedicaid reimbursement to pharmacies, like that of other payers, is based on a benchmark price called the average wholesale price (AWP). The AWP is reported by generic producers themselves, and until recently has been subject to essentially no independent verification. As a result, generic producers have had an incentive to compete for pharmacy market share by reporting AWPs that exceed actual average wholesale prices, as this “spread” leads to larger pharmacy profits. In 2000, after a federal government audit of actual wholesale prices of generic products, states were advised to reduce Medicaid reimbursement by as much as 95% for about 400 generic and off-patent drug products. We use variation induced by the timing of this policy along with its differential impact on drug products’ Medicaid reimbursement to estimate the impact of this exogenous price change on the market share of targeted products. Our findings indicate that pharmacies did respond to the perverse incentives of the Medicaid program by dispensing products with the highest AWPs. Overall, the Medicaid market share fell by about 45% for targeted drug products as a result of the policy.

Source: NBER Working Paper.

Comments (16)

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  1. Dewaine says:

    And we are told that the free market is causing drug prices to soar. Government involvement will always create perverse incentives and perverse results.

    • JD says:

      “In 2000, after a federal government audit of actual wholesale prices of generic products, states were advised to reduce Medicaid reimbursement by as much as 95% for about 400 generic and off-patent drug products.”

      That is a ridiculously large reduction. Entitlement programs are scamming us and raising our prices.

    • JD says:

      I agree with your comment on government. National entitlement programs like Medicaid raise prices by introducing artificial supply while leaching off of the productive. But some of the biggest damage is being done at the State level. Many State’s enact laws that create monopolies, oligopolies or simply run everyone out of business.

      • Dewaine says:

        The question is: how much government is too much and how much is too little?

        I think that we do too much, but is it really a balancing act or are their hard-and-fast rules?

        • JD says:

          Obviously the framers of the Constitution created hard-and-fast rules that we should be living by, but I would say that “voluntary government” is the solution to our problems. We know that markets work, why not in government?

          • Dewaine says:

            That is an interesting idea. That sounds scary to some people, but I think it would function much like any other market. Voluntary association is the cornerstone of freedom.

          • Crawford says:

            You make a great point here. What would the structure of a “voluntary government” look like?

  2. Sabal says:

    There has to be a way to help the needy without destroying efficiency.

    • Dewaine says:

      We can by not confusing incentive structures. People need to be effected by the decisions that they make.

      HSA’s are a step in the right direction. Also, take a look at Goodman’s recent post on the Singapore Health Care system. If we are looking for a compromise that will improve health care in this country, Singapore is the place to look.

  3. Studebaker says:

    Basically this study found that in the presence of third-party payment, drug providers (i.e. pharmacies) pursue a strategy of maximizing against reimbursement formulas. That’s hardly news.

    • Dewaine says:

      Exactly, companies maximize profit. In the free market, that is good. When government creates perverse incentives, we all suffer.

  4. Perry says:

    Our Health Care System is fraught with perverse incentives. Patients with insurance have no idea what things cost, so they are happy to have as much testing as they can. Doctors fear lawsuits, so they order as much as they think is needed.
    Large bureaucratic hospitals have no idea what they are charging and why, and can get away with it.

    As long as there is such a disconnect between the actual consumer of the product(health care) and the costs, we will not have any relief from this huge financial burden. The current path we are taking is only going to exacerbate the situation.

  5. Perry says:

    Oh, and I also cringe when I hear the media talk about “free” preventive care with Obamacare. It’s not free, there are simply no copays required. How do people think that’s going to be paid for?