A Dangerous Story of Misaligned Incentives

Never, ever, think about something else when you should be thinking about the power of incentives.
-- Charlie Munger

One of the most common questions I ask my doctor is: "If you were in my situation, what would you do?" Because I trust my doctor, I think his response is usually the best barometer for measuring what my next move should be.

Unfortunately for Sherry Lenox -- whose story was the impetus of a Washington Post cover story -- she still hasn't been able to get that answer. Her quest to find out more about her husband's death has helped unearth a trove of evidence pointing out the dangerous side effects of misaligned incentives in the medical community.

Helping anemia patients
Anemia is a condition where a person's red blood cells aren't as prevalent as they should be, making it difficult for oxygen to get to the rest of the body. Normally, 40% of a person's blood is made up of red blood cells. When that number dips down to 25%, measures are taken to raise it at least above 30%.

Amgen (Nasdaq: AMGN  ) has been a leader in treating the condition, with three drugs on the market: Epogen, Procrit, and Aranesp -- with Procrit being licensed by Johnson & Johnson (NYSE: JNJ  ) . Initially, the medications were used in only the most severe anemia cases -- patients for whom transfusions were the only viable alternative.

Over the years, however, the base of potential patients using the drug ballooned, and led to serious profits for both Amgen and Johnson & Johnson.

At what dosage?
If Amgen's drugs were being used to get patients' red blood cell count above 30%, why not give them enough to bring it all the way up to "normal" 40% levels? It's a fair question to ask, and the national hematocrit trial aimed to answer it. One group of patients were given enough Epogen to boost their red blood cell count to 42%; one group aimed to get to 30%.

As the Post story makes clear, the results were telling:

Three years after the study began, the trial was halted. Patients in the "normal" higher-dose group were dying or having heart attacks at a higher rate than those in the lower-dose, lower-hematocrit group.

Clearly, you would think that this would provide solid evidence to limit the drug's use. But the opposite happened. In fact, not only was the drug's recommended dosage allowed to float ever higher, but it was also expanded to include use in cancer patients. This was due in large part to claims that the drug could improve a person's well-being, happiness, and life satisfaction, among other things.

The problem with this claim, studies would later show, is that they were all false. And yet, between 1991 and 2003, the size of the average dose more than tripled.

The power of incentives
The only way to explain such a steep rise in the use of the drug, in the face of evidence that pointed to potentially lethal outcomes, was the incentive structure.

There was a distinct spread between the amount a doctor would have to pay for Epogen, and the amount he or she would be reimbursed by Medicare. This spread usually hovered around 30%, meaning that some doctors could earn $100,000 to $300,000 per year just by administering the drug. The higher the dosage, and the more patients on it, the greater the financial rewards.

Even some dialysis centers, like DaVita (NYSE: DVA  ) , the nation's largest chain, was a benefactor. They incentivized their chief medical officer to keep Medicare spreads wide.

For years, certain agencies would try to limit the amount of medicine given to patients. But each time, Congress would rebuff these efforts -- citing that they intruded on a doctor's ability to make decisions in the best interest of his or her patients.

That's fair enough, but it's telling that once Medicare changed its payment structure to bundle Epogen in with other drugs, doctors and clinics were no longer the beneficiaries of such lucrative spreads. Instead of giving out doses in the same amounts because it was better for patients, the use of Epogen experienced a precipitous 20% fall.

Since then, Affymax (Nasdaq: AFFY  ) has come out with its own anemia drug, Omontys. Unlike Epogen, the drug only needs to be taken once per month, and could represent a serious threat to Amgen.

What's a Fool to do?
Clearly, no matter how much we'd like to believe it, incentives matter. That's why we're such big fans of holding ourselves accountable here at the Fool. In that spirit, I'm offering you access to a special free report: "3 Stocks That Will Help You Retire Rich." You can rest assured that I believe in the companies in the report, as I personally hold two of the three stocks in my portfolio. Get your copy of the report today to find out what the three companies are, absolutely free!

Fool contributor Brian Stoffel owns shares of Johnson & Johnson. You can follow him on Twitter, where he goes by TMFStoffel. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Johnson & Johnson, and creating a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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