Cheaper is not always better: Drug shortages in the United States and a value-based solution to alleviate them

Abstract

Drug shortages threaten patients’ access to medications and are associated with adverse health outcomes and increased costs. Drug shortages disproportionately occur among generic drugs of limited profitability, most notably drugs administered by injection. In this perspective, we discuss how reimbursement and purchasing practices that were meant to create an efficient marketplace for generics have generated strong price pressure that threatens profitability in certain markets. We further explain how, faced with limited profitability, manufacturers lack incentives to invest in resilient supply chains, and in some cases, engage in cost-containment strategies or decide to exit the market, ultimately contributing to shortages. We propose the development and implementation of value-based reimbursement to provide needed incentives for drug purchasers and manufacturers to establish a more reliable supply chain as part of the policy solution to reduce the number and extent of drug shortages. This reimbursement model would necessitate the development of a rating system that measures supply chain resilience and maturity for each generic product. This rating would then be applied as a value-based modifier to reimbursement rates for generic products. The proposed model would result in higher reimbursement rates for generic products from more dependable supply chains, generating incentives for manufacturers to invest in supply chain resiliency. We propose the application of this reimbursement system originally in Medicare given Congressional interest on reforming Medicare payment to prevent drug shortages.

Plain language summary

Drug shortages often affect older, low-cost generic drugs. Some drug prices are so low that drug companies lack incentives to produce them. We propose to pay slightly higher prices for select drugs produced reliably. Such an incentive system would motivate generic companies to create dependable source of products, ultimately reducing drug shortages.

Implications for managed care pharmacy

Drug shortages threaten medication access and are associated with adverse patient outcomes and increased costs. We propose the implementation of a value-based reimbursement system to incentivize provider selection of multisource products manufactured in more resilient supply chains. The proposed model would result in higher provider reimbursement rates for generic products from more dependable supply chains, generating incentives for manufacturers to invest in supply chain resiliency.

Codified in federal statute, the Food, Drug, and Cosmetic Act defines a drug shortage as a period of time when the demand or projected demand for the drug within the United States exceeds the supply of the drug (FD&C Act 506C(h)(2) (21 U.S.C. 356c(h)(2)). The rising number of drug shortages—having reached an all-time high in the United States in 2023—has continued to attract attention by health care stakeholders, media, and federal policy-makers, who are calling for a better understanding of causes as well as potential solutions.^1,2 Shortages can lead to treatment delays, the omission of potentially life-saving therapy, or substitution with less effective treatment, contributing to adverse health outcomes and equity effects.^3-5

Setting aside unusual circumstances, drug shortages disproportionately occur among generic drugs of limited profitability, most notably drugs administered by injection.⁶ The aim of many manufacturing, purchasing, and reimbursement strategies is to create an efficient marketplace for generic drugs to keep costs low (Figure 1). However, strong generic competition has created the conditions for substantial price erosion that threatens profitability and market sustainability and contributes directly to drug shortages.

FIGURE 1.

Reimbursement and Purchasing Factors as Upstream Economic Drivers of Drug Shortages

Herein we (1) provide an overview of the US generic drug supply and reimbursement chain, (2) describe how existing generic purchasing and reimbursement practices contribute to shortages, and (3) propose a value-based reimbursement policy solution that could improve incentives for manufacturers to invest in a resilient supply chain. Our remarks are centered on Medicare as this is the largest purchaser of drugs, and Medicare reimbursement models are often adopted or mirrored by other payers. Our focus on Medicare is aligned with recent Congressional interest in reforming Medicare payment for generic injectables with the aim of preventing drug shortages.²

Generic Drug Supply

The federal government defines a multisource drug as “a drug for which there is at least one other drug product which is rated as therapeutically equivalent, is pharmaceutically equivalent and bioequivalent, as determined by the Food and Drug Administration, and is sold or marketed in the United States.”⁷ Multisource generic drugs are interchangeable by law as they are therapeutic equivalent, pharmaceutically equivalent, and bioequivalent versions of the same product but manufactured by different companies. Generic sponsors submit abbreviated new drug applications to the US Food and Drug Administration (FDA) to receive approval to market their generic products after patent and/or single-source exclusivity expiration. After approval, manufacturers either produce the active pharmaceutical ingredient and/or the final dosage form or outsource production to another manufacturer. Increasingly, generic sponsors coordinate regulatory approval, distribution, and sales, but do not perform finished product manufacturing. Frequently, active pharmaceutical ingredients are produced by independent chemical suppliers, and the production of the dosage form is outsourced to contract manufacturing organizations.⁸

