Rebate Reform: Big Changes Are Looming For The US Drug Market
Executive Summary
Changing US drug rebating policy is like throwing an activated grenade into the middle of the American drug distribution system. Yet, increasingly it seems the US drug market is poised for a big shake up when it comes to the way pharmaceuticals manufacturers price their drugs, negotiate market access with payers, and pay back-end discounts to offset the cost of their products.
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The difference between list price and net price in the US has grown from a gap to a chasm over the last decade. Now changes are anticipated to the current rebate system – but uncertainty is the watchword.
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The elimination of rebates would be overwhelming to the system unless implemented slowly.
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So what? While the industry is eager to change the drug pricing dialogue and paint the middlemen as the culprits who take savings out of the US health care system, drug makers have leveraged the current rebate system to their advantage at times. Now the sector is scrambling to figure out what exactly might be coming and how disruptive it will be.
The big talk in Washington, DC, currently is around rebate reform, as it is called, which could represent one of the biggest policy changes to impact US drug manufacturers since the implementation of Medicare Part D. Right now, there is a lot of uncertainty about which policies might ultimately be implemented, but a wide range of options appear to be under consideration.
Eliminating rebates altogether would represent an enormous change for the pharmaceutical sector, while passing rebates onto consumers at the point of sale or reforms to the system would be less disruptive. The elimination of rebates would be overwhelming to the system unless implemented slowly.
As Peter Bach, director of Memorial Sloan Kettering's Center for Health Policy and Outcomes, put it: "It might be a little chaotic upfront, but it's where we need to end up. Okay, maybe massively chaotic."
The Problem With Rebates
Rebates are the discounts drug makers reimburse US payers off the list price of drugs, through contract negotiations around volume sales and formulary access, which result in significantly lower net drug prices. That information is highly guarded and secretive, and is how pharmacy middle men – the pharmacy benefit managers (PBMs) – say they use their buying power to keep costs down.
The difference between list price and net price has grown from a gap to a chasm over the last decade (see Exhibit 1), however, resulting in confusion over the actual cost of drugs and questions over how, and if, the savings from rebates are being redirected to patients. Payers say the money saved from rebates is redirected to patients through lower premiums, but critics say PBMs and others keep some of the savings so that the system incentivizes payers to seek a higher list price to extract a bigger rebate. Another drawback, according to some critics, is that the offsets lower insurance premiums for the healthy at the expense of the sick.
For some of the most competitive drug categories, like respiratory drugs and diabetes treatments, the amount of a rebate has crossed 40% off the wholesale acquisition cost (WAC). The widening delta between WAC and net prices has created a public relations fiasco for the industry, particularly as patients rely more on high-deductible health plans and end up fronting the cost of drugs out-of-pocket, where rebates are not generally given at point-of-sale. It is also a nightmare for patients who have to pay the full cost. This has led to a sea change in the way industry thinks about rebates and pricing transparency. Pharma has spent the last year working to educate patients and legislators about the amount they spend on rebates and has been pointing the finger at the middlemen as the problem in the system with some success. (Also see "US Senators Seek 'Clarity’ On Middlemen Obstructing List Price Reductions" - Pink Sheet, 4 Jul, 2018.)
Scenario Planning For What Lies Ahead
Now, anticipated policy changes have the industry scrambling to figure out what exactly might be coming and how disruptive it will be. The range of options are plentiful and there is no real clarity yet from the Department of Health and Human Services (HHS). Operationalizing a new model, whatever it may be, will present serious challenges for industry. An important outstanding question that will impact the policy that emerges is how changing rebates could impact insurance premiums.
While many in the industry like the idea of rebate reform as a way to push back against the negative public perception around the high cost of drugs, there is apprehension across the industry about removing a well-known system and replacing it with something that, for now, remains uncertain. "We are hearing from our clients that they are expecting some kind of change and they are expecting it to be meaningful," says Howard Deutsch, a principal at the consulting firm ZS Associates, who works in pricing and market access. "We are seeing a mix of scenario planning type of work given the uncertainty and a continuation of business as usual on the ground for now."
Ian Spatz, a principal at public policy consultancy group Rock Creek Policy, says this is “massive confusion because we don't even know what is going to be proposed. People are trying to do scenario planning around what this future might look like."
Because the Medicare contracting and negotiation period for 2019 has already ended, the challenge of operationalizing any change will most likely occur in 2019 for the 2020 negotiation period.
"We just hope that whatever change evolves, it's done very thoughtfully and with a glide path to the new system that allows for adjustments to be made without abrupt disruption, especially for patients in terms of their benefit design and their out-of-pocket costs," says GlaxoSmithKline PLC's senior VP of managed markets and government affairs, Jamey Millar.
"There is the potential for a lot of unintended consequences because we have such an inter-related health care system," adds Millar.
