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Morningstar | HHS Proposes Changes to Drug Rebating System; PBM Outlook Most at Risk

The Department of Health and Human Services proposed a rule Jan. 31 that aims to untangle the opaque pricing and incentive schemes that exist under the current rebating system for prescription drugs. The rule attempts to force the pass-through of drug manufacturer discounts to plan beneficiaries at the point of sale by expressly excluding from safe-harbor provisions of the antikickback statute the discounts that are paid to Medicare Part D or Medicaid managed-care organizations. The net effect on pharmacy benefit manager and MCO economics should theoretically be minimal at face value, as rebates in government-sponsored plans are already passed through at 100% in one way or another. We think the bigger risk is from potential spillover into the private market.

Today, the bulk of rebates throughout the system are used to buy down plan premiums. This lowers monthly payments at the expense of higher co-insurance requirements for members as cost-sharing arrangements are typically struck against a manufacturer's gross, not net, price. The alternative being proposed by HHS is to force plans to apply rebates at the counter, lowering out-of-pocket requirements for beneficiaries. The trade-off is higher monthly premiums.

We expect the PBM industry to be the loudest critic of this policy. A transition to a rebateless system would be difficult and uncertain, with many unintended consequences associated with replacing a nationwide pricing system. As HHS gathers comments from industry and other stakeholders over the coming months, some of the perceived pitfalls that could affect various links in the supply chain are likely to become more clear. For now, we don't intend to change our projections or fair value estimates for the companies we cover as a result of this proposal, but we'll be watching its progression closely to better determine its potential reach.

The government's math lines up with what many of the companies in the space have been saying following a request for information on the topic by the Centers for Medicare & Medicaid Services in late 2017. UnitedHealth has been proactive in providing point-of-sale arrangements to its fully insured members, but CVS had seen little interest in its point-of-sale Part D offering, given the sticker shock of higher premiums. Express Scripts has suggested that lower pricing for beneficiaries would be more than offset by higher premiums and increased federal subsidy payments--a conclusion the government ultimately seems to agree with. The department's initial goal is to implement this change effective Jan. 1, 2020, but we think this timeline is probably too optimistic.

A policy change like this would only benefit a minority of the sickest, highest-cost patients. According to HHS, only 20% of beneficiaries enrolled in Part D would see a net reduction in total drug costs between 2020 and 2029. Nearly 50% of the population would probably see premium increases greater than any savings generated at the pharmacy counter, but the aggregate cost to beneficiaries in the program as a whole would decline over the period. The remaining 30% receive coverage through the low-income subsidy program and probably wouldn’t see much change either way.

While individuals would see an overall benefit, aggregate spending could actually increase over the next decade due to higher outlays by the federal government, according to the proposal. The increase in direct subsidy payments alongside higher per-member premiums would probably surpass the savings from lower reinsurance spending during a beneficiary's catastrophic phase of coverage and lower cost-sharing requirements to those with the low-income subsidy. This conclusion is backed by scenario analyses compiled by both HHS and CMS.

PBMs face the most risk under this proposal for two key reasons, in our view. First, adjusting what is acceptable under safe harbor creates inherent legal risk in the operations of those affected. Additionally, HHS explicitly references longstanding policy that disallows any price reductions offered to other payers that are not available to Medicare or Medicaid, which may hamstring the effectiveness of a PBM's formulary tiering. The potential for this policy to open the door to changes in the commercial market seems relatively straightforward as a result, but HHS intends to defer to Congress' regulatory authority as it relates to private insurance. We'll have to wait to see how PBMs intend to step around this language or await any further inquiry from congressional committees, but the path toward more wide-ranging changes seems relatively clear, should the proposal be implemented as written.

Second, along with changing what types of discounts are allowable in the industry, the rule intends to exclude any nonrebate PBM service fees tied to list price or volume metrics from the safe-harbor provision. HHS would expressly permit flat-fee arrangements in an attempt to better align incentives among plan sponsors, PBMs, and drug manufacturers. The potential magnitude of this change is unclear, but we think it'd be negative to PBM profitability.