Abolishing Drug Rebates Will Raise Costs for Seniors and Taxpayers

Abolishing Drug Rebates Will Raise Costs for Seniors and Taxpayers
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President Trump needs a win on health care, and prescription drug costs are in the crosshairs. He issued an executive order to eliminate drug rebates paid to Medicare Part D plans, claiming that this would save seniors billions of dollars. To ensure that costs won’t pop up elsewhere, the order directs Health and Human Services (HHS) Secretary Alex Azar to confirm that premiums, out-of-pocket costs, and federal spending would not increase.

That will be difficult to pull off. Two years ago, actuaries from the Centers for Medicare and Medicaid Services (CMS) took a hard look at the rebate ban. They estimated that seniors would pay less for their prescriptions but both Part D premiums and federal spending would increase by billions of dollars. That analysis is likely to stand. The executive order creates a conflict between the aspirations of the President’s policy and the realities of the market.

Pharmaceutical manufacturers pay billions of dollars annually in rebates to pharmacy benefits managers (PBMs). The Altarum Institute estimates that PBMs received $89 billion in rebates in 2016, including $31 billion from negotiations on behalf of Medicare Part D plans.

Manufacturers are willing to pay rebates to obtain favorable placement on drug formularies, which translates into larger sales. Generic drugs, for example, are often on the lowest formulary tier requiring low fixed-dollar copayments. Branded drugs on higher tiers typically require beneficiaries to pay an increasing percentage of the drug’s list price, rather than the lower price net of the rebate paid by the Part D plan.

The administration argues that banning rebates to PBMs would cause drug manufacturers to voluntarily discount list prices. According to the executive order, many patients would save “hundreds or thousands of dollars a year.”

This scheme fails on three counts. First, there is no reason to think manufacturers will continue to offer the same discounts once government changes the rules. Rebates tied to sales targets would shrink since there is no guarantee that the targets will be met. Moreover, the policy change opens the door to industry-wide negotiations, giving manufacturers an opportunity to capture more revenue than in the past. The actuaries assume that 15 percent of current rebates would be kept by manufacturers.

Second, list prices will remain high. Lowering list prices affects the entire market for prescription drugs, not just Part D plans. Manufacturers can retain their ability to negotiate with private insurers by offering “chargeback” discounts — a payment to the pharmacy equal to the negotiated discount. The actuaries assume that only 25 percent of the rebates remaining under the new system will be used to lower list prices. Given the strong incentive to retain high list prices and the ability to provide rebates through an alternative mechanism, that might be optimistic. The Congressional Budget Office (CBO) assumes that all rebates would operate through chargebacks, with no reduction in list prices.

Third, the loss of rebate revenue will drive up premiums for Part D plans. According to the President’s executive order, “the middlemen collect large ‘rebate” checks.” PBMs negotiate substantial rebates, but they don’t keep the money. The Government Accountability Office found that PBMs negotiated $18 billion in rebates for Part D plans, but kept only $74 million — or 0.4 percent. The loss of those funds would lead to higher-than-expected premiums in future years.

The bottom line from the CMS actuaries: outlawing drug rebates would raise premiums for Medicare beneficiaries by $58 billion over 10 years. That increase would be offset by $83 billion in savings from reduced cost sharing.  Federal spending would increase by $196 billion.

The actuaries’ analysis supports only one of the President’s goals — lower out-of-pocket costs for beneficiaries. Other studies also find that the rebate ban fails to satisfy the policy’s objectives. CBO determined the plan would cost the federal government $177 billion over nine years, largely from increases in the government's share in the cost of premiums. Milliman found that tight restrictions on formularies and aggressive bargaining would raise premiums but lower federal spending and overall costs to beneficiaries. Wakely estimated higher premiums with reduced out-of-pocket costs for beneficiaries.

The proposed rule is teed up and ready to go. The department’s own actuaries provide evidence that the policy is a step in the wrong direction. Can Secretary Azar credibly claim that the rebate ban will not result in higher costs for seniors and taxpayers?   

Joseph Antos is the Wilson H. Taylor Resident Scholar in Health Care and Retirement Policy at the American Enterprise Institute.

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