Historically, large purchasers contracted directly with manufacturers to acquire generic drugs. However, in the last decade, several large pharmacy chains partnered with wholesalers and other supply chain customers (eg, Red Oak Sourcing [Cardinal Health + CVS], Walgreens Boot Alliance Development [AmerisourceBergen + Walgreens + Express Scripts], and ClarusONE/McKesson [McKesson + Walmart]) to create joint ventures. This aggregation has resulted in a highly concentrated market. In 2018, these 3 buying groups accounted for more than 90% of US generic drug purchases.⁹ Given the dominant market share, these groups strongly weigh a manufacturer’s portfolio and their ability to supply the necessary volume of a specific generic molecule when choosing a product source. This behavior ultimately leads to further concentration of the manufacturer market, as only those who consistently produce large product volumes are competitive enough to establish preferred relationships with these organizations. Consolidation leaves limited room for small firms to enter the market and provides an alternative source of supply.

Independent pharmacies, health care providers, and the clinics or institutions for which they work aggregate their purchasing power by participating in group purchasing organizations (GPOs), many of which are aligned with wholesalers and their purchasing entities either by contract or indirectly. These buying consortia achieve greater discounts through volume than individual members would on their own. GPOs do not acquire the physical product, but simply negotiate prices, which are then applied by wholesalers. There is variability in GPO contracting practices with both their members and manufacturers, as it relates to contracting clauses. For instance, some GPOs enable their members’ limited flexibility to purchase product outside of the contracts. In February 2024, the Federal Trade Commission requested public comment on wholesalers and GPOs and their relation to shortages of generic products. Specifically, the Federal Trade Commission inquired about competition in the GPO and wholesaler market as well as contracting practices and the incentives they create.¹⁰

Generic Drug Reimbursement

To understand the generic drug reimbursement landscape, we distinguish between drugs that patients receive from a community pharmacy (ie, pharmacy-dispensed, in person or mail order, including long-term care), which are typically covered under the pharmacy benefit of an insurance or government sponsored program, and drugs that are directly administered to a patient in the clinical setting (ie, provider-administered), typically covered under the medical benefit. In Medicare, for example, Part D is the outpatient pharmacy benefit and Part B is the provider-administered benefit.

PHARMACY-DISPENSED DRUGS

When a patient presents a prescription for a generic drug, the specific generic product selected is determined by the dispensing pharmacy. Because pharmacies are typically reimbursed the same amount—maximum allowable cost—regardless of the generic product selected, pharmacies are incentivized to purchase generic versions with low acquisition costs to optimize margins. Pharmacies are typically reimbursed by pharmacy benefit managers, which administer the outpatient prescription drug benefit on behalf of payers.¹¹ As part of their services, pharmacy benefit managers develop pharmacy networks, set maximum allowable cost prices, and negotiate reimbursement rates, including generic reimbursement rates, with pharmacies.

PROVIDER-ADMINISTERED DRUGS

Under Medicare, the reimbursement of drugs administered in clinical settings—under Parts A and B—depends on a series of factors, primarily the clinical setting of medication administration and the drug cost.

Drugs Administered During an Inpatient Admission Under Medicare Part A. Of note, drugs administered during an inpatient admission are not separately reimbursed, as Medicare Part A payments for inpatient hospital services are bundles that cover all services provided under a hospitalization, including drugs. Drugs administered during inpatient admissions and thus reimbursed by Part A include low-cost injectable generics that have been decades in the market yet play a crucial role in the inpatient management of patients, such injectable antibiotics. As described above, these are the types of products particularly vulnerable to shortages, which justifies the relevance of Part A drug reimbursement reform in the alleviation of drug shortages.⁶

Drugs Administered in a Hospital Outpatient Department Under Medicare Part B. Drugs that qualify for coverage under Medicare Part B,¹² are administered in hospital outpatient departments and have an estimated per-day cost below the packaging threshold ($135/day in 2023) are reimbursed as part of bundled payments for the totality of services provided. In contrast, those that have estimated per-day costs above the packaging threshold ($135/day in 2023) are not reimbursed as part of bundles but rather have distinct payments from other services provided.

Drugs Administered in Office Settings Under Medicare Part B. When administered in physician offices, drugs and biologics that qualify for coverage under Medicare Part B¹² are reimbursed separately, regardless of cost. Independent of the setting of administration, reimbursement of provider-administered drugs follows the “buy and bill model,” under which providers purchase the drug and then bill Medicare using Healthcare Common Procedure Coding System codes. Medicare reimburses such drug and biologics products at 106% of the average sales price (ASP).¹³ The ASP is a statutory price benchmark net of manufacturer discounts. Importantly, multisource drugs have a unique weighted ASP that includes all branded and generic versions of the product. The ASP is calculated quarterly, and there is a 2-quarter lag in its application. Regardless of the reimbursement model for provider-administered drugs, providers are incentivized to procure drugs at the lowest acquisition cost. This allows them to maximize margin, as the reimbursement (if any) is the same for all versions of a drug.