What industry is waiting for is a policy proposal to come down from HHS, something that is anticipated shortly, particularly now that the US mid-term elections are over. Rebate reform was part of the Trump Administration's blueprint on drug pricing that was released in May this year, and HHS Secretary Alex Azar has talked about changing the US rebate system as a way of lowering drug costs by eliminating some of the incentives in the rebate system that lead to higher drug prices. (Also see "Trump Drug Pricing Plan Includes Part D Surprises, Challenges PBM Business Model" - Scrip, 11 May, 2018.)
The avenue that is being used to get there runs through HHS' Office of Inspector General (OIG), which is preparing a proposed rule that could remove the safe harbor that allows negotiated rebates protection from the anti-kickback statue. The rule is formally called, "Removal of Safe Harbor Protection for Rebates to Plans or PBMs Involving Prescription Pharmaceuticals and Creation of New Safe Harbor Protection." The proposed rule, which could have far reaching effects, was forwarded to the White House Office of Management and Budget for review in July, and the industry has been awaiting further news. (Also see "HHS Advancing Attack On Rebates With Proposal To Revoke Safe Harbor" - Pink Sheet, 24 Jul, 2018.)
The OIG has provided a safe harbor protecting discounts (including rebates) since the early 1990s, which has prevented the payment practices from being treated as a criminal offense under federal anti-kickback laws. Removing the safe harbor would change that unless it is replaced with something new, perhaps something that would encourage rebates to be passed directly to the consumer at point of sale, or for discounts to be taken in a different way.
In an Oct. 22 overview of the pharmaceuticals sector, Wolfe Research analyst Timothy Bernstein played down the policy. "Payers are generally rebuffing this and policymakers rightly fear that any material reduction in rebate streams may simply translate into higher insurance premiums," he says. "Where exactly this is headed is not clear, but we don't expect a wholesale change to the current system; instead, it will probably be smaller tweaks."
Upfront Discount Versus Back End Rebate
Industry has generally adopted positive talking points publicly when it comes to rebate reform, but that does not necessarily mean they want the elimination of rebates – or at least some system of discounting – altogether. Many industry insiders would prefer to see a new discount system that would replace the rebate model, while still allowing for confidential price negotiations between drug makers and payers. Eliminating rebates altogether, paving the way for a system under which drug makers would compete directly and publicly on list price, would be a big challenge to operationalize.
One big pharma market access specialist told In Vivo that there was a misconception around negotiations under the current system. “Nobody is saying that blind bidding shouldn't happen. What we are saying is that doing it through a tactic of rebating is not the best way to do it.” This expert adds that “a good replacement would be something like a net price negotiation for the medicine, which would still be that we provide concessions based on negotiations, but it would be upfront and it would be in a discount form. That's what is being discussed right now.”
AstraZeneca PLC president-US, Ruud Dobber, agrees: "I don't think in a country like the US, you move to a net realized price. It is still a hard negotiation you need to have with PBMs," he says. "I don't envision that if you are moving away from a rebate system that there is no negotiating."
The Pharmaceutical Research and Manufacturers of America (PhRMA) in comments on Trump's drug pricing blueprint advocated for an orderly transition to a system that focused on net prices of medicines and their value to patients. PhRMA supports reforms that will get rebates to patients at point-of-sale and discourage supply chain players from being paid based on list price as a first step.
GSK's Millar sounded open to eliminating rebates altogether as long as there is a slow transition. "We are aligned with the underlying premise of Secretary Azar's intent and that is that the rebate system has grown so significantly that it is distorting a naturally functioning marketplace. We would prefer that any remuneration to health plans or payers would be delinked from list price. If that ends up being the complete removal of the rebate system, then we think that's right,” he explains.
A new discount system would be less transformational, but advocates say it would have benefits over the current system. It would help the government and other stakeholders better track the flow of money through the system, even if drug pricing might not necessarily become more transparent to the patient. Information would be more transparent to other stakeholders in the system. Under the current rebate system, it is not clear who keeps what portion of the rebate and how the savings are directed.
As ZS' Deutsch explains, "It's not all that different from a rebate, but you have to figure out then exactly how the flow of money works."
Harvard Medical School professor of health economics, Richard Frank, agrees: "The current system makes it too easy for bad things to happen and part of the reason insurers haven't stepped in for the most part is that they can't see what's going on. They don't track it carefully."
The upfront discount would also eliminate the incentives for high list prices/high rebates that has evolved under the current system, which the industry says is driven partly by the administrative fees PBMs collect as a percentage of the rebate.
A discount taken upfront would also flow through the system immediately and reach the patient. Savings could be realized for those who pay out-of-pocket, which is different to the current system. With a rebate, based on utilization, the rebate is paid directly to the PBM or the health plan after they accrue with a lag time.
