Reform of federal drug discount program should target misaligned incentives

The dramatic growth of a key federal drug discount program has fueled debate about whether it is helping low-income patients as intended or primarily benefiting healthcare providers.

Congress created the 340B Drug Pricing Program over 30 years ago to help hospitals and clinics that serve high levels of uninsured patients purchase outpatient drugs from manufacturers at significantly discounted prices. However, the law does not require participating providers to pass on discounts to patients or dedicate program funds to safety-net care.

A new white paper from the USC Schaeffer Center for Health Policy & Economics traces how major eligibility expansions and distorted program incentives have helped transform the once-modestly sized initiative into the nation’s second-largest drug purchasing program in the U.S., growing from $4 billion in 2009 to over $66 billion in 2023.

The authors conclude that meaningful 340B reform must end “spread pricing,” in which participating providers profit by purchasing drugs at a discount and then billing insurers at higher rates for dispensing them. This practice disproportionately benefits providers with a higher mix of commercially insured patients, since private insurers reimburse at higher rates than public programs like Medicare and Medicaid.

Eliminating this distorted incentive is essential to ensuring 340B revenues can be directed to safety-net providers, rather than better-resourced ones.

"There’s broad bipartisan recognition that 340B needs reform so its benefits reach those most in need, rather than subsidizing wealthier providers and hospital systems that have learned to maximize profits by expanding into more affluent areas,” said lead author Ryan Long, a nonresident senior scholar at the USC Schaeffer Institute and former senior policy advisor and counsel to House Speaker Kevin McCarthy. “There is also growing awareness of how the program’s current structure increases government healthcare costs and private health insurance premiums. Fixing misaligned program incentives is key to solving these fundamental issues."

How spread pricing incentives drive program growth
The number of providers participating in 340B, known as “covered entities,” has grown from about 10,000 since passage of the 2010 Affordable Care Act to 66,000 today. The ACA’s Medicaid expansion increased the number of hospitals meeting the low-income patient threshold for 340B eligibility and broadened the categories of eligible hospitals. Over the same time, the number of participating pharmacies swelled from 1,300 to over 250,000 after providers lacking an in-house pharmacy were allowed to expand from a single contract pharmacy to an unlimited number.

This growth has been heavily influenced by the revenue generation opportunity created by spread pricing. Providers purchase drugs at a discount typically 25% to 50% below benchmark prices and can dispense them to all patients, regardless of insurance status. Providers may then bill insurers the typical amounts without accounting for 340B discounts and keep the difference, or spread, without limitations on how this profit is used. There’s mixed evidence on how much 340B discounts flow to vulnerable patients. 

While healthcare subsidy programs traditionally provide funding based on need, the 340B program works differently. Because of spread pricing, providers with more commercially insured patients often benefit more than safety-net providers, even though they have less need for support.

Consider a hypothetical drug a 340B provider acquires at $1,000. Report Figure 3 (attached) illustrates how the provider could generate a substantially larger profit on a commercially insured patient compared to one covered by Medicare or Medicaid.

According to a 2024 report from Minnesota, which provided rare transparency into 340B finances, more than half of (53%) covered entities’ net revenues are driven by commercial insurance. That’s about four times more than Medicaid (14%), while less than 1% comes from uninsured patients. 

Spread pricing also incentivizes the use of more and higher-priced drugs to generate more revenue while discouraging the use of more cost-effective generic and biosimilar options. This drives up federal healthcare spending, leading to higher insurance costs for Medicare beneficiaries.

It also incentivizes providers to hunt for more revenue by expanding their base of commercially insured patients, particularly through acquisitions of private physician practices or infusion centers. Provider consolidation reduces the number of independent practices, limiting competition and driving up prices.

“Research shows that spread pricing makes healthcare more expensive and diverts 340B benefits away from the providers that need them most,” said co-author Karen Mulligan, a research scientist at the Schaeffer Center. “Regardless of the program’s original intent, these outcomes are clearly illogical.”

Current proposals offer only incremental reform
Recent reform proposals have focused on improving transparency, regulating contract pharmacies and revising which patients and hospitals are eligible for discounts. The Health Resources and Services Administration, the agency administering 340B, has also announced a pilot program testing rebates, instead of upfront discounted purchases by covered entities.

The authors said some of these efforts may represent incremental improvements, while others could conflict with state laws or create compliance burdens that may make it challenging for some financially vulnerable providers to remain in the program.

Ultimately, the authors warned that reform efforts will fall short if covered entities still have the incentive to “buy low and sell high.” To ensure that subsidies are directed to safety-net providers, they recommended reforming 340B payments to reflect providers’ overall payer mix and other factors that indicate financial need.

About this study
Other authors are Melissa Frasco, a research scientist at the Schaeffer Center; Erin Trish, co-director of the Schaeffer Center and associate professor at the USC Mann School of Pharmacy and Pharmaceutical Sciences; and Michael Chernew, a nonresident senior scholar at the USC Schaeffer Institute and professor at Harvard Medical School.

This white paper was supported by the Schaeffer Center. A complete list of supporters of the Schaeffer Center can be found in our annual report. 

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