Hawaii Uh-Oh: Why Drug Prices Can Be 5 Times Higher Than They Should Be

The settlement between AstraZeneca (AZN), Pfizer (PFE), Merck (MRK) and others with Hawaii over inflated drug prices is a great primer for anyone who wants to understand why healthcare costs are so high in the U.S. The whistleblower suit behind the settlement is especially useful because its exhibits contain reams of spreadsheets showing the prices drug companies agree to sell their drugs at, and the higher price Medicare and Medicaid were charged instead. The companies settling with Hawaii are:
  • Merck (MRK), $28 million
  • AstraZeneca (AZN), GlaxoSmithKline (GSK) and Novartis (NVS) will combined pay $10 million
  • Pfizer (PFE), $8.2 million
  • Teva (TEVA), $6.5 million
  • Johnson & Johnson (JNJ), $5.2 million
About 40 companies were named in the suit, which is ongoing. Among the other remaining defendants are Abbott Labs (ABT), Sanofi-Aventis (SNY), Boehringer Ingelheim, Bristol-Myers Squibb (BMY), and Roche (RHHBY.PK).

Those settlement amounts are small but bear in mind Hawaii is a small state and only about 43,000 of its citizens use Medicaid. Companies overcharged Medicaid egregiously, in one case paying $1,480 for an ulcer medication that cost $27.70.

Here's how the scam -- which is ongoing -- works:

The government bases its drug payments on price lists published in two books, First DataBank and Redbook. Companies are supposed to list the "Average Wholesale Price," i.e. the price they get from drug wholesalers, and then the government agrees to pay slightly less than that. In Hawaii's case, it paid the AWP minus 10.5 percent.

However, the suit alleges that since 1995 virtually all these companies have been reporting falsely inflated prices to First DataBank, thus creating a spread between the lower price at which the drug is sold and the higher price that Medicaid reimburses at.

Companies achieve this through a sleight-of-hand. They do actually sell the drugs to the wholesaler at the AWP level. The wholesaler then sells the product at a lower price to a healthcare provider or pharmacy, thus losing money. The wholesaler then bills the drug company a "charge back" to make up the loss. That "charge back" is kept secret so the reported AWP appears to be much higher than it actually is. It would be impressive if it weren't evil.

Companies are so dependent on reporting false AWP levels to First Databank that Dey Pharma once sued First Databank when it published its actual prices instead of its higher AWP prices because that left Dey with no "spread" to advertise. (See page 11 of that link for more detail.)

This is why, in 1997, Hawaii's Medicaid bill was just $25.4 million. In 2004 it was $117 million, the suit alleges. Some examples of overpayments:

More seriously, the spreadsheet exhibits in the suit look like excellent raw material for any researcher or academic seeking to figure out just how broken the U.S. healthcare system really is.