The Bid To Keep Blind Bidding
Some health economics experts agree that negotiations – and particularly confidential negotiations that are kept out of public view – are an important element to keeping drug costs down. "It's not a good idea to just eliminate [the rebates] without replacing it with some other way of giving discounts," says Harvard Medical School's Frank. "And, there are advantages for the discounts not being public."
The thinking is that health plans have more bargaining power when drug makers do not have to publicize how much of a discount they are giving to a certain partner.
"It's almost like common sense," says Rock Creek Policy's Spatz. "If you give very deep discounts to someone because you have to, you are now going to be [thinking] everyone else is going to see that price and demand that price. They are going to know I gave it to someone else, so I'm going to be very careful about the kind of discount I do give."
But some stakeholders disagree and would prefer to see open price competition.
"Looking at other [categories] where products are able to compete, without these types of distortions, prices do come down," says Sean Karbowicz, the founder and general manager of MedSavvy, which develops report-card style grades for patients to evaluate drugs and cost information. MedSavvy is owned by Cambia Health, a non-profit company that also offers health insurance and pharmacy benefit services. Changing the back-end rebate to an upfront discount would be more like a "tweak," he adds. "I have a hard time understanding how that is going to inject competition, increase quality, and lower prices for consumers over all."
Memorial Sloan Kettering's Bach concurs: "All of the economic theory on this that suggests confidentiality achieves lower prices focuses on highly competitive markets with infinite numbers of suppliers and purchasers. It's essentially irrelevant to this monopoly/monopsony trade off."
Buying Market Access
As much as pharma is eager to change the drug pricing dialogue and paint the middlemen as the culprits who take savings out of the US health care system, drug makers have also leveraged the current rebate system to their advantage at times. Rebates are a powerful tool industry relies on to secure favorable formulary access for drugs. That presents drawbacks and advantages depending upon the position of the drug in the market. The current system favors mature high-volume drugs, which can deliver a bigger rebate because of the sheer volume, regardless of whether the drug is priced lower or the percentage of the rebate is higher.
This has become a growing issue in competitive drug categories where high-volume mature brands rule the formulary no matter how big of a discount a newer drug enters the market with. AbbVie Inc.'s Humira (adalimumab), for example, is a drug that comes up frequently in discussions about the "rebate wall" as it is referred to. Humira, with its big volumes, is a winner under the current system.
There are winners and losers across the pharma industry, with mature blockbusters blocking out newer medicines on formularies – depending on the category. As Pfizer CEO Ian Read pointed out during the company's second quarter sales and earnings call, the elimination of rebates could be helpful to new launches. He highlighted the rheumatoid arthritis drug Xeljanz (tofacitinib) as an example of a drug that would have had a stronger launch in a system without rebates. (Also see "Pfizer's CEO Is Bullish On Rebate Changes That Could Power New Launches " - Scrip, 31 Jul, 2018.)
The same scenario is playing out to some extent with biosimilars in the US, where high-volume brand drugs are able to retain strong market access by increasing rebates to defend against new biosimilar entries, which have limited volume at launch.
"Manufacturers will regularly offer larger rebates if they get to be covered in a preferred position with fewer competitors at that same level," says ZS' Deutsch. It has created something of a conundrum in the industry, which can benefit from the system or be at a big disadvantage, depending on the drug in question.
As MedSavvy's Karbowicz explains, "Payers can be locked into certain arrangements and basically maintaining the current status quo in the marketplace because they simply aren't able to forgo the rebate. It would be too impactful for them." He adds, "When you have out-sized representation of use by one or two products and then the other four to six products have very low market share because they have been suppressed unnaturally, then the payers seem to be locked in at that point.”
Eliminating rebates could be interesting when it comes to shaking up those long-standing commercial incentives in the market and perhaps leveling the playing field to some extent for drugs to compete more on price and quality over volume.
The upfront discount proposal would not alleviate all of those market access issues, but it would be a step in the right direction, Bach says. "It wouldn’t necessarily level the playing field, but it is still more normal market dynamics," he notes. "In normal markets you get more market share if your product is just as good as the other product if your product costs less."
From Public To Private
Any policy that does come down from HHS would relate only to government contracts and drug buying, not the private insurance segment. But many industry watchers expect payers will adopt similar systems across their businesses, if not immediately then over the long-term.
"The private market has always followed Medicare when it comes to payment reforms," highlights Spatz. "Two separate systems just wouldn't be sustainable in a marketplace where most payers are involved in both products."
Harvard's Frank also agrees the public policies will impact private contracts over time. "When you start getting that big piece of the book of business moving in a certain direction, then you start thinking am I going to have two or three different systems running or am I going to try to make it all fall under one system," he says.
Whatever the changes are, it will certainly have a widespread impact that will reverberate through the drug distribution system. For now, though, it is watch and wait.