The U.S. Department of Health and Human Services wants to eliminate drug manufacturer rebates in Medicare, a move that could improve affordability for consumers. Portfolio Manager Ethan Lovell and Research Analyst Rich Carney, of the Global Life Sciences team, explain why the change is significant and how it could potentially benefit the health care sector in the long run.

Key Takeaways

• In a new proposal, U.S. regulators want to require that drug manufacturer rebates in Medicare be passed on to consumers, rather than the pharmacy benefit managers (PBM) and plan sponsors that typically pocket the savings.
• This reform is significant in that it overhauls a key way Medicare’s prescription drug benefits are negotiated and removes a source of revenue for PBMs and plan sponsors.
• But at the same time, we believe it could improve affordability for consumers, potentially driving up volumes for drug manufacturers. In addition, we argue that PBMs and plan sponsors have increasingly moved away from rebates as a significant source of revenue and have ways to adjust their business models.

The ongoing debate over drug pricing in the U.S. came to a head recently when the Department of Health and Human Services (HHS) introduced a proposal to overhaul drug rebates for federal health insurance schemes, including Medicare.

In a press release, HHS described the proposal as having the “potential to be the most sweeping change to how Americans’ drugs are priced at the pharmacy counter, ever.” We agree that the reform is significant, but also think it could be a positive step for the industry in the long run.

Why Rebates?

Prescription drug prices continue to march higher. According to a report from the Kaiser Family Foundation, spending per enrollee in Medicare Part D, the program’s prescription drug benefit, is projected to rise by an average of 4.6% annually through 2027, roughly double the rate from 2010 to 2017. Contributing to that price creep, HHS argues, are rebates.

Rising Drug Costs: Average Annual Growth in Medicare Part D Spending, per Enrollee

[caption id=”attachment_234678″ align=”alignleft” width=”371″] Source: Kaiser Family Foundation. Data based on the 2018 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance. *Estimated.[/caption]

Here’s how rebates work: Pharmacy benefit managers (PBM) negotiate contracts between drug manufacturers and the plan sponsors administering benefits for Medicare. To win placement on a formulary, manufacturers often provide rebates – a kickback calculated as a percentage of a drug’s list price – to PBMs and related parties. HHS argues this creates perverse incentives because the higher a drug’s price, the bigger the rebate PBMs earn. What’s more, the savings do not trickle down directly to consumers. That’s because at the pharmacy, consumers are charged based on list price, not the post-rebate price. The difference can be substantial: HHS calculates that the average rebate ranges from 26% to 30%.

Consequently, HHS wants to change the power dynamic. The regulator is proposing that rebates be passed on to consumers in the form of discounts at the pharmacy. In doing so, HHS argues there will be less need for pharma companies to regularly increase list prices while simultaneously opening the door for more generic drugs (which have smaller, if any rebates) to be added to plan formularies. The net result: consumers pay less out of pocket.

The Impact to Health Care Companies

So why do we think this reform could be positive? For one, the more that patients can afford their medicines, the more likely they are to adhere to their prescriptions, potentially driving up volumes for drug manufacturers. Furthermore, the regulation does not dictate how list prices are set.

Even PBMs may come out OK. Already within Medicare, the majority of rebates get passed on from PBMs to plan sponsors, which typically use the savings to offset other costs*. As such, should rebates be eliminated, Medicare premiums are likely to rise modestly. Although HHS would like the reform to take effect January 1, 2020, we believe the date could get pushed out, as Medicare plan sponsors will need sufficient time to adjust pricing.

In addition, HHS proposes safe harbor protections for certain fixed fees that PBMs collect for providing services to manufacturers (such as relaying data about drug side effects). We argue this revenue stream has become increasingly important to PBMs’ bottom lines, even more so than rebates. Additionally, the proposal mirrors trends already occurring in the commercial market as some PBMs have moved away from pocketing rebates, instead choosing to shift the bulk of the savings to plan sponsors and employers.

No doubt, pressures on drug pricing are likely to remain, especially as the 2020 presidential election campaign heats up. Earlier this year, Sen. Bernie Sanders and dozens of other senators introduced three bills that would directly influence prescription drug prices, including pegging the price of medicines in the U.S. to drug prices in other developed countries, such as Canada. These developments are worth watching.

However, we’d also point out that while regulators want to improve drug affordability, they have another, equally important focus: making sure that today’s medical breakthroughs are delivered to patients quickly. We believe this dual emphasis – reducing costs while improving the standard of care – will be a driving force in the health care industry for years to come and that companies equally focused on these goals may be well positioned.

*https://www.pcmanet.org/new-data-rebates-are-unrelated-to-drugmakers-pricing-strategies/

The health care industries are subject to government regulation and reimbursement rates, as well as government approval of products and services, which could have a significant effect on price and availability, and can be significantly affected by rapid obsolescence and patent expirations.