MANDATORY REBATES UNDER GOVERNMENT PROGRAMS

The Medicaid Drug Rebate Program requires manufacturers to enter a rebate agreement for outpatient prescription drugs to authorize Medicaid coverage (§1927(a)(1)). Rebates are defined by statute, and for multisource, generic drugs, are estimated as the sum of (1) a base rebate, which equals 13% of the average manufacturer price and (2) an inflationary rebate, which penalizes price increases above general inflation (Consumer Price Index for All Urban Consumers). For drugs marketed after April 1, 2013, the inflationary rebate is estimated using as baseline the average manufacturer price—the average price paid to the manufacturer by wholesalers for drugs sold to retail pharmacies—for the fifth full calendar quarter after which the drug was marketed. For drugs marketed before April 1, 2013, it is calculated based on the average manufacturer price in Q3 2014.

Generic Purchasing and Reimbursement Practices and Contribution to Shortages

DOWNWARD PRICING PRESSURE

As generic drug reimbursement is the same across all therapeutically equivalent versions of a product, generic manufacturers solely compete to sell their product at the lowest price, generating a “race to the bottom.” Price erosion is aggravated by the consolidation of generic buying groups and generic purchasing organizations.¹² Unlike branded drugs, prices of generic products are generally lower in the United States than other countries.¹³

LIMITED ABILITY TO RAISE PRICES

This downward pricing pressure conflicts with manufacturers’ willingness to raise prices when costs of production increase. Moreover, inflation penalties under the Medicaid Drug Rebate Program and the 340B program further limit manufacturers’ ability to raise prices, especially for drugs with a large share of sales under these 2 programs. This is particularly problematic for the subset of generic products marketed before April 1, 2013, for which inflation penalties are estimated based on an arbitrary period (Q3 2014) instead of the fifth full calendar quarter after marketing. Some manufacturers may have lowered their prices to near marginal production cost by this arbitrarily set baseline period, so any increase in production costs would potentially generate a net loss of revenue. The reimbursement of generic products by Medicare Part B puts manufacturers that raise prices at a competitive disadvantage, as there is a 2-quarter lag in the application of the ASP to Medicare reimbursement rates (for example, reimbursement rates for Q4 2023 are based on the ASP in Q2 2023). Finally, contracts with purchasing organizations also limit manufacturer’s ability to raise prices, as these often include price protection clauses.

CONTRIBUTION TO SHORTAGES

The aim of the purchasing and reimbursement practices described above are to create an efficient marketplace for generic drugs and keep prices low. However, in some cases they have resulted in substantial price erosion that threatens manufacturer profitability and market sustainability, ultimately contributing to shortages through the following 2 major mechanisms: (1) engagement in cost-containment strategies (eg, foreign manufacturing) and (2) market exit.

First, price pressure induces manufacturers to engage in cost-reduction strategies, such as reduced investments in factory maintenance, equipment upgrades, and off-shoring.^14-16 The United States heavily relies on foreign manufacturing of generic drugs, with 87% of active ingredients and 60% of final dosage forms produced overseas.¹⁷ Foreign manufacturing of drugs is associated with increased quality issues—an analysis of warning letters issued by the FDA from 2010 to 2020 found that the majority of letters reporting violations of Current Good Manufacturing Practices were issued to manufacturers based in Asian countries.¹⁸ Quality issues create vulnerabilities across the supply chain, ultimately contributing to shortages.^16,19

Second, limited profitability leaves little financial room for manufacturers to invest in drug supply redundancies and quality management systems.⁴ Redundancies enable manufacturers to quickly ramp up manufacturing at the back-up manufacturing line while resolving issues affecting the primary line, and thus prevent manufacturing issues from ultimately disrupting product supply. Quality management systems proactively identify issues before they lead to shortages.⁴ Analogously, reduced profitability may eventually lead manufacturers to discontinue the production of less profitable drugs,¹⁶ particularly when facing failure to supply clauses in agreements with generic buying groups. Market withdrawals further concentrate the generic manufacturers,²⁰ which limits the market ability to respond to disruptions in the supply chain by a single manufacturer.

