Perverse Incentives in Healthcare


In 2011, Ken Frazier became CEO of Merck & Co, and in the process became the first African-American to lead a major pharmaceutical company. His story is an incredible one. He was born into poverty in the inner city of Philadelphia. He readily admits he caught a couple lucky breaks. He studied law, and practiced law as a death penalty lawyer, defending death row inmates. How did he end up as the CEO of Merck? You can learn about his story in the interview below which we’ve [Transcribed for Members Here].

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In the interview Frazier talks about the perverse incentives in the US Healthcare System.

If you could be king for the day, what’s the one thing you would change about the healthcare system in this country?

I would make it patient centered. I think the incentives in the system drive people away from what’s good for patients. I’m a CEO of a pharmaceutical company. I think Merck does great things in the world, but when you sit down with our friends in the insurance business, they have different economic incentives. Physicians have different economic incentives. I think the only way in which we can actually come together and get alignment around the cost of the system, around the value of the system, and the impact of the system on society, and our budgets in society, and on patients, is to actually say, “What is good for patients, as a whole, individually, and from a population standpoint?”

I think if we can all agree that we’re here to serve patients and that we want to do what’s in the best interest of patients, I think that would actually help us align the really badly aligned incentives in our system, right now.

How does that conversation start? How do you get everyone in the room together? Is it politically led? Is it industry led?

We’re trying to do it. A bunch of us are going to try to come together, again, in June from across the entire healthcare spectrum. We think of ourselves as the enlightened ones. We’re all going to try to get together and see if we can have a conversation that bridges some of those gaps. I mean, if you listen to what was being said the other day by President Trump and Secretary Azar, a lot of what they were focusing on is they can see how badly misaligned the incentives are in the system. For example, you hear a lot about drug pricing. The system in which we actually sell drugs, in the commercial market, is one in which if you actually lowered your list price, you’d be less competitive.

As an antitrust lawyer, I just can’t get that through my head. The way to be non-competitive, in my business, is to lower your price. Well, why is that? Well, because many of the actors in the supply chain make money as a percentage of the list price. So, for them, high prices are better than low prices. But if you’re a person who is filling a prescription at the pharmacy counter, you’re paying a co-pay based on a list price. So you would actually rather have a lower price. We actually ran that experiment with a hepatitis-C drug that we came out with a little while ago. We said, “We’re the third entrant in the market. This is a cure. Let’s see what happens if we bring this product to market significantly lower than our competition.”

Now, that was a category hepatitis-C where they used to talk about the $100,000 cure, you might remember a few years ago. We said, “Let’s see what happens if we bring in a drug at a lower price.” Well, I think the experiment that we ran showed that a lot of actors in the system would dis-favor a lower list price product. There’s something wrong with a system that operates that way.

The problem is though, of course, if Americans didn’t “overpay” for drugs, there would be no drugs. I mean, that’s the sad truth of the matter. At the end of the day, the only thing worse than Americans paying a very substantial amount for drugs is Americans not paying a substantial amount for drugs. Because if they didn’t, frankly, we couldn’t raise the capital to take the risk that we do in R&D.

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Intelligent Fanatics November 2018 Digest

This reminds me of a Munger episode where he explained the power of incentives. Here it is below:

I have posed at two different business schools the following problem. I say, “You have studied supply and demand curves. You have learned that when you raise the price, ordinarily the volume you can sell goes down, and when you reduce the price, the volume you can sell goes up. Is that right? That’s what you’ve learned?” They all nod yes. And I say, “Now tell me several instances when, if you want the physical volume to go up, the correct answer is to increase the price?”

There are two answers to the question -

  1. where price is an indicator of quality.
  2. where the incentive of the decision maker is aligned with that of a higher price. Example - think of a plumber who is incentivized by a household materials manufacturer (like sanitaryware for example). The higher the value of his goods sold, the higher is his commission.

As Munger says, “As usual what determines the behavior in human affairs is the incentive of the decision maker”

I am not very well-versed with the American Healthcare system, but I guess both of the above probably apply.