GENERIC INJECTABLE DRUGS—THE PERFECT STORM

Sterile injectable products are complicated to manufacture (and have higher acquisition prices than oral drugs) as they require specialized processes to ensure potency and sterility.²¹ The complexities of the manufacturing and marketing of generic injectable drugs generate a “perfect storm” that explains their susceptibility to drug shortages—two-thirds of recent shortages were generic injectable products.⁶ First, generic injectable products have smaller markets because of lower demand and reduced profit margins.²² Second, generic injectable markets have fewer entrants and higher rates of market exit than generic oral product markets.²² An analysis of molecules that lost patent production during the 2010-2013 period found that, for generic products with small markets, more than half of generic manufacturers had exited the market by the end of the fourth year after loss of exclusivity.²² As a result, the injectable generic drug market is considerably more concentrated. Two years after loss of exclusivity, generic oral products in the highest third of sales had an average of 13 generic manufacturers, compared with 2 for those in the lowest third of sales. In comparison, injectable generics in the highest third of sales had an average of 4 manufacturers, and those in the lowest third had only 1 manufacturer.²² Third, the manufacture of generic injectable products is particularly vulnerable to maintenance cost-reduction strategies because of the requirement for specialized manufacturing processes that ensure sterility. Fourth, supply redundancies are particularly uncommon for generic injectable drugs, which require specific facilities and clean rooms in order to comply with FDA-required Good Manufacturing Practices. This requirement for specialized manufacturing lines limits the ability of other manufacturers to ramp up production in the setting of a drug shortage.

A Value-Based Reimbursement Policy Solution to Drug Shortages in the Medicare Program

Current purchasing and reimbursement models consider all similarly packaged multisource versions of a specific product to be equivalent, resulting in a market in which generic manufacturers compete mainly on price. The partiality of purchasing entities and pharmacies toward less expensive generic versions should not compromise quality of the product dispensed or administered to patients, as all generics marketed in the United States must adhere to Current Good Manufacturing Practices.⁴ These regulatory requirements are considered a minimum threshold for accessing the US marketplace but do not necessarily reflect the current and future resilience of the supply chain.

We recommend the development and implementation of a value-based reimbursement system that would incentivize the selection of products manufactured in more resilient and mature supply chains, and therefore reduce the risk of shortages. The underlying premise is that supply stability and continuity are valued elements that justify incremental payment, as they offset costs associated with averted shortages, including labor costs for personnel to manage shortages, increased purchasing rates associated with the procurement of drugs off-contract or in the gray market, higher costs of alternative drug products and drugs on shortage,²³ and expenses associated with increased health care utilization and poorer health outcomes because of delays and omissions in treatment or use of less effective alternatives.^24,25

The deployment of a value-based reimbursement system would require the following 2 main policy innovations: (1) the development of a rating system assessing supply chain resilience and maturity for each generic product and (2) the application of this rating system as a value-based modifier to generic products. We propose the application of this reimbursement system originally in Medicare (fee-for-service), as this is the largest purchaser of drugs, and there is significant Congressional interest on reforming Medicare payment for certain generic products to preventing drug shortages.² Eventually, this value-based reimbursement model could be adopted by other payers, following the tradition of Medicare’s influence on payment models in the private and Medicaid markets. We propose to apply this value-based reimbursement model initially to multisource sterile injectable drugs, as these are the products particularly prone to drug shortages. This is the reason why our deployment strategy described below focuses on Medicare Parts A and B. Once such a system has been developed, it could be similarly applied to multisource oral products predominantly reimbursed by Medicare Part D. This phased implementation would enable the development of a supply chain resilience and maturity rating system for a small subset of products in the first instance, addressing capacity concerns on the implementation of such a system for the entirety of multisource products.

Within this framework of a phased implementation, the first step toward a value-based reimbursement system is the development of a rating system measuring supply chain resilience and maturity for each multisource injectable product. This system would differentiate from the Current Good Manufacturing Practices in that it would measure attributes of the supply chain that are not needed to ensure minimum levels of quality but are relevant to supply stability and continuity. The US Department of Human and Health Services recently proposed the development of a system with these attributes, naming it the Manufacturer Resiliency Assessment Program.²⁶ We propose mandatory manufacturer participation in the assessment program for reimbursement of products under Medicare. Ratings would be measured at the manufacturer-generic product level on an annual basis, as manufacturer-level measures would incentivize manufacturers to invest in resilient supply chains for high-use profitable products but not necessarily for generic drugs most vulnerable to shortages.

The resulting rating would be applied as a value-based modifier to multisource injectable products separately reimbursed under Medicare Parts A and B. Reimbursement would continue to be based on the weighted ASP, which would then be modified based on supply chain ratings. Using a hypothetical 3-star resiliency rating system as an example, generic products scoring 3 stars could be reimbursed at 125% of the weighted ASP, products with 2 out of 3 stars reimbursed at 115%, and 106% for products with 1 out of 3 stars. Claims would incorporate national drug codes in addition to Healthcare Common Procedure Coding System codes to enable identification of the specific generic version selected, as is currently done in Medicaid for rebate collection. The value-based modifier could be applied at the claim level.

The incorporation of value-based modifiers would increase provider reimbursement rates when selecting generic versions with high ratings. The differential reimbursement based on value would enable them to pay higher purchasing rates for generic versions with resilient and mature supply chains. As a result of this system, manufacturers would not compete on price solely and GPOs would be incentivized to contract with manufacturers with resilient and mature supply chains to provide an option to their clients who opt to use drugs from more resilient chains with higher reimbursement rates.

ESTABLISHMENT OF ELIGIBLE DRUG PRODUCTS AS SEPARATELY PAYABLE PRODUCTS UNDER MEDICARE

Drug shortages disproportionately affect low-priced generic injectable drugs, which are not separately reimbursed under Parts A or under Part B when administered in outpatient hospital departments. The incorporation of value-based modifiers at the drug claim level would require the separate reimbursement of eligible drugs with daily costs under the packaging threshold under Medicare Parts A and B, independent of clinical setting. Eligible products would include those in a list elaborated by HHS based on prices per unit, market concentration, recent history of shortages, vulnerability of the existing supply chain, and criticality of the product.²⁷

Discussion

Generic drug shortages threaten patient access to essential medications. Several commonly used purchasing and reimbursement strategies implemented to create an efficient generic drug marketplace have contributed to substantial price erosion, limited profitability, and uncertain supply chain sustainability. These consequences directly contribute to the increasing number of generic drug shortages that lead to negative clinical outcomes. We propose the establishment of a rating system that measures supply chain resilience coupled with incremental increases in reimbursement for drugs produced with consistent reliability as a policy solution to bolster generic manufacturing infrastructure and lower the likelihood of shortages.

Our proposed reform is not free of limitations. First, it is likely that the proposed reimbursement system would potentially increase per unit costs in the short term. It should be noted, however, that such costs could be partially offset by savings associated with prevented drug shortages. Second, our proposal relies on the development of a rating system measuring supply chain resilience, which is currently nonexistent. According to experts, it would not be feasible for the FDA to develop and administer such a laborious program²⁸; therefore, reliance on private vendors would be necessary, as suggested by HHS.²⁶ Third, the success of our proposal relies on providers’ response to the incentives to purchase drugs with higher resiliency ratings, which in turn may depend on GPO willingness to incorporate products with higher resiliency ratings. Despite differential reimbursement rates, it is possible that providers and GPOs may continue to prefer drugs with lower ratings (and lower acquisition costs) because of wider margins, which would limit the ability of the model to incentivize manufacturer investment in resilient supply chains.

Our proposal is aligned with the stated interest from Congress and the current administration in reforming Medicare payment to prevent shortages of generic injectable products.^2,26 HHS has signaled interest in the deployment of a hospital resilient supply program, which would establish incentives or penalties to hospitals based on a scorecard reflecting practices related to supply chain resilience. These include inventory management and stockpiling, procurement from manufacturer with resilient supply chains, and engagement in contracting practices with GPOs that are meant to promote supply chain resilience, such as establishment of long-term contracts with minimum purchase requirements. A difference between our proposal and the hospital resilient supply program is the unit of implementation of the incentive. By creating differential reimbursement at the product level, our system incentivizes providers to purchase every multisource sterile injectable product from a manufacturer with resilient supply chain. In contrast, a hospital-based incentive system could disproportionately incentivize hospital engagement in desired practices for high-use products, which weigh more heavily on hospital aggregate measures. The shortage of a single product can trigger a major public health disruption²⁹; therefore, we believe that effective policy intervention should aim to prevent drug shortages across the entire therapeutic arsenal. With this objective, we propose a product-level value-based reimbursement system that would reward manufacturers’ investments in supply chain resiliency for every single multisource generic injectable product.

Drug shortages threaten medication access and are associated with adverse patient outcomes and increased costs. We propose the implementation of a value-based reimbursement system to incentivize provider selection of multisource products manufactured in more resilient supply chains as a policy solution to drug shortages. The proposed model would result in higher provider reimbursement rates for generic products from more dependable supply chains, generating incentives for manufacturers to invest in supply chain resiliency.